Swiss banks search for alternatives to M&A boom

Te near death of once widely accepted banking secrecy has led to a period of soul-searching in Swiss private banking, as the industry strives to re-invent itself. It would not be an exaggeration to say the upheavals facing Zurich and Geneva call into question the industry’s ultimate survival. Moreover, a clear decision by all of the Swiss authorities to adopt internationally acceptable, stable solutions to the external demands on the industry in relation to tax evasion charges may trigger certain opportunities for M&A activity in Switzerland.

But the situation in its entirety is altogether a more complex and challenging one. In addition to external factors such as tax evasion crackdowns and increased regulatory demands to clean up the industry’s image and strengthen the international standing of the sector as part of an overall financial stability plan, questions around structural risks are also reaching a crescendo. An expensive and unsustainable business model is struggling to cope with inflows of un-hedged foreign currency revenues, while the local currency continues to appreciate and costs continue to rise. As a result, cost-income ratios remain as vulnerable as ever.

Given the harsh business environment prevailing across the Swiss financial industry, academics and traditionalists might be forgiven for predicting significant consolidation through M&A activity. Examining perhaps one key indicator, it could be argued M&A has been at a record high in terms of assets under management changing hands in recent months.

The acquisitions of Sarasin by Brazil’s Safra, ABN Amro Suisse by UBP of Geneva and Clariden by Credit Suisse amount to a funds transfer to new houses of nearly SFr200bn (E166bn) in managed client assets. Although these are sizeable movements, the two largest were a result of one-off special events, hardly describable as an industry consolidating due to catalysing factors such as cost or regulatory pressures.

Rabobank exited its non-core holding in Sarasin at a profit after years of holding on to a standalone subsidiary then selling it on to a non-consolidator. Credit Suisse, in pursuit of a one-bank brand, integrated Clariden, aiming to hold onto as much of the Clariden client base as possible.

Even the sale of relatively smaller ABN Amro Suisse appeared driven more by head office-induced restructuring efforts, selling off non-core assets to raise capital to satisfy national and EU bailout terms and regulatory capital increase demands, than part of a traditional consolidation process. Heavily anticipated sector consolidation has not yet taken place at anything like the required pace, especially considering present stresses and short and medium-term perceived negative outlook for the industry.

In reality, such consolidation has effectively been stopped dead in its tracks, for several important reasons. First, the number of ‘bona fide prepared buyers’ –those able to face business risks and integration challenges as well as outbidding competitors – has fallen dramatically since the 2008 financial crisis and its aftermath, with this fall accelerated by taxation assaults on Switzerland from its neighbours and US authorities.

In statistical terms, M&A advisers have been misled into believing the demand side was, or is still, high by repeated expressions of interest from frustrated would-be ‘false’ consolidators. Such ‘consolidators’ wish to examine every opportunity, but discard them quickly as they are not fully prepared, unable to handle the risks, and hoping to find cheap acquisition ‘jewels’ absent of any serious challenges.

Thought to be an exception by some is the recent putative (not yet closed) acquisition of Merrill Lynch's non-US business by Julius Baer.Here again it was driven by the seller’s parent to generate much needed capital (much less than originally touted) with the Swiss component of the transaction relatively small and more importantly the deal is in essence an acquisition of client portfolios with a floor price, not a takeover of a brand and total legal entity business.

In the true sense this transaction can be alternatively described as a large potential purchase of clients in the belief that most wish to be transferred and that their relationship managers are willing to move over to a new culture with a different business model.

Strictly speaking this event is not a forced Swiss consolidation but a reflection of home country banking realities and considerations. It is quite ironic that a US bank is shedding a significant international offshore business to a Swiss and Swiss-based bank in the midst of ongoing negotiations by their respective governments and institutions on the subject of recovering unpaid taxes due by reportedly previously undeclared funds by US nationals.

In detailed, post-mortem examinations of the numerous Swiss acquisition opportunities either not pursued or dropped midway, it became apparent that the majority have been abandoned not because of price competition, but other factors. In particular, risks associated with ‘undeclared’ client portfolios, be they regulatory risks, tax risks, compliance risks or client retention risks (which increase dramatically after change in bank ownership).

Ironically, in an environment where private bank and wealth management valuations are at almost record lows, the propensity to see the transaction through and acquire has all but disappeared. Potential buyers are more concerned, and rightly so, about how to assess risks and value them, as well as how to legally define these risks to satisfy sellers’ perception of the risks, which are always going to be lower than those of putative buyers.

Consequently the degree of risk management clauses desired by buyers in purchase contracts makes most deals onerous to organise prudently and efficiently, leading most to be abandoned as fatigue sets in. This applies equally to large and small deals, although the perception is that larger deals can easier pass the risk test, as larger portfolios are simply an aggregation of smaller portfolios.

People issues also remain major hurdles and the current crisis has not really softened the demands of client-facing personnel, which further frustrate complex efforts to close a deal.

The current Options

We should recall the main reasons why buyers, who presently determine the direction of markets more than sellers, still appear interested in acquisitions.

Some believe cheap prices enable client acquisitions in bulk, saving time and effort compared to client by client organic growth; there is also a view that acquisition enables a bank to leverage their operating platform to result in a significant improvement in efficiency ratio. But others see acquisitions as a mere tool for survival given their small size and recognise the need to bulk up to become profitable or delay the inevitable option of selling.

We are convinced about the difficulty and improbability of significant private banking and wealth management consolidation in the near term. Despite the abundance of announced theoretical purchase targets, there exist certain options in the interim that can be proactively pursued while awaiting better days for M&A:

• Hire teams and migrate their clients onto your platform but only in a compliant and well documented way on the basis of ‘pay as they come in’.

• Buy client portfolios preferably with their client advisers equally on a ‘migration if compliant’ basis, only paying for actual real results. This tactic applies equally to independent asset managers, so long as clients are migrated in a compliant state or are held compliantly in an external custodial arrangement.

• Focus on international markets where your institution can add value and develop an expertise and knowledge base, operating in a compliant way and consider divesting or running off those sub-scale coverage areas.

• Establish fee-sharing alliances with domestic participants in your international markets of focus to draw in new client assets in a compliant fashion.

None of the above are innovations or major discoveries but they afford time while M&A conditions are difficult and leave the hard decision of winding down in surrender, especially for the smaller players, as a last resort. If a decision is made to sell, a sale of only the client assets is recommended, with a subsequent winding down of the legal licence-holding entity as the least onerous route, yielding the highest probability of successful closure at acceptable terms and conditions.

The outlook for M&A in Switzerland is modest at best in the near term, although certain foreign owners of Swiss-based private banks may accelerate their exits from the market place due to their own capital preservation needs and strategies, this being the worst time to sell from every possible perspective, price and conditions alike. Those banks, which are upgrading compliance and risk management, which manage to survive the next two years, will become more attractive targets for consolidators, whose risk appetite will nevertheless remain subdued.

While the majority of banks and wealth managers are in effect for sale, only the best will be able to attract buyers at reasonable terms, whenever that may be.

This is the first in a series of articles by Ray Soudah, founding partner of Swiss and UK based independent M&A advisory firm MilleniumAssociates AG