UBS-Credit Suisse Deal Jeopardizes CS First Boston's Revival

The potential government-brokered takeover of Credit Suisse Group AG by UBS Group AG has put the future of the investment banking spinoff, CS First Boston, into uncertainty. Michael Klein, the CEO-designate of the spinoff, might face challenges in building the new entity as UBS displays a lack of interest in Credit Suisse's investment banking business. The riskier investment banking and trading operations have become a major point of contention in the ongoing takeover negotiations.

Credit Suisse's investment banking and trading operations are a key obstacle in the discussions. UBS is particularly concerned about the balance sheet risks associated with the investment bank, which has experienced a series of losses and scandals in recent years. Notably, its leveraged finance sector has been targeted by regulators. As of the end of December, the investment bank division held nearly one-third of Credit Suisse's risk-weighted assets, which help determine capital requirements.

In the midst of talks between Credit Suisse and UBS, the future of the First Boston brand remains unclear. The situation has been further complicated by the collapse of U.S. lenders Silicon Valley Bank and Signature Bank, intensifying the crisis of confidence in Credit Suisse. Regulators are pushing for a resolution before markets reopen, but significant obstacles remain, including potential job losses and the size of the government guarantee that UBS is demanding.

The banking crisis has tightened financial conditions and put additional pressure on vulnerable borrowers. As a result, high-yield companies may need to get more creative to access capital. The average yield spread on U.S. bonds with the worst credit ratings has surpassed 1,000 basis points, while leveraged loans plunged to a 10-week low. Companies have pulled debt deals at the fastest pace in a year as buyers flee.

The swift and dramatic events in the banking sector may lead to bigger banks consolidating their power, smaller banks struggling to keep up, and more regional lenders shutting down. In response to the crisis, U.S. banks have sought a record $153 billion in emergency liquidity from the Federal Reserve in recent days. The S&P Banks index has fallen 22%, marking its largest two-week loss since the pandemic rattled markets in March 2020.

As a part of their efforts to resolve the crisis, Credit Suisse may still seek to carve out the investment bank and even accelerate the effort, according to a person briefed on the discussions. However, such a move would likely require regulatory approval and could be complicated. Another scenario could see the parts of the investment bank originally planned for First Boston ending up in a bad bank, to be wound down, as per a person familiar with the matter.

The ongoing crisis has prompted authorities to consider using emergency measures to fast-track a potential deal between Credit Suisse and UBS. U.S. authorities are also involved, working with their Swiss counterparts to help broker a deal. In the meantime, Credit Suisse shares have lost a quarter of their value in the last week, with the bank tapping $54 billion in central bank funding as it tries to recover from a string of scandals undermining investor and client confidence