The COVID pandemic, the war in Ukraine and the merger of UBS and CS represent the three most prominent in a series of events that have affected the Swiss economy. While pandemic-related aid given by the Swiss government was covering up parts of it, the consequences of higher corporate debt are manifesting now. In this blog we investigate the effects of these developments on corporate loans and on how financial services providers are and will be affected.
Over the past few years, the financial markets have experienced several shocks, most recently the announcement of the merger of Switzerland’s two largest banks, Credit Suisse, and UBS. Before that, the armed conflict between Russia and Ukraine and the COVID-19 pandemic had already weighed on the economic outlook. The accumulation of these events in a short period of time resulted in severe economic consequences, which we explore in this blog.
To begin with, the measures taken by the Swiss government in March 2020 to counter the impact of COVID-19 negatively affected the local economy. The restrictions on personal mobility led to a sharp reduction in household consumption. Consequently, many firms faced a large drop in revenue. Liquidity shortages and a wave of company bankruptcies were expected, and a spillover into the banking sector, with defaults and, ultimately, loan losses was widely anticipated.
Such scenarios were not just predicted by analysts and the media – banks themselves were anticipating an increase in defaults in their loan books. This expectation manifested itself mainly through large increases in banks’ loan loss provisions in the first quarter of 2020. Banks in both Europe and the US reported much higher loan loss provisions compared to the same reporting period in the previous year (Deloitte 2020). A similar pattern was observed for Swiss banks. Graph 1 shows the changes in Swiss banks’ loan loss provisions over time. The large Swiss banks increased their loan loss provisions by over 100 bps in the first half of 2020, whereas the retail and cantonal banks increased their provisions more moderately.
Graph 1: Development of provisions by banks (loan loss provisions as a share of total loan book)
Nevertheless, as shown in Graph 2, a wave of corporate defaults did not occur in 2020. On the contrary, a significant reduction in the number of defaults was observed throughout 2020-2021, compared to the pre-pandemic years. This was likely a consequence of the legal and fiscal measures implemented by the Swiss government.
The legal measures, which included an extended debt collection holiday and no obligation to report over-indebtedness, gave firms additional time to adapt to the changed circumstances. The financial aid directly supported firms through two different measures: first through the COVID-19 credit programme which from the end of March 2020 onwards enabled companies to obtain state-backed loans on favourable conditions, and second, the government allowed firms to introduce short-time working, thereby reducing their fixed personnel costs.
Graph 2: Cumulative number of Swiss corporate defaults on a monthly basis
These government measures were successful in preventing the anticipated wave of bankruptcies. However, COVID-19 was only the first in a series of hits to the economy.
Interplay of negative factors
While the pandemic did not cause an immediate wave of bankruptcies, it had several secondary effects. In order to remain liquid, many Swiss firms made use of additional credit lines and corporate loan volumes in Switzerland increased substantially, both during and after the pandemic, by a total of CHF 53 billion. Of this total, only CHF 13 billion in loans were granted as part of the federal COVID-19 credit programme. The remaining credit of over CHF 40 billion since then has consisted of standard bank loans.
In addition, the global economy experienced complications due to the mobility restrictions imposed around the world. This resulted in a first wave of upward price pressure, but central banks did not respond to the signs of inflation because they considered it transitory. Subsequent the easing of pandemic measures by governments, the macroeconomic outlook worsened following the attack by Russia on Ukraine in February 2022, which led many European countries to impose sanctions on Russian fossil fuel exports. The resulting energy scarcity and rising energy costs led to increased production costs in many industries, and higher consumer goods prices. The price pressures in Switzerland were lower than in many other European countries. This can be attributed to the favourable energy mix in Switzerland and the comparatively low energy intensity of the Swiss economy. Nonetheless, as shown in Graph 3, year on year price inflation in Switzerland reached more than 3 per cent in June 2022, a 25-year-high. In response, the Swiss National Bank raised its key interest rate by 225 bps in a period of less than a year.
Graph 3: Development of the inflation rate in Switzerland and the SNB key interest rate over time
The rising cost of capital might already have worried over-leveraged Swiss firms, but the overall lending outlook for the Swiss market worsened further with the announcement of the merger between Credit Suisse and UBS. Given that the share of the enlarged UBS in trade finance, bank guarantees and unsecured corporate loans might be as high as 70 per cent, costs for corporate clients are expected to increase. Corporate clients from Credit Suisse are in a particularly difficult situation. In the best-case scenario, UBS will take over the existing loans from Credit Suisse – 15 per cent of total corporate loan volume in Switzerland – and refinance firms at similar risk assessments. In the worst-case scenario, the newly established bank would introduce stricter risk assessment and therefore deny refinancing of some corporate loans. Given that clients may be unknown to the bank, this second scenario is not unlikely. If it turns out to be the case, further corporate liquidity shortages would occur – assuming that no smaller lender would be willing or able to take over the credit risks instead.
