UBS - UBS Stock Gains But Don't Get Too Excited Just Yet

2023-08-14 23:48:33 ET

Summary

• UBS terminates loss protection agreement and liquidity backstop from Swiss authorities, causing shares to soar.
• Credit Suisse repays debt to Swiss government, but UBS still faces challenges from acquired assets.
• UBS stock is not overvalued, whilst the acquisition of Credit Suisse has potential for future success.

On Friday UBS (UBS) announced that it ended a 9 billion Swiss franc loss protection agreement and a 100 billion Swiss franc public liquidity backstop (financial help, in other words) put in place by the Swiss authorities when the bank acquired its smaller rival Credit Suisse (CS) in March. UBS shares soared when this was announced. But don’t get too excited. Earlier on I covered UBS and its forced acquisition of Credit Suisse. Although it is a good deal, it is also a source of problems for the bank. However, UBS is the largest financial institution in Switzerland. It is highly profitable. Its stock is not overvalued even though it is near record highs.

What’s happened?

UBS shares rose substantially on Friday after the bank voluntarily terminated the CHF 9B loss protection guarantee granted by the Swiss government to finance Credit Suisse's non-core assets and stress loss scenarios.

Just a reminder, the Swiss government offered a loss protection deal to UBS for its takeover of Credit Suisse. With the help of that money UBS was supposed to cover any realized losses when winding down Credit Suisse's assets. But after having a careful look at all the assets once the Credit Suisse takeover was over, UBS said it no longer needed the government’s guarantee as well as the CHF 100B public liquidity backstop. That is because all the loans under the public liquidity backstop were fully repaid by Credit Suisse, not UBS.

Moreover, CS has also paid back the emergency liquidity assistance plus loan of CHF 50B but most importantly a risk premium totaling CHF 476M to Switzerland’s central bank. So, the government did not have to pay for any losses resulting from these guarantees. The relevant financial risks have also stopped being the taxpayers’ problem.

On the surface it does look very good, indeed. Credit Suisse repaid its debt to the Swiss government and UBS even returned the government’s help. But UBS still has not quite accumulated its smaller rival because Credit Suisse was a big bank, indeed.

Why UBS has not solved all the takeover problems?

Although the guarantees were fortunately paid back, the questions remain. Not all Credit Suisse’s assets acquired by UBS are free of problems. Why is that? Many of Credit Suisse’s foreign branches were loss-making before the acquisition.

Earlier on, I also wrote about all the relevant problems UBS might face thanks to its acquisition of Credit Suisse. Here is just a short recap of these:

• UBS did not fully evaluate Credit Suisse's assets and liabilities before the execution of the takeover. True, it has been announced Credit Suisse has paid back the government’s help. But some of Credit Suisse’s assets can still potentially mean problems for UBS. Earlier on I used to be bullish on Credit Suisse but fully admitted the problems it had. One of the strongest branches the bank had was its Swiss office.
• This obviously means that the bank’s rescue might be considerably more difficult and riskier than expected.
• The deal is already a done fact. I was not in favor of it. But at the very least it removes the resulting uncertainty surrounding the deal's approval.
• Although the transaction is a done fact, the relevant direct and indirect costs of this acquisition might obviously be higher than expected. The write-down of Credit Suisse's AT1 instruments, for example, might result in more expenses for UBS due to many litigations ahead. For example, very recently it was announced a suit was filed by the Swiss Investor Protection Association (SASV) on behalf of about 500 Credit Suisse shareholders.
• Among the indirect costs I would name the difficulty motivating, and retaining employees. Most of Credit Suisse’s veterans have been made redundant. In my view, some of the existing members of staff might feel frustrated and demotivated.

But right now it is still hard to tell how exactly would the takeover forced by the monetary authorities affect UBS’s performance. The 2Q 2023 earnings results will only be announced on 31 August. So, more uncertainties remain here. At the same time, UBS shares are trading near their record highs. First, the market assumes that the acquisition deal was a great success for UBS because a large bank was bought for a small amount of money. Secondly, the banking sector is doing quite well because we are not experiencing a full-scale recession plus the interest rates are rising. This is a very good factor for the banking sector.

Valuations

But the truth be told. UBS is a sound bank but its stock is not trading too high. Its stock price is near multi-year highs. But its valuation ratios are quite moderate.

This is true of the bank’s price-to-earnings (P/E) ratio. It is less than 12, quite a normal figure for UBS. It is quite an average indicator among other banks. I took the example of Julius Baer ( JBARF ), another Swiss bank, Goldman Sachs ( GS ) and Bank of America ( BAC ).

Data by YCharts

It is partly true of the bank’s price-to-book (P/B) ratio.

It is not near its all-time lows, but it is reasonable. UBS's P/B is even lower than Julius Baer's but slightly higher than Goldmans Sachs's or BAC's.

Data by YCharts

The same is true of the bank’s price-to-free cash flow (P/FCF) ratio.

Many banks' P/FCF ratios are much higher as you can see from the graph above.

UBS's valuation indicators are quite moderate. The Swiss giant's stock is trading near multi-year highs but it is trading fairly, given its valuation ratios.

Risks

Let me also discuss the key risks here. The first one is that it is still unclear how CS takeover affected UBS performance because we have not seen the bank’s earnings after the acquisition. Moreover, many investors seem to forget the fact that the current condition the economy is in will eventually end. By this, I mean that the higher interest rates environment and rising banking earnings would eventually end if there is a full-scale recession. UBS is a risk because it is in the financial sector. It is the largest Swiss bank. It has got even bigger thanks to the acquisition but the stock price may well correct in the near future, especially if investors get disappointed with its quarterly performance or if there is a general market selloff.

At the same time, UBS entered the deal of the century. It bought the second-largest Swiss bank for a ridiculously low amount of money. So, it has a potential to become a monopoly and do extremely well in the future.

Conclusion

The situation with CS takeover does not seem as obvious. There are many resulting problems. UBS, however, will only report its earnings on 31 August. So, we shall see how exactly the acquisition affected UBS performance. Just like any asset UBS stock has risks. At the same time, the deal to buy CS was extraordinarily profitable for UBS, given CS objective value as of the time of the purchase. But the resulting consequences also matter of course. I do not consider UBS shares to be expensive, whilst the bank is very profitable and sound.

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