Credit Suisse Lays Bare UBS’s Chance and Challenge

A huge one-time profit at bondholders’ expense creates a necessary cushion against further losses

By guest author Stephen Wilmot from the Wall Street Journal.

April 24, 2023

Credit Suisse CS -5.34%decrease; red down pointing triangle is in terrible shape, but UBS UBS -4.67%decrease; red down pointing triangle is being well paid to nurse it to health. Bizarre quarterly results from the failed bank on Monday put fresh numbers on the risk-return bargain at the heart of Switzerland’s rescue merger.

On the face of it, Credit Suisse had probably its best-ever quarter, with pretax profit equivalent to roughly USD 14.4 billion. Stripping out one-time effects, though, Credit Suisse’s loss before tax swelled to about USD 1.5 billion, compared with USD 1.1 billion in the previous quarter, when the crisis of outflows that eventually sank the ship started.

The main reason for the difference is the controversial write-off of Credit Suisse’s USD 17 billion in AT1 capital notes by the Swiss financial regulator as part of last month’s deal, which is expected to close this quarter. Counting these subordinate bonds as capital, rather than liabilities the bank owes to creditors, prompted a matching accounting “write-up” that boosted profit.

It also transformed the balance sheet: As of March 31, Credit Suisse had a common equity tier 1 ratio—a customary measure of capital adequacy—of 20.3 %, up from 14.1 % three months earlier and far above industry norms.

The same dynamic was at play in the bank’s liquidity. The credit lifeline extended to the company by the Swiss National Bank increased the so-called liquidity coverage ratio, which compares the amount of high-quality assets banks have available for sale with asset flows, to 178 % for the quarter, up from 144  % in the previous period.

The company needed the extra liquidity because it is still losing assets: Outflows of deposits and assets totaled about USD 70 billion in the quarter, and as of April 24 they haven’t yet ended, its statement said. It needed the extra capital because those outflows are helping to push most of Credit Suisse’s business lines further into the red. Its flagship wealth management unit lost roughly USD 129 million in the quarter, compared with USD 119 in the prior three months and profit in the quarters before that.

The question for UBS stock investors is just how much capital will be absorbed by Credit Suisse’s losses over the coming quarters. It depends how quickly the company stabilizes asset flows and stops key rainmakers from getting poached by rivals and if it can wind down large chunks of its big investment bank without too much trouble.

Nobody can really know what kinds of costs this process will entail. Banking turnarounds following the 2008 crisis were infamously complex. Yet Credit Suisse’s historic first-quarter profit at bondholders’ expense gives UBS a huge buffer to work with.