Spill-over to banks
While the effects of lower corporate revenues caused by the pandemic were partially offset by state intervention, the effects of events following the pandemic could not be dealt with as effectively by the Swiss government. Even though the state interventions during the pandemic could mitigate the problems temporarily, due to the subsequent external shocks they failed to prevent corporate defaults in the long run. In the current situation, Swiss firms not only pay significantly higher interest for the debts they accumulated in the past, they also face challenges in refinancing their debt.
Mortgage rates in Switzerland are an illustrative example. These rates hit a low of below 1 per cent in 2020 but in less than 3 years, correcting slightly to levels that still constitute an increase by a factor of 2.5. The increases in loan rates, combined with historically high loan volumes, negatively affect companies with tight budgets. This is also reflected in the analysis of corporate defaults, shown in Graph 2, which shows a 14 per cent year on year increase in the first months of 2023. It is expected that this rising trend will continue further throughout the year. The sharp increase in corporate defaults is worrying not only for the indebted firms themselves, but it also directly affects banks. Lenders are expected to incur significant losses on defaulted corporate loans as a consequence of these developments. In addition, losses due to greater market volatility and the resulting need to reshuffle loans will weigh on banks’ operations and results. Similar trends are visible in wealth management, securities-backed Lombard loans as well as retail, private, and leasing credits. Graph 1 shows that the large Swiss banks began to readjust their loan loss provisions in Q4 2022 in response to recent developments.
In addition to being concerned about loan defaults, lenders should also be aware of the fair value of their loan books in relation to their liquidity reserves. The recent outflows of upwards of USD100 billion in deposits at First Republic Bank can be taken as a warning sign of what can happen when lenders neglect this ratio. As a result, the lender was first seized by the Federal Deposit Insurance Corporation and later sold to JP Morgan.
Rising key interest rates will in general cause a fall in the fair value of loans: the fall is greater the longer the maturity and the lower the interest rate on the loan. In the current situation, in which central banks are trying to counter inflation and are therefore raising interest rates at a faster than usual pace, it is more important than ever to stay alert to changes in the fair value of loan books.
In order to minimise their losses, lenders need to act fast to mitigate rising non-performing loan ratios and perform quality reviews on their loan books and assets. Measures such as stress testing uncover potential problems in time to allow banks to adjust their asset and loan books to fit their risk appetite. Additionally, lenders should monitor closely the fair value of their loans and ensure that they have sufficient liquidity reserves to meet a potential outflow of assets.
This is the third blog in our series on the impact of the COVID-19 crisis on Swiss banks and the increased risk of loan defaults. Read the previous parts here.
Key contacts
Dr. Marc D. Grüter – Partner – Risk Advisory
Marc leads the FS Regulatory, Risk and Compliance practice of Deloitte in Switzerland and is part of the leadership team for FS Regulatory within Deloitte North West Europe (NWE). In addition to this he is a senior financial services Partner and lead client Partner for leading Financial Institutions in Switzerland. With nearly 20 years of experience in financial services and Consulting (leading global Strategy Consulting firms, Big4) he has built deep expertise in this context with large financial services organisations in Switzerland, Germany, UK, USA, Middle East and Asia.
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Eric Gutzwiller – Director – Risk Advisory
Eric is a Director at Deloitte specialising in the Financial Services industry, with a particular focus on process optimisation and digitalisation as well as TOM design projects. He brings over 10 years of strategy consulting experience in financial services, for both, leading global institutions and developing players, as well as central banks and regulators, in various established markets (Switzerland, UK, US, HK, Germany, Canada) and also in emerging markets (CEE, Middle East).
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Marco Käser – Assistant Manager – Risk Advisory
Marco is an Assistant Manager with the Financial Services Transformation team of Deloitte’s Risk Advisory practice in Zurich. Besides his core focus on front-to-back process optimization, Marco worked on projects around stress testing, scenario modelling as well as operational risks for Swiss and international banks. The first-hand client expertise coupled with his quantitative background contribute to his interest in macroeconomic developments and their manifestation within the banking sector.
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