ZURICH (Reuters Breakingviews) – Ever since Goldman Sachs chieftain David Solomon signalled his interest in expanding further into consumer financial services, many investors have speculated the Wall Street firm will want to buy an American bank like U.S. Bancorp or PNC Financial Services. But imagine if the target of Goldman’s affections were to reside someplace entirely different – like in Switzerland.
The logos of Swiss banks UBS and Credit Suisse are seen on a sign in Zurich, February 13, 2013.
A transatlantic banking deal probably sounds like the stuff of regulators’ nightmares. As the conventional wisdom would have it, no watchdog in Washington, Frankfurt or Bern wants to see big banks get bigger, more complicated or harder to oversee. Blending a Wall Street behemoth with a Swiss juggernaut is, therefore, hard to contemplate.
But by partnering with one of Zurich’s banking beauties, Goldman – or rivals including Morgan Stanley or Bank of America – would have a better-balanced business that is arguably safer and less dependent on risky trading. It’s basically the argument that has propelled Morgan Stanley Chairman and Chief Executive James Gorman to bulk up on wealth management, culminating in the $13 billion purchase of E*Trade he announced on Thursday.
That strategy explains why Morgan Stanley commands more market respect than its traditional nemesis. As Gorman has reduced the share of the firm’s revenue from securities trading, investors have been willing to attach a higher valuation to its shares. They now trade at 1.14 times historical book value per share, compared to about 1.06 times for Goldman. By contrast, JPMorgan, the U.S. bank that has pulled ahead of all its peers since bulking up during the financial crisis, is worth 1.8 times its book value.
But shareholders aren’t the only ones who might benefit from a Swiss-American combo. A deal could be structured in a way that would allow Swiss regulators to sleep more comfortably at night. True, UBS and Credit Suisse appear unlikely merger partners right now. Both just named new CEOs: Ralph Hamers of ING will take over from UBS CEO Sergio Ermotti in September, and Thomas Gottstein replaced Tidjane Thiam at Credit Suisse earlier this month. The new executives and their boards won’t be looking to entertain suitors. But their rivals across the Atlantic will be watching closely for any sign of a slip up.
UBS and Credit Suisse both have a domestic financial institution serving Swiss consumers and companies; an asset management arm; a global investment bank and a wealth management business catering to the world’s richest people. An American merger partner would be most interested in this last business.
UBS, with a market value of about $50 billion, is the most alluring of the two. It had a balance sheet of $972 billion at the end of 2019, with $259 billion of risk-weighted assets against which it holds $36 billion of Common Equity Tier 1 (CET1) capital. Credit Suisse, whose market capitalisation is around $35 billion, has a balance sheet of 787 billion Swiss francs ($800 billion), with 290 billion Swiss francs of risk-weighted assets – reflecting the relative importance of the riskier and more asset-intensive investment banking business – and 39 billion Swiss francs of tangible equity.
The Federal Reserve, which oversees Goldman and Morgan Stanley, would probably blanch at the prospect of either bank expanding their balance sheets by nearly $1 trillion. And even if it blessed such a union, the resulting combo would probably face a capital surcharge because its size makes it even more “too big to fail”. But there are a few ways around this.
First, Credit Suisse and UBS could spin off their domestic banks directly to shareholders. That would both reduce the cost of a takeover and reduce risk. Moreover, untethering lenders serving Swiss retail and business customers from a parent involved in trickier global operations might appeal to the Financial Market Supervisory Authority and the Swiss National Bank, which are charged with monitoring the safety and soundness of the country’s banking system.
Credit Suisse flagged the idea back in 2016, when it considered an initial public offering of a 30% stake in its Swiss bank to raise capital. The division was then run by Gottstein, now the group’s CEO. It accounts for about 78 billion Swiss francs of risk-weighted assets, some 27% of the total. At 10 times its 2019 operating profit, adjusted for one-time gains, the bank is probably worth more than 20 billion Swiss francs on its own.
The equivalent business at UBS has $67 billion of risk-weighted assets, accounting for about a quarter of the total, and made about $1.5 billion of operating income. It might be worth $15 billion. When Credit Suisse contemplated spinning off its Swiss bank, regulators wanted it to hold CET1 equal to 10% of risk-weighted assets – significantly less than the 12.7% ratio reported by the group at the end of last year. That means a spinoff could free up money for the parent.
Enough, though, about what a suitor wouldn’t keep. The prize for Goldman or Morgan Stanley would be the private wealth management business. UBS oversees $2.9 trillion of client assets, through 10,000 advisers, about half of them in the United States. The $3.5 billion of operating profit the business generated last year accounted for about 63% of the bank’s bottom line.
