So close to each other on either side of Zurich’s exclusive Bahnhofstrasse that staff can wave to each other through the windows, stand the headquarters of two venerable banks. Between them, they rule the Swiss banking market and both are world leaders in the archetypally Swiss and highly lucrative business of private banking.
Both had built strong corporate banks but, until a few years ago, Credit Suisse was the clear winner in investment banking, especially in the cut-throat US market. Its merger with white shoe US house First Boston had propelled it into an exclusive group of top tier, global investment banks, to which UBS, particularly before its merger with Swiss Bank Corporation, had not gained entry.
However, five years ago, the investment banking tables began to turn and the two banks’ paths began to diverge.
UBS is now the world’s biggest private bank by far, as measured by assets under management, while Credit Suisse has fallen behind to third place, at one-third of the size. In Credit Suisse First Boston’s (CSFB) investment banking heartland, UBS is beginning to make more than a cameo appearance in the top ranks. In the first quarter, it sat alongside Goldman Sachs as adviser to Gillette in its $57bn sale to Proctor & Gamble. CSFB’s investment banking franchise, meanwhile, has weakened. In the US, at least, it clings to the bigger name but it is no longer in the top three for M&A. And even in high yield, where the bank was at one time virtually invincible, it has been knocked off its top perch.
So what happened? In this tale of Dickensian reversals of fortune, there are clear faultlines on which the businesses of these two traditional rivals have diverged. They offer object lessons to any bank CEO about what drives a successful growth strategy, and what destroys it.
M&A divergence
The most visible fissure that defines the pair has been the success or failure of their acquisitions. In the ability to pick the right firm and to integrate it into its business, UBS has proved masterful. Credit Suisse has not.
Few years were more critical to the two banks than 2000, when both decided to make another US acquisition. On paper, Credit Suisse’s decision to buy Donaldson, Lufkin & Jenrette (DLJ), an investment bank that was number one in leveraged finance, looked like a good enough move. Bringing two strong US franchises together, it was thought, would surely propel CSFB to the top position, creating the global player in investment banking.
If that goal had been achieved, maybe the $13bn that Credit Suisse paid for DLJ would have been worth it. Instead, the deal ripped the firm apart. Synergies turned out to be overlaps and the whole was weaker than the sum of the parts. In every banker’s chair were found two people. A bloodbath was inevitable. Efforts to keep hold of top talent led to spiralling remuneration packages and an inflexible cost structure that left the bank particularly vulnerable in the imminent downturn.
Separately negotiated deals led to rival fiefdoms, in which politicking became a full time activity. It exacerbated a star culture and set the scene for CSFB’s technology meltdown by giving Frank Quattrone, head of its top-rated tech team, the long leash that led to his 18-month prison sentence for obstructing an investigation into the allocation of hot stock offerings during the bull market. With the first senior Wall Street figure to go to prison for more than a decade, it was a PR disaster for CSFB.
Gaining critical mass
UBS’s acquisition in 2000 was Paine Webber, a retail brokerage that was otherwise noted mainly for its municipal bond underwriting – hardly a sexy business. Nor did it come cheap. Like Credit Suisse, UBS was buying at the top of the market, coughing up about $12.2bn in cash and stock. Analysts still complain that UBS paid too much and that, although the business is now profitable, pre-tax margins of about 15% still lag behind those of the group, where pre-tax profits margins in Q1 stood at 31%.
And yet, the acquisition has been enough to give UBS critical mass in the US market. Christian Stark, a bank analyst at Cheuvreux, the equity brokerage subsidiary of the Calyon group, says that although both banks paid handsomely for their acquisitions, the Paine Webber transaction always made more sense for UBS. It not only “filled a gap in asset gathering” but UBS makes a good case for how Paine Webber has helped the bank overall, he says. “It had some businesses that could be transferred to UBS’s investment banking side and, with the commitment that the acquisition showed to the US market, UBS will argue that the Paine Webber brand helped it to build recognition and hire the right people.”
Sadly for CSFB, the influx of talent at UBS included Ken Moelis, a high yield rainmaker at DLJ, who was tipped to head up investment banking after the CSFB merger. He stayed at CSFB only a week before decamping to its rival and has helped to form the core of UBS’s current investment banking success. Under John Costas, who was appointed CEO of the investment bank in 2001, Mr Moelis, as head of investment banking, has attracted some of the talent required to build the sort of serious investment banking franchise that the firm previously lacked. Not surprisingly, several of them are former DLJ/CSFB staff, including co-head of M&A Jimmy Neissa and co-head of US equity capital markets Tom Fox.
