UBS - UBS Group Scores A Massive Win With The Acquisition Of Credit Suisse

2023-03-20 10:08:22 ET

Summary

• Shares of both UBS Group AG and Credit Suisse Group AG are set to fall materially in response to news that the former is buying the latter.
• The deal prices Credit Suisse well below what it was trading for previously.
• Investors in UBS Group should see this as a significant win when all aspects of the transaction are taken into consideration.

I had my first experiences in investing back during the financial crisis of 2008 and 2009. Because those were my formative days as an investor, I became very sensitive about and interested in financial crises in general. While many avid readers dot their bookshelves with fiction or memoirs, mine are dotted with histories of financial speculation and collapse. So you can imagine my intrigue during this rather tumultuous time. Although painful from an investment perspective, it is fascinating to watch events unfold as the world finds itself teetering on the edge of the abyss once again. The latest move in the chain of events occurring today has been the news that UBS Group AG ( UBS ) has agreed to acquire Credit Suisse Group AG ( CS ) in an all-stock transaction in what is effectively a take-under as opposed to a takeover. Naturally, these developments are rather painful for shareholders of Credit Suisse Group AG. But for investors in UBS Group AG, this development should be a delight that should add significantly to the company's prospects in the long run. Because of these reasons, I have decided to establish a 'hold' rating on Credit Suisse Group AG while placing a 'buy' rating on acquirer UBS Group AG.

Recent developments

Plagued by multiple factors over the prior few years, including various controversies and poor management, the management team at Credit Suisse Group AG has been focused on restructuring its operations in order to focus more on its core operations. The big push by management to do this began late last year when the company began divesting itself of various assets. In November of 2022, for instance, the company said that it had agreed to sell a significant part of its Securitized Products Group to Apollo Global Management ( APO ) in a bid to reduce its exposure in this line of business from $74 billion to around $20 billion. Management also made other moves, such as carving out its CS First Boston operation as a capital markets and advisory business by means of an acquisition that the firm made. The company even created what it called a Capital Release Unit in January of this year in the hopes of accelerating its reduction of assets, releasing capital, and reducing risk and managing the residual of its Securitized Products Group.

The ultimate goal of management was not only to reduce the company's exposure to various assets but also to cut costs materially. Using current exchange rates, the goal was to reduce annual run rate expenses by roughly $2.7 billion by 2025. Of this, nearly half was slated to be realized in this current fiscal year. Unfortunately, the market had other plans. Starting with the collapse of Silicon Valley Bank, a subsidiary of SVB Financial Group ( SIVB ), shockwaves began reverberating throughout the global financial system. Financially speaking, Credit Suisse Group AG had already been on some rather shaky ground in recent years. So after the most vulnerable companies fell, it wasn't long before eyes started to shift toward it. Last week, the company gave investors a bit of hope when it announced that the Swiss National Bank had agreed to lend the entity up to nearly $54 billion of capital in order to survive this downturn. Fast forward to today, however, and we have something very different taking place.

On Sunday, March 19th, news broke that UBS Group AG had agreed to acquire Credit Suisse Group AG in an all-stock deal valuing the company at a substantial reduction compared to where the stock was previously. In essence, shareholders of Credit Suisse Group AG will receive 1 share of UBS Group AG stock in exchange for every 22.48 shares of Credit Suisse Group AG stock that they currently own. Based on current prices as of this writing, that will translate to around $0.81 per share for Credit Suisse Group AG. That values the company at only $3.25 billion. For context, shares ended trading last Friday at $2.01. That worked out to about $8 billion. The 52-week high for the company had it valued at about $33.4 billion.

This is a classic take-under scenario that is really quite rare. But it does happen during times of crisis. One of the most famous and extreme examples was of Bear Stearns initially planning to be sold to JPMorgan Chase ( JPM ) for only $2 per share, pricing the business substantially lower than the value of its headquarters building. This was back in 2008. Ultimately, however, it's worth noting that the deal did get pushed up to $10 per share. The obvious downside for shareholders of Credit Suisse Group AG is that they are taking a massive haircut and any upside they receive is now related to the health of UBS Group AG. The downside for UBS Group AG is that the company now has the perception of accepting the contagion that Credit Suisse Group AG brought to the table.

