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Swiss National Bank Is On To This "Swiss Banks Are So Great" Scam

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The Swiss National Bank is not particularly thrilled with the state of the Swiss Not-Quite-National Banks and wants them to do something about it:

The SNB is therefore of the view that both big banks should further expand their loss-absorbing capital. For UBS, this implies a continuation of its capital strengthening process; and for Credit Suisse, an acceleration of the process, with a marked increase during the current year. ... For Credit Suisse, given the low starting point and the risks in the environment, it is essential that it already substantially expand its loss-absorbing capital base during the current year. Apart from the planned reduction of risk, these improvements can also be achieved in other ways, such as by suspending dividend payments, or even by raising capital on the market through share issuance.

This was unwelcome news, and the banks' loss-absorbing capital absorbed some losses, with CS down 9.4% today. This may have come as some surprise to the SNB, which thought that its suggestions were actually shareholder-friendly, saying that it "is also in the banks’ own interest to strengthen their resilience, as a sound capital base constitutes a competitive advantage in the core business of wealth management." JPMorgan's Kian Abouhossein agrees, arguing in a report today that CS will improve capital by shrinking assets, mainly in the investment bank, and that:

Tier II FICC IBs such as CS need to shrink their operation consuming 69% of group capital, considering the IB is valued at zero. A release for equity valued at 1x is clearly earnings enhancing in our view. Hence, in respect to capital concern any measures taken by management in our view will be likely in shareholder friendly way by reducing RWAs rather than increasing share count.

So at least some people think that the big Swiss banks' forays into balance-sheet-intensive investment banking activities is misguided and it should be getting back to private wealth management, which never causes any problems. But those people seem to be in the minority, with shareholders overall reacting poorly to the possibility of dilution and/or asset-shedding.

The difference of opinion is not surprising since the SNB's report has sort of a contrarian vein running through it - the central bank is just not that impressed by what markets think about its charges:

Currently, the market considers the creditworthiness of both big banks to be above average compared to other international banks. ... Both Swiss big banks have good long-term credit ratings, despite both having experienced a downgrade compared to the previous year as part of a generally more cautious assessment of the banking sector. Their risk premia, measured in terms of their CDS premia and bond spreads, are some of the lowest among their international peers, although they are markedly higher than in 2007, before the onset of the financial crisis. ... However, without a strengthening of their capital base, this positive assessment remains fragile.

Having been raised on risk-neutral pricing, I'm always skeptical of people who say "the markets are wrong and here's why." (Obviously those people are often right, say 49% of the time, but there's plenty of time for me to find that out after the fact.) Here, though, there's good reason to trust the bank and distrust the market. For one thing, while it's not exactly CS & UBS's regulator, the SNB may have some more insight into how those banks risk-weight their assets than the market does - and it's not thrilled about it:

To transparently demonstrate their ongoing progress in risk reduction, they should calculate and disclose their risk-weighted assets not just according to internal models, but also according to the Basel standardised approach.

That is, the SNB is worried that its banks are fooling the market by just risk-weighting their assets less than other banks do, and wants them to be more comparable, or at least make it clear that they're not. Here is a pretty chart from this 2010 report that might make you worry about similar things; CS and UBS are the pink bars in the middle that show much lower risk weights on their assets than other banks have:

More importantly though, the SNB, as the Swiss lender of last resort, has a particular competitive advantage in knowing one thing:

Both CDS premia and long-term credit ratings are highly dependent on the market continuing to factor in state support of the Swiss big banks in the event of a crisis. The ‘too big to fail’ legislation entered into force on 1 March 2012, and it will take time to implement the measures it envisages with regard to resolvability. On that basis, the rating agencies are explicitly giving the Swiss big banks a higher long-term credit rating than would be justified by their resilience. There is currently a rating ‘premium’ of up to three notches, depending on the agency. If expectations of state support are lowered, the market’s assessment may deteriorate accordingly.

This report may be a step toward lowering those expectations. And that may explain why, although CS and UBS stocks are down in (perhaps) expectation of equity dilution (which should be credit positive), their CDS spreads are wider today (I see CS at 197 (+3), UBS at 204 (+4)), implying that credit markets aren't that impressed by the possibility that the banks will be raising equity. The additional equity is nice, but the slight hint that Switzerland might be less keen to support the banks at the center of its economy seems to outweigh it.

SNB Says Credit Suisse, UBS Should Boost Capital [WSJ]
Credit Suisse falls on capital concerns [CS]
Swiss National Bank Financial Stability Report [SNB]


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