Banking stocks and bonds fell sharply on Monday as the hit to investors from UBS Group's state-backed takeover of Credit Suisse fanned worries about the health of the global banking sector.
UBS Group AG (UBSG.S) shares sank by 7 percent amid concerns among investors about the long-term benefits of the deal and the outlook for banks in Switzerland, a country once seen a paragon of sound banking.
In a package engineered by Swiss regulators on Sunday, UBS will pay 3 billion Swiss francs ($3.23 billion) for 167-year-old Credit Suisse Group AG (CSGN.S) and assume up to $5.4 billion in losses.
Investor focus has now shifted to the massive blow some Credit Suisse bondholders will take, adding to anxiety about other banking sector risks including contagion and the fragile state of US regional lenders.
European bank shares slumped, with an index of leading lenders (.SX7P) down 2.3 percent. German banking giants Deutsche Bank (DBKGn.DE) and Commerzbank dropped 3.1 percent and 3.3 percent respectively, while France's BNP Paribas (BNPP.PA) fell 3.7 percent.
Euro zone banking supervisors tried to stop a rout in the market for convertible bank bonds by saying owners of this type of debt would only suffer losses after shareholders have been wiped out - unlike at Credit Suisse, whose main regulators are outside of the currency bloc.
"A week can be a very long time in financial markets. UBS acquiring Credit Suisse for 3 billion francs a week ago would have seemed like a terrific deal. Now the position is less clear," said Johann Scholtz, analyst at Morningstar, adding the acquisition should ultimately benefit UBS.
The cost of insuring exposure to the debt of the continent's lenders rose, with UBS's credit default swap widening to 153 basis points from 117 bps, S&P Global Market Intelligence data showed.
CO-ORDINATED ACTION
Investors appeared to have shrugged off promises by top central banks over the weekend to provide dollar liquidity to stabilize the financial system.
In a global response not seen since the height of the pandemic, the US Federal Reserve said it had joined central banks in Canada, England, Japan, the EU and Switzerland in a co-ordinated action to enhance market liquidity.
The European Central Bank vowed to support euro zone banks with loans if needed.
The banking sector lurched into crisis earlier in March with the failure of US lenders Silicon Valley Bank (SVB) and Signature Bank (SBNY.O) before ensnaring its biggest name yet in Credit Suisse.
The Fed's relentless rate hikes to quash inflation were seen as a trigger for the collapse of SVB and Signature. Traders have now increased their bets that the central bank will pause its hiking cycle on Wednesday to try and ensure financial stability and stop the banking jitters snowballing into a bigger crisis.
US banking shares are still under pressure despite several large banks depositing $30 billion into First Republic Bank (FRC.N).
On Sunday, S&P Global downgraded First Republic's credit ratings deeper into junk, saying the deposit infusion may not solve its liquidity problems. Its shares were sharply lower again in premarket dealing on Monday.
RECALIBRATING RISK
The shotgun Swiss banking marriage is backed by a massive government guarantee, helping prevent what would have been one of the largest banking collapses since the fall of Lehman Brothers in 2008.
The Swiss regulator also decided that Credit Suisse's additional tier-1 (AT1) bonds with a notional value of $17 billion will be valued at zero, angering some holders of the debt who thought they would be better protected than shareholders.
AT1 bonds - a $275 billion sector also known as "contingent convertibles" or "CoCo" bonds - can be converted into equity or written off if a bank’s capital level falls below a certain threshold.
Prices of AT1 bonds issued by other European banks such as Deutsche Bank , HSBC , UBS and BNP Paribas dropped 10-12 cents, data from Tradeweb showed.
"There are certain rules that everybody thinks are being followed, and there's been this one very puzzling treatment of these bonds," Allianz advisor Mohamed El-Erian told Britain's Sky News.
"People are recalibrating what they thought the risk was," he said.
QUESTIONS FOR UBS
The deal to buy Credit Suisse will make UBS Switzerland’s only global bank and the Swiss economy more dependent on a single lender.
On Monday, it appeared to be business as usual at Credit Suisse's major offices in Asia, but staff arriving at work in Hong Kong and Singapore fretted about retrenchments and retaining business.
Roger Nordmann, leader of the Social Democrats (SP) in the Swiss parliament, said the rescue deal creates enormous risk for Switzerland and UBS, and blamed Credit Suisse's leadership for the bank's failure.
"What has happened is terrible for the credibility of Switzerland," he said.