Another bank down. How many more to go?
Last week, it was Silicon Valley and Signature Banks down, with an almost-gone to First Republic.
And now, too big to fail Credit Suisse almost failed this past weekend. Instead, fellow Swiss bank UBS is buying its former rival for negative $14 billion. Say what?
Yes, UBS is paying $3.2 billion to Credit Suisse shareholders, but only because Swiss banking regulators are eliminating $17.2 billion of the bank’s liabilities, leaving its bondholders with nothing but worthless paper.
Global regulators have determined that 30 megabanks – Global Systemically Important Banks, as they’re known – are too big to fail.
You know the usual suspects – Citibank, JPMorgan Chase, Barclay’s, Deutsche, UBS and the like.
Because of their designation as G-SIB, they operate under stricter capital standards and regulatory scrutiny than their smaller peers.
Nevertheless, with Credit Suisse propped up as Exhibit #1, they can still end up being worth a negative amount of money.
Emily Peck and Matt Phillips write today that in the normal world of mergers and acquisitions, that wouldn’t be possible.
“Bondholders are senior to shareholders, meaning that they get paid first, and only once they’re paid out in full do shareholders get anything.
“In the real world of rescuing a too-big-to-fail bank, however, such niceties can end up being sacrificed for the sake of managing to get a deal done.”
Wow! Turns out that senior UBS management and its major shareholders didn’t particularly want to buy Credit Suisse, while Credit Suisse management and shareholders reportedly didn’t want to be caught holding an empty bag.
It’s unlikely this deal would have gotten shareholder approval – from either side – which is one reason why Swiss authorities changed the law to permit the deal.
The interests of international financial stability ended up overriding the interests of shareholders. Justice prevails, right? Well, kinda or something like that.
Swiss regulators sort of forced the two banks together, threw Credit Suisse shareholders a $3.2 billion bone, and zeroed out a bunch of junior contingent convertible bonds that are supposed to convert into equity when a bank gets into trouble.
Credit Suisse shareholders ended up losing about $17 billion in equity value over the past year. At that point, Peck and Phillips point out, there wasn’t another $17 billion left to lose, “so the next tier up had to take a hit.”
In the interests of expedience, it was easier to just zero out the convertible bonds and leave shareholders with $3.2 billion than it would have been to convert them to equity and then pay them out at pennies on the dollar.
Apparently, just finding a conversion price would have been incredibly a big burden.
Bank balance sheets comprise one pile of assets offsetting another pile of liabilities. Shareholders only own the slice in between, which in the case of Credit Suisse was nothing.
When a bank is failing, they generally have no say in what happens to it. The convertible bondholders have more reason to feel betrayed. But they were going to lose most of their money anyway — and besides, convertible bonds are supposed to behave like equity in a crisis.
In that sense, it shouldn’t come as a complete surprise that they’ve been wiped out to keep Credit Suisse alive – or now embedded as part of a new UBS.
Meanwhile…
A lot of news competing for our attention – financial, political and otherwise – as a new week unfolds:
But here’s the story I want to highlight today:
David Hollerith reports today that depositors pulled another $126 billion out of U.S. banks in the week ending March 22nd – primarily from the nation's largest institutions.
The largest 25 banks in the U.S. by asset size lost $90 billion (on a seasonally adjusted basis), according to the Fed.
Smaller banks, which suffered a huge run the previous week as regional lenders Silicon Valley and Signature Banks were going bust, were able to stabilize their assets, gaining back $6 billion.
Total industry deposits fell to $17.3 trillion, down 4.4% from the same week a year ago – the lowest level since July 2021.
Hollerith says the new numbers reinforce some trends that were already in place.
For example, deposits had been falling at all banks before the Silicon Valley failure in the first two months of 2023. Deposits for all banks were also down 5% annually in last year’s 4th quarter.
Many observers attribute this systemic shift to pressure being applied by the Fed’s aggressive (obsessive?) campaign to bring down inflation closer to its 2% target.
During the early part of the pandemic, when interest rates were virtually zero, banks were drenched in deposits.
When the Fed started raising those rates last March to cool the economy, customers who had deposits began seeking out places with higher yields.
The first year-over-year deposit decline for all banks came in the 2nd quarter of 2022.
As we’ve pointed out, some of this money has been flowing to money market funds, which are offering investors a rate of return in the range of 4-5%.
Since January 1st, investors have poured over $500 billion into those funds, according to too big to fail Bank of America.
That’s the highest quarterly inflow since a peak earlier in the pandemic, and another $60 billion was added to these funds in the past week.
Government and banking officials have been working to prevent massive deposit outflows in the aftermath of last month’s bank failures.
Federal regulators pledged to cover all depositors at both banks they seized, hoping that would calm any panic, and also promised to help other regional banks if needed.
Eleven megabanks also decided to provide another troubled regional lender, First Republic, with $30 billion in uninsured deposits to stabilize its dire situation.
The challenge that outflowing deposits create for all banks is that if they raise rates on their deposits to keep or attract customers, their profits fall, making shareholders wary.
But if they lose too many customers, as SVB did, they lose critical assets and may have to sell assets, like long-term Treasuries, at a loss to cover withdrawals.
SVB customers withdrew $42 billion in one day, leaving the bank with a negative cash balance of $958 million, forcing regulators to seize the bank, which was the 16th largest in the U.S.