Rui Soares is an investment professional for FAM Frankfurt Asset Management, an independent investment firm.

The collapse of Credit Suisse and takeover by UBS created the ultimate Swiss behemoth.

New UBS will have total assets of around Sfr1.6tn, accounting for about 200 per cent of Swiss GDP. To put things in context: BNP Paribas’s balance sheet size accounts for approximately 100 per cent of France’s GDP. Deutsche Bank’s for around 35 per cent of German GDP and JPMorgan’s for about 15 per cent of US GDP. It’s beyond reasonable argument that New UBS is too big to fail; and too big to resolve.

So why are New UBS senior unsecured bonds trading between 90 and 190 basis points wider than Swiss government bonds?

[zoom]

Let’s imagine that some time down the road, NewCo UBS collapses like Credit Suisse did. Let’s assume for a moment that the Swiss government of the day will want to keep the control of the bank in Switzerland, and that a shotgun marriage with a foreign entity for some token amount is not possible. National pride may be at stake, or perhaps a desire to keep trade secrets close to home.

The Swiss authorities will be left with one option only: nationalisation. Shareholders will be bailed-in, as will AT1 bondholders. But after the asset write-downs on the left side of the balance sheet and bail-in of financial instruments on the right side, the bank may still be left undercapitalised. What then?

One could now argue that in such an event the Swiss government could bail-in Tier 2 bonds and even force, via a “Notgesetz”, a bail-in of plain vanilla senior unsecured bonds. None of that is implausible, particularly for Tier 2 , but the cost of wiping out senior unsecured bonds is to establish Switzerland as an international pariah.

If the Swiss government did allow the collapsing bank to be sold to a foreign entity, would the picture change? No. Any bail-in of senior unsecured bonds would here too trigger a buyers’ strike and effectively force the Swiss government to become the buyer of any senior unsecured bonds to be issued over the following years.

No matter how you slice it, the result is always the same: if NewCo UBS becomes OldCo CS, either there are enough AT1 and Tier 2 bonds to be bailed-in and fully recapitalise the bank or the Swiss government will have to step in and inject taxpayers’ money in the local behemoth. Bailing-in senior debt holders will not be really feasible.

UBS senior unsecured bonds are Swiss government bonds in disguise. Shouldn’t the credit spread between the two narrow?

Further reading:
— Beware of Greek lessons for AT1 bondholders (FTAV)
— Who killed Credit Suisse (FTAV)
— How the Swiss ‘trinity’ forced UBS to save Credit Suisse (FT)