The March 2023 bank run on Credit Suisse (CS) has received much attention. As a result of this bank run, the Swiss banking regulator (FINMA) pushed for the merger of CS with UBS, another large Swiss bank, thus creating one of the biggest banking unions in history. The demise of CS shook faith in a stable Swiss Confederation, often affectionately called “Helvetia.”
The emergency rescue deal engineered by the Swiss regulator has come under intense criticism, much of it focused on the decision to wipe out additional tier one convertible bonds (“AT1 bonds”) while preserving some value for the CS equity holders. Not surprisingly, AT1 bondholders have initiated legal proceedings against Swiss authorities, resulting in a high-profile litigation process following the merger. The Swiss government asserted that the bailout merger was a private transaction that had the potential to come at zero cost to the taxpayer. But has it achieved this goal? Alternatively, has there been a transfer of wealth from taxpayers to the stakeholders of the merged UBS/CS entity?
In a recent study, we investigated this deal, which marks the end of 167 years of proud Swiss banking history and follows a series of unprecedented scandals experienced by CS. First, we measure the wealth effects of this merger and find that it resulted in a significant increase in the combined stakeholder net wealth, totaling 22.8 billion US dollars. UBS stockholders’ and CS bondholders’ wealth appreciated by approximately 5.1 billion and 18.8 billion US dollars (“USD”), respectively. CS stockholders partially financed this wealth increase. They paid some of the bills, experiencing abnormal negative wealth effects of –1.1 billion USD. Moreover, AT1 bondholders shouldered a significant portion of the burden as FINMA wiped out their bonds with an approximate market value of 3.9 billion USD. Apparently, the net wealth increase of UBS stockholders and CS bondholders in the total amount of 22.8 billion USD must have had additional sources. We argue that the unexplained wealth increase is likely rooted in (i) bidder restrictions imposed by the Swiss National Bank (“SNB”) and FINMA, (ii) a co-insurance effect, and (iii) a “too-big-to-fail” effect associated with a wealth transfer from taxpayers to the stakeholders of the merged entity.
Government imposing bidder restrictions
Prior academic research indicates that the number of competing bidders in failed bank auctions positively influences the bids submitted. This research aligns with Roll’s well-known winner’s curse hypothesis, which suggests that the winning bidder in a bid auction of an object with an uncertain value tends to overestimate its unobservable value. It appears that restricting the number of bidders to just one (i.e., UBS) was unnecessary. Aside from BlackRock, which allegedly prepared a rival bid for CS, 23 global systemically important banks (G-SIBs) larger than UBS could have participated in an auction. Such an auction would likely have resulted in a higher transaction price for the equity of CS, minimizing the wealth transfer from CS to UBS shareholders. While we are uncertain why no other banks were invited to submit a bid for CS, prior empirical evidence suggests that political access and regulatory lobbying may have influenced this decision. Banks that engage in regulatory lobbying are more likely to win auctions on more favorable terms. While the industry-wide lack of liquidity may have created a situation in which no other bidders were willing to make an offer for CS short-term (the bailout merger took place during a period of industry-wide shocks, with Silicon Valley Bank and Signature Bank being closed shortly before the CS event), it seems that SNB and FINMA should not have been caught off guard by the CS crisis.
Bond spreads serve as warning signals for bank supervisors. They typically rise as early as six quarters before a bank failure, and this was also the case for CS, with numerous market prices indicating the approaching bank failure. For instance, the spread between AT1 bond prices of UBS and CS started to significantly widen in the first quarter of 2021 – nine quarters before the merger bailout – steadily increasing from approximately zero to over 20% by the end of the third quarter in 2022. Similarly, CS’s CDS spreads surpassed their 2007/2008 crisis levels in mid-2022, implying that FINMA and SNB could have prepared a well-thought-out resolution plan for the bank or facilitated a transaction. Moreover, it is publicly known from F-4 registrations that top-level representatives of CS, UBS, and the Swiss government engaged in active talks concerning M&A, contingency planning, and a potential merger of CS and UBS as early as December 2022. In the US, when a bank is on the verge of failing, the Federal Deposit Insurance Corporation (“FDIC”) typically allows only 90 days for the bank to take corrective actions, for example, recapitalization or voluntary merger negotiations with a competitor. Concurrently, the FDIC begins structuring the resolution process. Therefore, considering international bank resolution standards, the Swiss regulators had ample time to organize a multi-bidder process for a CS bailout merger.
