Credit Suisse, UBS Told to Shape Up by Central Bank (CS, UBS)

Shares of Credit Suisse Group (NYSE: CS) are getting hammered in the pre-market this morning following an unusually direct instruction from the Swiss National Bank (SNB) to expand the Credit Suisse’s “loss-absorbing capital.” UBS AG (NYSE: UBS) was also singled out in the SNB’s 2012 Financial Stability Report.

The SNB said that “imbalances on the Swiss real estate and mortgage markets increased” beginning in the second half of 2011 and that signs of economic recovery in the Eurozone “have vanished again,” increasing “the risk of a rapid and marked deterioration in conditions for the Swiss banking sector.”

The central bank goes on:

The big banks’ importance for the Swiss economy and for financial stability requires that they further strengthen their resilience. The SNB therefore recommends that UBS continue with this process – including, in particular, a policy of dividend restraint – and that Credit Suisse significantly expand its loss-absorbing capital during the current year.

Credit Suisse paid a dividend of about $0.78/share in 2011, while UBS paid just under $0.11/share, but the central bank is recommending that the two banks reduce — or eliminate — the dividends and use the cash to improve the two banks’ capitalization.

The SNB specifically calls out Credit Suisse, noting that the bank has reduced risk-weighted assets and expanded its capital base since June 2011, but that the bank’s capitalization remains “below average in an international comparison.” The central bank also notes that if the Eurozone crisis gets worse (as it shows every sign of doing), Swiss banks face “relatively small” direct losses, “the accompanying general deterioration in economic conditions would bring with it substantial losses compared to the banks’ loss-absorbing capital.”

Leverage at the banks remains “very high” even after the reduction of risk-weighted assets and it remains “uncertain to what extent the reduction of risk-weighted assets is matched by an effective reduction of economic risks.” Then comes the kicker:

Finally, the above-average market assessment is partly based on the continuing expectation of state support in the event of a crisis.

In other words, the financial world views Credit Suisse and UBS as “too big to fail.” Whether that’s a warning that the SNB won’t bail out either bank — as it did UBS in 2008 — is not entirely clear, but investors are taking it as such.

Shares of Credit Suisse are down nearly -10.5% in pre-market trading this morning, at $17.76, which is below the 52-week range of $18.81-$40.47.

Shares of UBS are doing somewhat better, down just -1.6% at $11.40 in a 52-week range of $10.41-$18.64.

The SNB’s report is available here.

Paul Ausick