The parent trap
European concerns about systemically important banks have raised the cost of borrowing for Credit Suisse as it borrows both from a holdco and an opco.
When Tidjane Thiam was appointed as the successor to Brady Dougan in March this year as chief executive of Credit Suisse it was a change of direction for Switzerland’s second-largest bank. Shares in the bank lifted 7.5% the day after the news was announced.
Part of the reason that Thiam’s accession has been so welcomed, is his background in insurance. While Dougan’s strength is investment banking, Thiam’s experience in government (as minister for planning for his native Cote d’Ivoire) and senior roles at insurance companies Aviva and Prudential is what the bank needs now.
Change has been in the air for years, but a tipping point was the decision by S&P to downgrade the holding company ratings of Credit Suisse Group AG from A– to BBB+ in November.
“Extraordinary government support is now unlikely,” the ratings agency said. “Even if the Swiss government decided to support the operating companies of systemic Swiss banks, we now consider that it is uncertain whether the government would be willing to extend that support to holding company creditors,” it added.
This is all part of the EU’s Bank Recovery and Resolution Directive and the long-running European debate about bank financing and concerns about bank liquidity in the face of another economic crisis. Although Switzerland is not in the EU, it pays attention to European banking directives, especially with regards to Credit Suisse and rival bank UBS which are deemed too big to fail.
Swiss regulator L’Autorite federale de surveillance des marches financiers (FINMA) has said that were there another crisis, it likes the idea of a “single point of entry” approach. This would allow for resolution at the level of the bank’s ultimate parent instead of the operating company that is in trouble.
The presumed lack of government help and the need to sell bonds to meet total loss-absorbing capacity has dramatically shaped Credit Suisse’s bond issuance this year. Financial advisory company Kepler Cheuvreux estimates that Credit Suisse needs an extra SFr6bn (US$6.44bn) to bring its core capital levels up to those of UBS.
It is something that the bank recognises. In its annual report, the bank bluntly stated: “We plan to issue senior unsecured debt in 2015, which should qualify for future capital treatment under the total loss-absorbing capacity rules. With this, we are further developing the possibility to absorb losses at the group holding company in order to facilitate a single point of entry bail-in resolution strategy, as set out in FINMA’s bank resolution guidelines”.
Behind the good news
All good news, but what this has meant in practice is an increasing divergence both in terms of tenor and in spreads between whether issuance comes from the holding company, Credit Suisse Group AG or the operating company Credit Suisse AG. The difference can be seen first and foremost in the ratings. The former is Baa2/BBB+/A while the latter is A1/A/A.
The Swiss bank debuted its holdco debt at the end of March and in the Yankee market. It sold US$4bn five and 10-year self-led holdco notes split into US$1.5bn and US$2.5bn tranches. The former priced at US Treasuries plus 137.5bp while the longer tranche priced at US Treasuries plus 187.5bp. It printed another Yankee deal, a 30-year this time, in mid-May. The US$2bn self-led 2045s priced at Treasuries plus 187.5bp.
The first US dollar deal was followed soon afterwards by issues in Swiss francs, euros and then sterling. The Swiss franc deal was originally a SFr825m eight-year at mid-swaps plus 100bp level (it was later upsized to SFr1bn); the next was a €2.25bn seven-year at mid-swaps plus 100bp; and then £600m seven-years at IPTs plus 147bp.
Two points stand out in these deals. First is the long tenor on the paper. The shortest is five years but the long end is where the weight is and the bank has gone out to 30 years. What also stands out is the premium that the bank had to pay for the risk that it might be bailed in. That on the US dollar, the Swiss franc and the euro deals was between 40bp and 50bp; while that on the sterling deal was nearer 55bp.
The difference between holdco and opco issuance is clear. The latter clearly has a shorter tenor and is cheaper, to the tune of around 50bp. The operating company debt that was issued at the end of March is typical. It sold a dual-tranche senior unsecured transaction made up of a €2.5bn two-year FRN at Euribor plus 35bp and a €1bn three-year at bond at mid-swaps plus 45bp area.
Will that differential between the holdco and opco tighten? In all likelihood it will, probably to around 35bp, but as the hunt for yield continues, there is little chance of investor appetite for Credit Suisse debt drying up. The challenge for Thiam as he takes the helm of the bank – he officially started on July 1 – is to keep the bank on the steady path that both regulation and the post-crisis banking world have created.