March 27, 2023/Fitch Ratings

The takeover of Credit Suisse by UBS avoids a full-blown banking crisis with sizeable spillovers to Switzerland’s public finances, but highlights how the sector represents a contingent liability risk for the sovereign, Fitch Ratings says. The fiscal cost of the authorities’ intervention will depend on how far government guarantees to the banks are drawn on.
 
UBS’s CHF3 billion all-share acquisition of Credit Suisse was initiated by the Swiss financial regulator (FINMA), the Swiss National Bank (SNB), and the Swiss Federal Department of Finance. As well as its existing liquidity facilities, the SNB will give UBS and Credit Suisse access to a liquidity assistance loan for up to CHF100 billion (13% of 2022 GDP) that would have privileged creditor status in a bankruptcy. The SNB can grant Credit Suisse a liquidity assistance loan based on the public liquidity backstop (PLB) and backed by a federal default guarantee, also for up to CHF100 billion.
 
The federal government is providing a guarantee for up to CHF9 billion (1.2% of 2022 GDP) of potential losses from winding down a defined portfolio of “difficult-to-assess” assets, with UBS assuming the first CHF5 billion of losses.
 
Contingent liabilities associated with the very large banking sector are a long-standing feature of Fitch’s sovereign rating analysis of Switzerland. A record of outperformance against strict fiscal rules has enabled the sovereign to build up fiscal space, some of which is now being used to avoid a disorderly resolution of Credit Suisse.
 
How far the sharp rise in explicit guarantees to the financial sector will cause contingent liabilities to be realised on the sovereign balance sheet will depend on how effectively the merger is executed and how the new bank performs, as well as the extent of losses on the “difficult-to-assess” assets. Adding the combined value of the guaranteed SNB PLB facility and the government’s guarantee of potential losses to public debt would push Switzerland’s debt/GDP ratio to 41.6% from 26.8%, marginally above the current ‘AAA’ median (39.2% of GDP). At this level, Fitch’s Sovereign Rating Model would still produce a ‘AAA’ rating for Switzerland, all else equal.
 
However, a scenario in which the maximum guarantees were drawn on, which is not our base case, would imply that the merged bank were experiencing significant liquidity challenges – a situation that could reflect, or lead to, pressures on the sovereign rating. Assuming the merger proceeds as planned, contingent liabilities will be even more concentrated. Based on end-2021 data, the new entity will have assets worth about CHF1.8 trillion, equivalent to roughly half of total banking sector assets and 230% of GDP. Fitch placed UBS Group’s ‘A+’ Long-Term Issuer Default Rating (IDR) and the ‘AA-’ IDRs of UBS AG and UBS Switzerland AG on Rating Watch Negative and Credit Suisse Group’s ‘BBB’ Long-Term IDR on Rating Watch Evolving following the announcement of the transaction.
 
At our November 2022 sovereign rating review, we said that risks to the sovereign balance sheet and economy from Credit Suisse’s business model were minimised due to FINMA’s resolution framework that includes bail-in of the bank’s creditors and a spin-off of the domestic bank. Nevertheless, the UBS-Credit Suisse merger illustrates that regulatory intervention can be swift, and that authorities’ crisis management toolkits can broaden if a bank is deemed systemic.
 
The implications for the banking sector and the extent of any lasting reputational damage, which could weigh on the Swiss economy, will partly depend on how market participants react to some features of the government’s intervention, such as the decision not to consult UBS shareholders. Fully bailing-in Credit Suisse’s AT1 bondholders but not its shareholders is likely to affect the viability and cost of raising this type of hybrid debt, at least in the near term, for Swiss issuers. The Swiss banking system has strong buffers, with the Tier 1 ratio at 18.7% at end-3Q22, and a non-performing loan ratio of only 0.6% at end-3Q22.
 
The Swiss franc’s status as a global reserve currency is an underlying sovereign rating strength, underpinning demand for franc-denominated assets and hence very favourable financing costs. Reserve-currency status contributes 0.6 notches to Switzerland’s SRM rating outcome. Evidence that recent events were negatively affecting this status, for example through a tangible reduction in the franc’s share of global reserves, could be negative for the sovereign rating.