Can UBS make the most of finance’s deal of the century?

Since the deal was announced, shares in ubs have risen only a little. Yet the acquisition ought to be a boon, at least eventually. ubs bought Credit Suisse at a bargain: it will report an estimated $35bn of “negative goodwill”, the difference between what it paid and the higher book value of Credit Suisse’s equity. Turning this scale into profit hinges on the mammoth task of integrating the two institutions’ operations. All the usual post-merger headaches—combining it systems, aligning accounting standards, laying off staff and resolving culture clashes—are especially troublesome at a bank, let alone a failed one. Compared with ubs, Credit Suisse was appallingly inefficient: the bank had a higher ratio of costs to income in every one of its businesses. Its collapse was preceded by five consecutive quarters of losses and a stunning evaporation of confidence among clients and counterparties.

When ubs unveils its plans and delayed quarterly results at the end of August, investors will scrutinise any outflow of assets managed by the bank. There is little to suggest a large exodus has taken place. Julius Baer, a Swiss outfit that is likely to benefit from any flight, reported only modest inflows at its quarterly results on July 24th. But investors should also focus on two strategic decisions—ones which will ultimately determine the success of the deal. Both require knife-edge calls and present enormous execution challenges.

Credit Suisse’s domestic business is the first question mark. Bosses at ubs are debating whether to keep none, some or all of Credit Suisse Schweiz, which was established in 2016 as part of a plan, later shelved, to spin off the business. The Swiss bank was Credit Suisse’s only profitable division during the first quarter of 2023. Last year Schweiz’s equity had a book value of SFr13bn ($14bn). Selling the outfit at a valuation near this figure might be impossible given the speed with which clients fled before March. A shaky balance-sheet would hinder efforts to pick off better bits of the business, since the rump might struggle to support itself as a standalone operation.

Yet whereas gains from second-guessing political currents are uncertain, gains from keeping the business and making cuts are almost guaranteed. Assuming ubs’s shears are sufficiently sharp, and 70% of Credit Suisse Schweiz’s costs can be chopped, separating the whole business would mean forgoing nearly a third of the deal’s total annual cost savings, according to Barclays, a bank. Lay-offs affecting Credit Suisse’s 16,700 employees in Switzerland, such as from shutting retail branches, would draw particular ire from politicians and the public. According to Jefferies, an investment bank, around 60% of UBS and Credit Suisse branches are located within a kilometre of each other.

The second question mark concerns Credit Suisse’s investment bank, which accounted for a third of the institution’s costs last year, and will bear the brunt of the cuts. Mr Ermotti is no stranger to felling bankers: the number of people employed in ubs’s investment bank declined from about 17,000 in 2011 to 5,000 in 2019, leaving behind a leaner operation to play second fiddle to the bank’s elite wealth-management division. Credit Suisse failed to accomplish similar manoeuvres of its own. Therefore ubs last year generated nearly five times as much revenue per dollar of value at risk.

Winding down these operations will be a slog. Much of Credit Suisse’s investment-banking operations will be shoved into a “non-core” unit, along with some small parts of Credit Suisse’s money-managing businesses. Modern “bad banks” do not contain masses of toxic derivatives, like an older generation did after the global financial crisis. But they are still hard to shutter without incurring significant losses.

Protection against losses from selling some of Credit Suisse’s assets is provided by the Swiss government. As part of the acquisition agreement, the authorities committed themselves to absorbing up to SFr9bn of losses, so long as the first SFr5bn are shouldered by ubs. They are unlikely to have to cough up, however, given the relatively small pool of assets covered by the agreement. As a result, ubs could move to end the agreement before it has wound down the portfolio. The guarantee proved reassuring to investors during March’s turmoil. Today it carries a lot of political risk for not all that much financial gain.

Moreover, the loss guarantee fails to insure against the greatest danger when it comes to winding down an investment bank: that revenues plummet faster than costs, creating uncomfortable losses. Even excluding the sizeable cost of employees and one-off items, outgoings in Credit Suisse’s investment bank last year amounted to more than 60% of revenue. Many of these costs, such as the technology systems required to run a trading floor, will remain high even as assets are sold off. Consider Credit Suisse’s own wind-down unit, which the bank created as part of its failed restructuring programme. The unit’s assets have fallen by almost half since 2021, to SFr98bn; its costs, at SFr3bn in 2022, have hardly changed.

How quickly ubs is able to shutter this unit will be closely watched. So will what the bank’s bosses do with their remaining investment bank. European investment banks have retreated since the financial crisis, especially in America. Both Barclays and Deutsche Bank have struggled to convince investors their businesses are worth retaining. ubs’s investment bank is profitable, but would need a mighty boost to woo billionaires with its dealmaking advice. The prospect of building an elite, capital-light bank might be appealing in theory, and was the crux of Credit Suisse’s plan to spin out its own investment bank under the moniker of “First Boston”, a famous old institution that it acquired in 1990. But in practice this would require significant turnover among ubs’s own bankers, too.