A lot has been going on in global banking. In just the past ten days, we've seen the U.S. regulators step in and backstop depositors at two failing banks, Silicon Valley Bank and Signature Bank, the Swiss government step in to shore up Credit Suisse (CS) which was subsequently bought by UBS (UBSG) for US$3.2 billion, and the U.S. regulators work with 11 banks – including wide-moat rated JPMorgan Chase (JPM) – to shore up First Republic Bank (FRB) by placing US$30 billion of their own funds in deposits at the struggling institution.
DBRS Morningstar believes that these events – especially the U.S. bank failures – have resulted in significant volatility in the banking sector, including in Canada. However, they say they are idiosyncratic and not representative of the Canadian banking sector. At this point, DBRS Morningstar does not think the failure of SVB will have a significant adverse impact on Canadian banks.
Canadian Banks Feeling Immediate Aftershocks, But Investors Shouldn’t Worry
“Although U.S. regulators quickly took remedial actions intended to stem the contagion and calm market jitters, investors remain nervous of significant unrealized losses sitting on bank balance sheets. Indeed, the Big Six Canadian banks lost approximately $57 billion (or 9.2%) in market capitalization over the past two weeks,” authors Carl De Souza, Josh Veenkamp, and Michael Driscoll write.
The Canadian banking sector is concentrated around the systemically important Big Six Banks – Canadian Imperial Bank of Commerce (CM), The Toronto Dominion Bank (TD), Bank of Nova Scotia (BNS), Royal Bank of Canada (RY), Bank of Montreal (BMO) and National Bank of Canada (NA) – all of which are diversified across geographies, business lines, and industries.
“As a result, the risk of a bank run is somewhat lower in Canada compared with the U.S. because there are significantly fewer banks in Canada (85 Canada Deposit and Insurance Corporation (CDIC) member institutions compared with more than 4,700 Federal Deposit Insurance Corporation-insured institutions). The Canadian Banks have a relatively broad base of clients, particularly the Big Six, and do not have highly concentrated exposures to riskier industries susceptible to boom and bust periods such as technology, or even oil and gas,” the authors write.
Canadian banks in their rating coverage universe generally have lower exposure to fixed-income securities, the authors write, and other structural factors that should help them survive: “Diversified and stable funding, sufficient liquidity, prudent risk/liquidity management, and capital buffers that should enable them to navigate current market turbulence.” The authors will continue to closely monitor liquidity positions and exposure to fixed-income securities for banks in our rated Canadian bank universe, with an eye on margins. “Credit default spreads in the banking sector have been widening and the volatility will likely result in higher funding costs that adversely impact profitability,” they write.
What Happened to Credit Suisse?
Late last night, UBS Group (UBS) acquired Credit Suisse (CS) in a deal in which Credit Suisse shareholders will receive one UBS share for every 22.48 ordinary shares. Based on March 17 closing prices, the transaction values Credit Suisse shares at 0.76 Swiss francs, or 59% below its closing price of 1.86 Swiss francs.
However, as Morningstar France editor Jocelyn Jovene points out, the wording of the deal has raised eyebrows, as Credit Suisse describes it as a merger, while UBS describes it as an acquisition.
"Credit Suisse and UBS have reached a merger agreement on Sunday, following the intervention of the Swiss Federal Department of Finance, the Swiss National Bank and the Financial Markets Supervisory Authority (FNIMA)", Credit Suisse said in a statement. "UBS will be the surviving entity," it added. In a separate press release, UBS announces its intention to "acquire Credit Suisse", with the combined creating an asset management giant with more than 5,000 billion dollars of assets under management, of which over $3.4 trillion is in wealth management. UBS Chairman Colm Kelleher said: “This acquisition is attractive for UBS shareholders but let us be clear, as far as Credit Suisse is concerned, this is an emergency rescue.”
“Credit Suisse’s descent into banking hell follows a long string of difficulties in internal control and governance – despite solid positions in wealth management. Last week the nightmare suddenly accelerated amid jitters in the US after the collapse of Silicon Valley Bank in the U.S.,” Jovene points out.
UBS said the group will take over the activities of Credit Suisse in wealth management, asset management and its universal banking activity in Switzerland. The corporate and investment banking activities, long a source of difficulty for the Swiss bank, seem destined to disappear or be heavily restructured.
Will Credit Suisse Impact Canadian Banks?
According to Morningstar banking analyst Johann Scholtz, UBS will benefit from the takeover in the long run. “UBS is in a much better position to execute a radical restructuring of Credit Suisse's business than Credit Suisse was”, he said. “We calculate that UBS’s 2027 cost savings target would reduce Credit Suisse's 2022 adjusted operating expenses by around 60%. The restructuring will come with material costs, but UBS is better placed than Credit Suisse to absorb this. The challenge for UBS will be to keep revenue attrition to a minimum during the restructuring period.”
“Credit Suisse has been a known problem for over a decade, and while the bank had an international reach, rumours suggest that counterparties had been reducing their exposure to the bank over time. Combined with the overall support of the Swiss regulators and UBS, we wouldn't expect a large effect on the Canadian banking sector,” said Eric Compton, Morningstar analyst covering the big six Canadian Banks. He added that Canada's oligopolistic banking system should remain stable, and he imagines the risks of deposit flight in the Canadian banking system are also low.
“Canada's main financial system issue will be how the mortgage market plays out, the effect on consumers, and how this impacts the banks and the economy,” Compton said.
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