Bronte Capital - UBS: There Is Now Only One Large Swiss Bank

The following segment was excerpted from this fund letter.

UBS Group AG (NYSE:UBS)

The biggest thing that happened in markets in the quarter was the collapse of three banks: Credit Suisse (CS), Silicon Valley Bank and Signature Bank (OTC:SBNY). We have held short positions in each of these banks, but we traded them poorly and profits were smaller than they could have been.

We have also purchased the successor banks for two of them. We initiated positions in UBS (UBS), which has purchased Credit Suisse under advantageous terms, and First Citizens Bank, which purchased much of Silicon Valley Bank on even more advantageous terms.

Swiss banks were sharply weakened by the end of banking secrecy. Historically, Switzerland was a clean place to hide your dirty money, and Swiss banking was almost synonymous with tax avoidance.

Swiss banking secrecy is now extinct, and many American clients either paid their back taxes or were prosecuted.

Secrecy made Swiss banks profitable despite excessive cost structures. They had many rich customers who really couldn’t move their money elsewhere.

The end of banking secrecy left Swiss banks with unhappy clients who could now move their money elsewhere, excessive cost structures, and big fines from the US government. It wasn’t great.

Profits were going down.

Banks can, of course, increase their profitability by taking more risk, and both major Swiss banks (UBS, Credit Suisse) took this route. UBS, however, lost a lot of money in the financial crisis and sharply reduced their risk profile. They have maintained the lower risk profile ever since.

The last annual report makes this clear with a short company history:

Since our origins in the mid-19th century, many financial institutions have become part of the history of our firm and helped shape our development. 1998 was a major turning point: two of the three largest Swiss banks, Union Bank of Switzerland and Swiss Bank Corporation (SBC), merged to form UBS. Both banks were well established and successful in their own right. Union Bank of Switzerland had grown organically to become the largest Swiss bank. In contrast, SBC had grown mainly through strategic partnerships and acquisitions, including S.G. Warburg in 1995.

In 2000, we acquired PaineWebber, a US brokerage and asset management firm with roots going back to 1879, establishing us as a significant player in the US. For nearly 60 years, we have been building our strong presence in the Asia Pacific region, where we are by far the largest wealth manager, with asset management and investment banking capabilities.

After incurring significant losses in the 2008 financial crisis, we sought to return to our roots, emphasizing a client-centric model that requires less risk-taking and capital. In 2011, we started a strategic transformation of our business model to focus on our traditional businesses: wealth management globally, and personal and corporate banking in Switzerland.

Today, we are a leading and truly global wealth manager, a leading Swiss personal and corporate bank, a global, large-scale and diversified asset manager, and a focused investment bank.

Credit Suisse, by contrast, continued to take more risks (and risks inconsistent with the franchise and the skills of the staff). They got a deserved reputation as “accident prone.”

It was during this time we shorted Credit Suisse. We were aware of one accident unfolding, namely that the bank was putting a large amount of client money at risk with Greensill (blogged about that here.)

While we were short due to Greensill exposure, we made money on the short due to another “accident” at Credit Suisse that was exposed roughly simultaneously: large losses on margin loans to Archegos, an insanely aggressive family office.

We covered. We shouldn’t have. We understood just how much dross was in the bank. But we made money accidentally (on the Archegos incident, about which we knew nothing), and when we make money fortuitously, we like to take unearned profit—but not undue credit— for our luck. In this case, with multiple issues appearing, we should have remained short.

Though a legal dispute over culpability rages on, Greensill was part of the reason why Credit Suisse failed, having contributed to the erosion in market confidence. Credit Suisse put clients into their fixed income funds, marketing that they were safe. They were far from safe. Later, when Credit Suisse assured clients that their deposits were safe, some of those clients did not believe them.

Regardless, the multitude of accidents eventually doomed Credit Suisse.

UBS was given Credit Suisse on favorable terms by regulatory fiat. The terms are a discount to book of tens of billions of francs and liquidity guarantees from the Swiss National Bank.

The liquidity guarantees ensure that for the next few years, UBS is immune to bank runs. There is now only one large Swiss bank, and the large share of domestic business should ensure profitability.

We have purchased a long position in UBS, a rare new long for our fund.

Credit Suisse remains overstaffed with overpaid and risk-loving staff. We hope and expect UBS will fire many of them. If they don't, our UBS stock position probably won’t work that well. But the merger integration plans are not yet nailed down, so we consider this position provisional.

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