The UBS-Credit Suisse Merger: Helvetia’s Gift

The March 2023 bank run on Credit Suisse (‘CS’) has received much attention. As a result of this bank run, the Swiss banking regulator (the Swiss Financial Market Supervisory Authority, or ‘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?

In a recent study, we investigate this deal, which marks the end of 167 years of proud Swiss banking history and follows a series of unprecedented scandals experienced by CS. The combined stakeholder net wealth increased by 22.8 billion USD, with UBS stockholders gaining 5.1 billion USD and CS bondholders gaining 18.8 billion USD. However, CS stockholders experienced negative wealth effects of -1.1 billion USD, and AT1 bondholders bore a significant burden as FINMA wiped out their bonds, totaling 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. The net wealth increase may be attributed to (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 leading to a wealth transfer from taxpayers to the stakeholders of the merged entity.

Government Imposing Bidder Restrictions

Prior academic research suggests that the number of competing bidders in failed bank auctions positively influences the bids submitted. It appears that restricting the number of bidders to just one (ie, UBS) was unnecessary. Aside from BlackRock, which allegedly prepared a rival bid for CS, there were 23 global systemically important banks (G-SIBs) larger than UBS that 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.

Bond spreads served as warning signals for bank supervisors, rising significantly as early as six quarters before the bank failure of CS. The spread between AT1 bond prices of UBS and CS started to widen from the first quarter of 2021, indicating the approaching bank failure. Despite these warning signs, regulators seemed unprepared for the CS crisis. It was publicly known that talks about mergers and contingency planning involving CS, UBS, and the Swiss government began as early as December 2022. In comparison, US regulators typically allow only 90 days for corrective actions when a bank is on the verge of failing, facilitating a structured resolution process.

Considering international bank resolution standards, it is suggested that Swiss regulators had sufficient time to organize a multi-bidder process for a CS bailout merger, potentially leading to better outcomes for stakeholders.

The Co-insurance Effect

The UBS/CS merger resulted in positive bondholder wealth effects, which align with prior research on the co-insurance effect. Co-insurance typically leads to higher returns for target bonds when the target's rating is below that of the acquirer or when the combination reduces target risk. However, in the present case, the observed wealth increase of 34.74% or 22.65 billion USD appears to be exceptionally high, and the co-insurance effect alone does not explain it. The study considers the possibility of an injection of new money (equity) through the AT-1 bond write-down, which may result in co-insurance. Although US government interventions in 2008 demonstrated a co-insurance effect relative to the value of new money invested, the write-down of AT1 bonds in this merger does not fully explain the substantial wealth increase. Thus, the co-insurance effect cannot fully explain the large abnormal wealth increase.

The ‘Too-Big-to-Fail’ Effect

Prior research shows that achieving ‘too-big-to-fail’ (TBTF) status leads to abnormal returns for bondholders in merger situations. The merger between UBS and CS has created a new bank that falls under the TBTF category, providing assurance to CS bondholders against potential defaults in the near future.

The study finds that bond markets strongly believe in TBTF policies and assesses the TBTF cost indirectly by examining changes in the financing costs for the Swiss government. The bailout merger had a discernible impact on Switzerland's sovereign credit risk, as evident from a significant jump in CDS spreads. The sustained elevated levels of the CDS spread indicate increased market perceptions of risk associated with Switzerland's creditworthiness during and after the event, leading to increased future cost of debt for the country.

The estimated capitalized value of Switzerland's increased cost of debt amounts to between 6 to 7 billion USD, indicating a significant burden on Swiss taxpayers due to the state-orchestrated merger.

Conclusion

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 to the financial system has implied a massive transfer of resources from taxpayers to the banking sector. The example of the UBS-CS emergency bailout shows that the reforms adopted after the GFC are still not capable of effectively resolving systemically important 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 a Professor of Practice in Finance and the Chair of Finance and Private Markets at Tilburg School of Economics and Management at Tilburg University, The Netherlands.

Tim Kröncke is a Professor of Finance and the Chair of Finance at the University of Neuchâtel, Switzerland.

Florin Vasvari is a Professor of Accounting and the Chair of the Accounting Faculty as well as the Academic Director of the Institute of Entrepreneurship and Private Capital at London Business School (LBS), UK.