Contrast that with Goldman’s wealth management division, which has about a fifth the assets, and accounted for 12% of its parent’s 2019 net revenue. Absorbing its Swiss rival would reduce Goldman’s dependency on riskier, less predictable, activities like global markets or investment banking, which last year brought in 40% and 20% of net revenue, respectively. A deal would boost Goldman in an area where it lags Morgan Stanley, especially once the latter completes its purchase of E*Trade; and Bank of America, which bought Merrill Lynch during the financial crisis. UBS established itself as serving wealthy Americans with the $10.8 billion purchase of PaineWebber 20 years ago.
As established U.S. wealth managers, Morgan Stanley and BofA would be in a better position to squeeze costs out of a merger with UBS. Combining two of the three largest U.S. wealth management businesses wouldn’t be pretty and could lead to the loss of both clients and relationship managers. But slicing 10% from the Swiss bank’s operating expenses in wealth management would free up some $1.3 billion a year. That alone could justify paying a premium of nearly $10 billion to UBS shareholders, before accounting for other potential synergies.
UBS also has a $900 billion asset management division which made $532 million before taxes last year. For Goldman, that would boost its investment arm by nearly two-thirds to around $2.2 trillion. Morgan Stanley’s investment management unit ended the year with $552 billion under management and $447 million of pre-tax income. That’s not far off from Credit Suisse, which had 438 billion Swiss francs of assets under its wing, generating pre-tax profit of 473 million Swiss francs.
The last big piece of the puzzle, investment banking, is where things get knotty. Combinations in the sector almost never meet expectations, largely because the best employees leave and customers often do less business with the larger entity to reduce counterparty and concentration risk. That was the case, for instance, with Credit Suisse’s purchase of American securities firm Donaldson, Lufkin & Jenrette back in 2000. But what if the goal was not to expand market share but rather to reduce the amount of capital tied up in the U.S. arms of the two Swiss banks?
There would still be some benefits to Goldman or another investment bank from going Swiss. Credit Suisse came in seventh globally in the league table rankings compiled by Refinitiv for advising on mergers and acquisitions, syndicating loans and underwriting stock and bond deals last year. UBS came in 14th. Credit Suisse has some expertise in areas a Wall Street partner might covet, such as structured products and leveraged finance. UBS would bring depth in Asia, where it ranked 9th, just ahead of Goldman, last year. It has also launched a joint venture with Banco do Brasil that might help in Latin America. But by and large, combining investment banks would be what one executive termed “a firing squad”.
Still, as bloody as the union might be for the bankers involved, it potentially would allow for the combination to hack away at the balance sheet of the Swiss groups, particularly in the United States where the Fed requires them to hold dedicated capital against their trading businesses. In such a scenario it’s possible that a sizeable chunk, if not all, of the $15 billion in capital held by UBS Americas in June last year could be released to shareholders as the investment bank unwinds its $81 billion of risk-weighted assets.
CHALK AND CHEESE
Just because a compelling case can be made in a spreadsheet for a Swiss charm offensive, doesn’t mean it will happen. For starters, the companies have very different corporate cultures. Goldman is a former partnership founded by a Jewish émigré from Bavaria. The Swiss banks were forced to compensate Holocaust victims for dormant accounts and lost assets 20 years ago. To placate Swiss interests, moreover, any acquirer would probably need to commit to making Zurich a global headquarters for the combined international wealth and asset management businesses.
Another risk is that the billionaire customers of Swiss banks in Asia and beyond might not take kindly to having their assets managed by an American institution. Though changes to bank secrecy laws no longer give Switzerland the same edge as in years past, there is arguably a halo effect to the idea of entrusting money to a bank headquartered in neutral Switzerland, especially as the administration of U.S. President Donald Trump has aggressively used financial sanctions as an instrument of U.S. foreign policy.
Those considerations could merit selling some of the international wealth operations to another bank, such as HSBC or Banco Santander. Similarly, a U.S. owner might want to offload the Swiss private banking business, as Morgan Stanley did for compliance reasons in 2014. Finally, there’s the question of whether the Fed would let an American bank get so adventurous, even if it could make a case that a deal reduced market risk without measurably expanding its balance sheet. Goldman has yet to agree a settlement with regulatory and judicial authorities in Washington, Malaysia and elsewhere over the multibillion 1MDB sovereign wealth fund fraud. Even when it does close that chapter, the Fed could still decide to tie Goldman’s hands on doing a big deal for years to come.
For now, the prospect of a Wall Street expedition to the Alps may seem remote. But as the new brooms at UBS and Credit Suisse confront the harsh realities of their businesses, and identify their strengths, the logic may become clearer to them. Ditto for Solomon as he watches Morgan Stanley – which is watching JPMorgan – expand its domestic lead over Goldman.
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