The co-insurance effect
We observe positive bondholder wealth effects that align with previous research in principle. Prior studies found a significant co-insurance effect, showing that target bonds exhibit significantly higher returns when the target’s rating is below the acquirer’s or when the combination is anticipated to reduce target risk. This holds true for the UBS/CS merger. However, the effect of co-insurance is likely to be much smaller than what we observe in the present case and does not explain a 34.74% or 22.65 billion USD abnormal bondholder wealth increase. This wealth increase appears to be extraordinarily high. Therefore, we also consider the possibility of the effects of an injection of new money (equity), such as the AT-1 bond write-down. This write-down may represent the equivalent of an equity injection, resulting in co-insurance. According to prior research, US government interventions in the financial sector announced in 2008 resulted in a co-insurance effect relative to the value of new money (equity) invested by the government. Based on this research, one might thus expect a co-insurance effect from the write-down of AT1 bonds. However, we find that co-insurance from the acquirer and target rating differences, i.e., the reduction in the credit risk of CS, and from (indirect) new money injected (by writing down AT1 bonds) are likely to explain less than five billion USD of the abnormal 22.65 billion USD bondholder wealth increase, leaving us with a wealth transfer puzzle.
The “too-big-to-fail” effect
Certain financial institutions, particularly large banks, are deemed so crucial to the functioning of the economy that their failure could have severe systemic consequences. As a result, banks that are “too big to fail” (“TBTF”) may receive special treatment or support from the government and regulators to prevent their collapse. Prior research demonstrates that achieving TBTF status leads to abnormal returns for bondholders in merger situations. The bailout merger between UBS and CS resulted in a new bank that undeniably falls under the TBTF category, making it unlikely that CS bondholders will experience any defaults soon.
Our findings suggest that bond markets strongly believe in TBTF policies. We assess the TBTF cost indirectly by looking at changes in the financing costs for the Swiss government. The government has taken substantial risks to rescue CS, and its sovereign credit risk has been affected by doing so. We use CDS spreads to assess whether Switzerland’s sovereign credit risk has increased due to the merger bailout. Before the merger, Switzerland’s CDS spread hovered around eleven basis points, lower than that of neighboring countries such as Germany, the Netherlands, and Sweden, ranging from 13 to 15 basis points. However, we show that Switzerland’s CDS spread jumped from 11.16 basis points to 20.08 basis points and maintained this level until the following Friday of the first trading week after the bailout merger. Subsequently, it further increased to 25.01 basis points on the subsequent Monday. Throughout the 60-day period following the event, Switzerland’s CDS spread remained at an average of 20.4 basis points. These findings suggest that the merger bailout has had a discernible impact on Switzerland’s sovereign credit risk, as reflected by the significant jump in CDS spreads.
The elevated and sustained levels of the CDS spread indicate increased market perceptions of risk associated with Switzerland’s creditworthiness during and after the event. This impacts the pricing of bonds, increasing Switzerland’s future debt costs. To gauge this effect, we assume a persistent increase in the CDS spread and estimate the presumed present value of Switzerland’s increased cost of debt. We find that the capitalized value of the increase in Switzerland’s cost of debt amounts to between six and seven billion US dollars. Apparently, the state-orchestrated merger has come at a significant burden on Swiss taxpayers, while the stakeholders of the merged entity, especially the CS bondholders and UBS stockholders, have experienced substantial wealth increases.
Our study shows that the UBS-CS merger substantially impacted the wealth of the participating firms’ stockholders and bondholders. It created a net value of 22.8 bn USD, distributed to UBS stockholders (5.1 bn USD), CS stockholders (-1.1 bn USD), and CS bondholders (18.8 bn USD). On the other hand, taxpayers face increased TBTF costs. The observable increase in Switzerland’s cost of debt alone amounts to between six and seven billion US dollars. To this figure, one must add unobservable taxpayer costs, for example, expected future tax increases.
More than ten years after the Global Financial Crisis (“GFC”), with a banking system that is allegedly more resilient due to increased regulation, bank runs are back. As in the 2008 GFC (see Veronesi and Zingales), restoring confidence in the financial system has implied a massive transfer of resources from taxpayers to the banking sector. The UBS-CS emergency rescue deal example shows that the reforms adopted after the GFC are still insufficient for resolving systemically relevant banks. Helvetia’s gift seems surprisingly high, making us pause for thought about the efficiency of current banking regulation. In the case of CS, the failures of bank executives and supervisors to address severe management problems are the starting point for any policy discussion.
Pascal Böni is Professor of Practice in Finance and Chair of Finance and Private Markets at Tilburg School of Economics and Management at Tilburg University, The Netherlands.
Tim Kröncke is Professor of Finance and the Chair of Finance at the University of Neuchâtel, Switzerland.
Florin Vasvari is Professor of Accounting, Chair of the Accounting Faculty, and Academic Director of the Institute of Entrepreneurship and Private Capital at London Business School (LBS), UK.
This post was adapted from their paper, “The UBS-Credit Suisse Merger: Helvetia’s Gift,” available on SSRN.