Credit Suisse: Five Key Takeaways CreditSuisse:FiveKeyTakeaways

Swiss authorities and central banks are making bold proclamations about a return to stability following UBS’s ‘emergency rescue’ of 167-year-old Credit Suisse. Market nerves have settled for now, but what potentially lies ahead? Here are five key takeaways in the aftermath of this weekend’s ‘fire sale’ of the Swiss banking giant.

1. This is not 2008

“Regardless of the initial negative market reaction today, it is worth remembering that the fallout would have been much worse if authorities had not dealt with Credit Suisse so swiftly.” Dr Sushil Wadhwani, CIO PGIM Wadhwani

Days after Silicon Valley Bank’s collapse, Credit Suisse’s plight ramped up fears of a wider financial emergency. Hesitation erodes confidence, and the Swiss National Bank were quick to avoid a repeat of the lessons learned from delayed decision making during 2007-2008. 

Meanwhile, post 2008 European regulations ensure that banks have stringent stress testing frameworks and greater capital in place in order to absorb losses. The avoidance of the collapse of a systemically connected major bank can be seen as a positive, as is the supportive involvement of the ‘home’ Government, regulators, and central banks in the main other jurisdictions where Credit Suisse and UBS operate. 

2. A reminder that Additional Tier 1 bonds are risky

“AT1’s being written off in full was reasonably draconian” Ed Farley, Head of European Investment Grade Corporate Bond Team, PGIM Fixed Income

One reason for the initial adverse market reaction was the surprising decision to wipe out AT1 bonds even though holders of CS equities received a non-zero amount. It remains to be seen as to whether it was a mistake to leave AT1 owners fully out in the cold, as investors question whether their holdings could be worthless in the event of another bank collapse. They have certainly had a painful reminder of the risk associated with the high-yield instrument, and any other subordinated bonds. The ECB has already reacted to reassure these markets, indicating that any resolution involving the Euro Area banks will involve shareholders bearing losses ahead of AT1 holders, but uncertainty may remain.

3. The authorities will want to separate the fight against inflation from financial stability considerations

“Prompt action of the kind taken to deal with Credit Suisse should be interpreted as allowing monetary policymakers to stick to their knitting.” Dr Sushil Wadhwani, CIO, PGIM Wadhwani

“Having started on its rate hiking cycle earlier than a number of other central banks puts the BOE in an advantageous position at this juncture.  The Bank had already signalled the possibility of a pause in rate rises at its previous meeting, and early signs that inflationary pressure is coming off the boil should give the central bank sufficient comfort to pause its rate hiking cycle without giving the appearance that it is stepping back from delivering on the inflation target.  Such a move would have the added advantage of offering some relief to markets at this time given recent concerns in pockets of the banking sector.” Katherine Neiss, Chief European Economist, PGIM Fixed Income

The ECB went ahead with their 50bp hike last week and pointed to other tools to deal with financial stability. Whilst monetary policymakers fully recognise that ongoing stressors in the banking sector are likely to lead to a tightening of lending standards and slow the economy, they cannot be seen to be procrastinating on elevated inflation. Early signs that inflationary pressure is coming off the boil should give the central bank sufficient comfort to pause its rate hiking cycle without giving the appearance that it is stepping back from delivering on the inflation target. 

4. The situation is still evolving

“Keep your eye on the screens; the Fed’s response will tell you not just about its thoughts on the US financial system, but more importantly what it’s thinking about contagion.” Michael Dicks, Chief Economist and Deputy Head of Research, PGIM Wadhwani

We will learn over the coming days how far the Fed is willing to go. Does it want to keep separation in people’s minds and remind them that it still has significant situation to deal with at home?

Of course, monetary tightening cycles almost always throw up surprises in terms of previously underappreciated vulnerabilities. Markets are now obviously more vulnerable to future shocks in the wake of Credit Suisse. If debt limit discussions in the US go badly, the impact on the global economy and markets could be much greater than in more ‘normal’ times. 

5. No obvious European next shoe to drop at this stage

“Credit Suisse has been the sick man of Europe for a long time and had decoupled from the rest of the European banking sector. Deutsche Bank did what Credit Suisse could not; it turned a corner and is no longer in hospital.” Ed Farley, Head of European Investment Grade Corporate Bond Team, PGIM Fixed Income

Credit Suisse has seen plenty of turmoil in recent years, working through a number of restructurings, management reshuffles and governance crises. It managed to withstand substantial outflows from its core wealth management business equivalent to the run on deposits that led to SVB’s downfall, but ultimately could not survive. The road to this outcome has been long, and whilst recent events have been concerning, they are not entirely surprising. 

CIO Pulse

“It is very sad we are losing Credit Suisse - one of the key players in the global banking industry - and I’m now increasingly concerned about the banking system as whole. The Credit Suisse debacle was a confidence issue amplified by SVB's insolvency. Further interest rates hikes will put more pressure on the banking system. At some point, Central Banks will need to decide whether they prefer to fight depression or inflation.” Grégoire Haenni, CIO of the pension fund of the state of Geneva (CPEG)

_{The views expressed by PGIM are not intended to constitute investment advice, were accurate at the time of recording and are subject to change. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. 2023-0059.}