This deal is a big win for UBS Group AG

The way I see it, the upside for UBS Group AG is massive. On day one, the maneuver will increase the tangible book value per share of the banking giant by roughly 74%. At current exchange rates, the deal also brings with it roughly $27 billion of downside protection to support marks, purchase price adjustments, and restructuring costs. Most of this is in the form of AT1 instruments written off by FINMA, with the rest coming from Swiss authorities in case of losses extending beyond the first $5.4 billion that would be borne by UBS Group AG, with said losses totaling about $9.7 billion under current exchange rates.

On top of this, the transaction is also highly beneficial because of how it helps UBS Group AG transform further. As of the end of the 2022 fiscal year, UBS Group AG boasted assets under management between its Global Wealth Management and Asset Management businesses of $3.9 trillion. Absorbing Credit Suisse Group AG into the mix will raise this number to roughly $5 trillion. This will place the Asset Management portion of the enterprise in the number three position throughout Europe, with total assets of $1.5 trillion compared to the $1.1 trillion it has today. As for the Global Wealth Management portion of the business, which focuses on the financial needs of mostly ultra-high-net-worth individuals, institutions, and entrepreneurs, the end result will be highly beneficial for the business. I say this because, compared to similar firms throughout Southeast Asia, the Middle East, and Latin America, UBS Group AG will grow to become the second largest player.

As of the end of the 2022 fiscal year , UBS Group AG was already a massive player on the global stage. The firm had 677 business and banking locations worldwide. 48% of these, not surprisingly, were located in the Americas. Another 10% was focused on the Asia Pacific region. The Americas and the Asia Pacific region have been two areas where management has been pushing for additional strategic growth. But the company does also have about 9% of its locations spread throughout Europe (excluding Switzerland), the Middle East, and Africa. The final 33% of locations are spread throughout Switzerland, about two-thirds of which the company owns the assets of. Even though it wasn't the company's plan, this acquisition will push the business up to the number one spot in Switzerland as measured by customer deposits. Total customer deposits should grow from about $180.2 billion to $359.2 billion. The value of loans, meanwhile, should climb from $154.4 billion to $331.5 billion.

Although investors might be worried about the contagion spreading to UBS Group AG, my belief is that this is unlikely to transpire. Yes, the company does have a significant amount of deposits. All combined, customer deposits work out to roughly $527.1 billion. Of this amount, $362 billion is uninsured. Such a large portion of capital could, in theory, lead to concerns about a bank run that could, in turn, become a self-fulfilling prophecy. But we need to keep a couple of things in consideration here.

For starters, it's clear by now that UBS Group AG is slated to receive any help that it likely needs from the Swiss National Bank. But even that might not be needed. This is because, at present, the company has a core loan portfolio of $389.8 billion. Of this, $184.1 billion comes due within one year. And of this amount, $124.7 billion is associated with its Lombard loans (of which it has about $154 billion in total). Lombard loans are loans that are secured by pledges of marketable securities, guarantees, and other forms of collateral. These are almost always highly liquid assets that can be sold if need be. Of course, they do come with the downside of being subjected to market forces. But because of their short-term nature, it's unlikely that the company would need to divest to the point of taking significant losses on its portfolio.

It's also important to note the primary business that UBS Group AG is focused on. The company's goal is not to be the biggest bank in the world. Rather, it's to be a major player in the wealth management space. As we saw last week with Charles Schwab ( SCHW ), companies that are focused on this area of finance are much more likely to be sturdier during a collapse than peer banks. Using data from the 2022 fiscal year, UBS Group AG generated nearly $19 billion, or 54.3%, of its revenue from activities associated with its Global Wealth Management operations. Another nearly $3 billion, or 8.5% of sales, came from its Asset Management division. Meanwhile, the Investment Bank portion of the enterprise accounted for 24.9% of sales, compared to the 12.3% that came from Personal and Corporate Banking.

Takeaway

From what I can see, this maneuver made by UBS Group AG was a wise one. Yes, the company is taking some risks here. But in my opinion, it's incredibly small. Between the support pledged by regulators, and the massive amount of tangible assets the company is receiving in the transaction, not to mention the additional revenue and the projected $8 billion in annual run rate synergies management has forecasted by 2027, I see this as a very compelling win for the business and its shareholders. As such, I've decided to rate UBS Group AG a 'buy' at this time. As for Credit Suisse Group AG, I would normally assign a very bearish rating. But since its fortunes are now tied to UBS Group AG, I suspect that the stock will be stable or move higher with its acquirer's stock, after the initial plunge.

For further details see: