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Monday, Jun 05, 2023

Why once 'unthinkable' UBS-Credit Suisse takeover is like merging Liverpool and Manchester United and a win-win

Why once 'unthinkable' UBS-Credit Suisse takeover is like merging Liverpool and Manchester United and a win-win

How Credit Suisse emerged from the financial crisis - via a private sector solution compared to UBS's taxpayer bailout - may have created a sense of hubris that ultimately led to its downfall, Sky's Ian King writes. But the deal to combine the two is like merging Coca-Cola and Pepsi.
To those who do not work in or follow closely the fortunes of the banking sector, it is impossible to neatly sum up the seismic nature of UBS's takeover of its Swiss rival Credit Suisse.

These two are the Coca-Cola and Pepsi of the Swiss banking world, the Liverpool and Manchester United, the McDonald's and Burger King.

Combining the pair would have been absolutely unthinkable even a few weeks ago.

It was the bitter rivalry between the two that, for example, was at the centre of the espionage scandal which, four years ago, ultimately cost Tidjane Thiam, a former Credit Suisse chief executive, his job.

The two banks watch each other like hawks and constantly compare themselves with the other.

Never was this more the case than in the wake of the global financial crisis.

UBS required a bail-out from Swiss taxpayers while Credit Suisse, which was offered the same terms by the Swiss government, engineered a private-sector solution that appeared to leave it in better shape than many European lenders.

That may in turn have created a sense of hubris at Credit Suisse that ultimately led to the events of this weekend.

For it meant that when other banks began to retrench and dial down their appetite for risk post-2008 - no more, perhaps, than UBS itself - Credit Suisse, under its then chief executive Brady Dougan, continued with comparatively riskier activities.

More than a decade of tripping over every banana skin

In the decade and a half that followed the rescues of the banking crisis, Credit Suisse found itself tripping over every potential banana skin around.

Apart from the corporate espionage scandal, it lost $5.5bn when the hedge fund Archegos Capital collapsed and racked up further losses when the British supply chain finance business Greensill Capital collapsed.

It was fined for making fraudulent loans, nicknamed 'tuna bonds', to the government of Mozambique between 2012 and 2016 and again when Swiss courts ruled it had failed to stop money laundering by Bulgarian drug smugglers.

Other corporate mishaps included the resignation of its former chairman Sir Antonio Horta-Osorio, best known for his distinguished stint as Lloyds Banking Group chief executive, after he was found to have breached COVID protocols.

You get the picture.

This is a bank that has stumbled from one crisis to another in the past 15 years - but the rot arguably set in immediately after the financial crisis because Credit Suisse's management, led by Mr Dougan, failed to recognise that the world had changed.

A risk-taking, buccaneering culture

While the likes of UBS pivoted to less risky activities, such as wealth management, Credit Suisse largely carried on as it had before.

That became problematic when, obliged to set aside more capital in the wake of the financial crisis, Credit Suisse found its competitive position eroded by larger Wall Street giants able to access more capital.

That in turn prompted Credit Suisse to take ever greater risks as its returns began to lag behind those of the Wall Street giants.

To the management of UBS now falls the task that eluded successive Credit Suisse chief executives - stripping away the risk-taking, buccaneering culture at the heart of the bank and making it altogether more boring.

It is a task that is likely to involve heavy job losses in the investment banking division of Credit Suisse, which employs more than 5,000 people in the UK, the majority of them based at London's Canary Wharf.

Tantalising prospect for UBS after the short-term risks

There are plenty of risks involved here for UBS.

The Swiss government has guaranteed losses of up to CHF9bn (£7.94bn) on some portfolios of assets it is taking on from Credit Suisse.

However, those guarantees only kick in after UBS has borne some CHF5bn (£4.41bn) of losses itself. That is why UBS shares fell by as much as 16% shortly after trading began this morning.

What is interesting though is that, as the day has gone on, shares of UBS have clawed back the majority of those losses as investors focus on the longer-term potential benefits.

Because yes, while UBS is taking on a great deal of risk and will see its profits diluted in the short term, it is ultimately going to emerge with a much more powerful position in key markets.

As equity analysts at the investment bank and brokerage Jefferies International told clients this morning: "We think the objective of this transaction, while solving Credit Suisse's situation and associated risks for the system, is to reach a win/win where UBS shareholders also get value out of this deal over time.

"The low price paid (CHF3bn) and significant safety net provided to UBS (with government guarantee) are positive, while UBS's strategy is unchanged."

And that's the point here.

UBS is getting a gigantic banking business for just a fraction of its book value - which stood at CHF41.8bn as of the end of last year - and, more to the point, will boost its market share in key areas.

For example, the combined pair will control 30% of the domestic banking market in Switzerland.

Nowhere is this more the case than in wealth management - the field which UBS has increasingly treated as its priority.

Andrew Haslip, head of wealth management at the data provider Global Data, points out that the combined private bank would have had assets under management of $4trn at the end of last year - or 6.2% of the so-called high net worth market.

He added: "While on paper this move looks like a fairly neat solution with minimal government intervention, it is likely to cause significant competitive issues.

"The combined Swiss bank's nearest private wealth rivals Morgan Stanley (with 2022 global assets under management of $1.7 trillion) and Bank of America (with 2022 global assets under management of $1.4trn) would only equal 78% of its private wealth assets under management taken together."

Julius Baer - the closest Swiss bank competitor - ended 2022 with $458.6 billion.

"These are all impressively large client portfolios but are vastly dwarfed by the combined UBS/Credit Suisse."

In that sense, this deal has shades of the merger between Lloyds Banking Group and HBOS, engineered by the then prime minister, Gordon Brown, at the height of the financial crisis.

The short-term pain for shareholders of Lloyds proved immense and the bank ended up receiving support from UK taxpayers.

Longer term, however, Lloyds benefited from being able to take control of a rival that it would never have been allowed to buy in normal times.

The merger has left the enlarged Lloyds with near-impregnable positions of UK market leadership in an array of banking products, including current accounts, savings accounts and mortgages.

That is the tantalising prospect, longer term, for those UBS shareholders currently cursing their government and the bank's management for denying them a vote on this crucial deal.
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