In a move that could be considered the deal of the decade, UBS, having rescued rival Credit Suisse from a liquidity crisis prompted by the collapse of Silicon Valley Bank, has announced extraordinary gains for the second quarter.
UBS's CEO, Sergio Ermotti, revealed that the bank raked in a staggering $29 billion in net profit, a remarkable 14-fold increase solely attributable to this emergency acquisition.
“We are very proud to see that clients are entrusting us and really believing in the story,” he said, citing wealth management customers placing more of their money with the bank despite the turmoil surrounding the deal.
This substantial Q2 gain, however, is a paper gain resulting from "negative goodwill" arising from the transaction—a term that sounds bad but is in fact a sign of sharp negotiating skills.
Normally when a company acquires another, it pays a premium over the market price, creating an intangible asset called goodwill, representing the difference between the target company's perceived worth and the acquisition price.
In most cases, less goodwill is seen as favorable for investors since excessive goodwill can lead to substantial impairment charges if assumptions behind the transaction fail.
Probably the most famous example is AOL Time Warner. After merging at the height of the dotcom bubble, the new group in 2002 wrote down close to $100 billion of the deal’s goodwill, leading to the largest loss in corporate history.
By comparison, UBS created negative goodwill by underpaying for Credit Suisse. At the time of the shotgun wedding, Credit Suisse was already trading at a substantial discount to its book value when UBS insisted to the federal government that they would only countenance a purchase if a deal was priced even lower.
In the end, they agreed to end 166 years of Credit Suisse history for just 3 billion Swiss francs ($3.4 billion).
Distraction is now the number one integration risk
Today’s quarterly results revealed the sheer scale of the discount it got for the franchise.
Thanks to the negotiation of chair Colm Kelleher, UBS managed to generate nearly 30 billion in value for its own shareholders in one fell swoop.
Had it not been for this windfall profit, the lender would have seen its $2.1 billion net income from the previous year swing to a small loss for the period.
There is a downside, however. As much as $28 billion in added costs, including $4 billion in litigation risks, could result from the deal. But this estimate from the company is likely a worst-case scenario.
The merger of Switzerland’s two biggest names in banking has however created an entirely different problem.
The combined $1.7 trillion balance sheet of the new behemoth is roughly twice the size of the Swiss economy.
This has sparked concerns UBS bankers may be tempted to take oversized risks just like their colleagues at Credit Suisse, knowing the institution is now definitively too big to fail.
To soothe fears in the country, Kelleher has said his management team will screen Credit Suisse’s notoriously free-wheeling investment bankers to ensure no bad apples make it through the ongoing integration process.
Earlier this month UBS assured Swiss citizens the bank had no need of 9 billion francs in taxpayer money to backstop losses arising from Credit Suisse’s derivatives exposure and already returned all support to the country’s central bank.
The Swiss native, brought in for political reasons in conjunction with the deal, said he wanted the process of consolidating Credit Suisse and restructuring the merged entity to take a back seat in the minds of his employees to prevent any distractions from their day-to-day tasks.
“Everybody wants to talk about it, but the reality is that what we need to do is to continue to stay close to clients and manage our current business, both at UBS and Credit Suisse,” he said, before going on to call the integration “a second priority.”