John Costas chairman and CEO of UBS Investment Bank: under his leadership, UBS's head of investment banking Ken Moelis attracted the talent needed to build a serious investment bank franchise
Cohesion is key
Is the key that UBS is good at making acquisitions and Credit Suisse is not? Partly. Just as critical is its ability to integrate people and businesses into a cohesive whole. UBS has made an art out of forging a single culture. Over the years, it has absorbed a large number of different outfits, but they all sing from the UBS hymn sheet.
An extension of this has been building the UBS brand and ensuring that it is the bank that matters, not the banker. This is a firm where brand is king. Just like Goldman Sachs, whose place in investment banking it is chasing and whose branding strategy it emulates, it is not the bankers that UBS wants people to remember but the business card that they carry.
Credit Suisse has not proved so clever at picking the right partners. While tying up with First Boston was an undoubted success, its merger with Swiss insurance firm Winterthur in 1997 became a millstone around its neck when the equity markets crashed. This may have been as much bad luck as bad judgement, but the pursuit of then chairman Lukas Muhleman’s bancassurance model cost it dearly. Here, UBS was just plain lucky. In 1995, it took a 25% stake in Swiss Life with a view to turning that into a majority holding. Ultimately, the board of Swiss Life was not interested in being part of a bank and UBS sold its stake before Swiss Life went public in 1997.
Credit Suisse has also lacked the ability to make a happy marriage bed once the deed is done. The DLJ acquisition was a disaster, destroying the esprit de corps of both firms. It dragged its feet over the inevitable job cuts and stretched out the pain over a number of years. Everybody was looking over their shoulder. “It was the kind of place where people wouldn’t say hello to each in the other elevator,” says one former banker, trying to explain the atmosphere that persisted when he left 18 months ago, two years into the tenure of John Mack ‘the Knife’, the chief executive brought in from Morgan Stanley in 2001 to cut costs and return CSFB to profitability.
Who is in control of risk?
UBS and Credit Suisse are perceived as polar opposites in terms of risk and risk control. One is seen to have the risk appetite of an adrenalin junky, the other of a grey-haired granny. At Credit Suisse, group management let CSFB run its own show: the Swiss bank and the investment bank were essentially different firms, joined only at the balance sheet. It was a structure that helped to foster an entrepreneurial, go-getting spirit that won the firm huge gains: CSFB was the first bank to push into Russia after the collapse of communism, it made big profits in commercial mortgages and made its name as the tech bank during the technology/media/ telecoms (TMT) boom.
However, such gung-ho freedom translated into a loose risk management culture that exposed the bank to huge losses. When Russia declared a moratorium on its rouble and domestic dollar debt, CSFB had to swallow a $1.3bn write down. The credit market turmoil sent investors scurrying from commercial-mortgage-backed securities. The bank’s transaction group, which underwrote commercial mortgages, is said to have chalked up around $1bn losses. Mr Quattrone’s fall from grace in 2001, meanwhile, dragged CSFB’s reputation through the mud.
“In the past 15 years, [CSFB] has had three major blow-ups, which it only survived because it had a parent with deep pockets,” says Dirk Becker, a banking analyst at Kepler Equities in Frankfurt.
Public image
In the public mind, UBS’s highly centralised and conservative approach to risk could not be further from CSFB’s voracious risk appetite. “A lot of people perceive UBS as the bank that sidelines all the risk,” says Mr Stark. “Whenever there is a hiccup somewhere, they’re always ‘that bank that was not involved, or had its positions hedged or didn’t have any client relationships’.”
In fact, the firm’s current conservatism has emerged from the shadow of its own blow-ups. It was by far the biggest loser in the Long-Term Capital Management debacle – being forced to write off almost $1bn when the hedge fund collapsed in September 1998 (compared with Credit Suisse’s $55m). Dazzled by the fund partners’ fantastic reputation for big-number but low-risk arbitrage, UBS risk managers had never woken up to the possibility of its collapse.
Before that, in late 1997, UBS had already lost a huge sum in complex derivatives transactions. According to reports, the equity derivatives division had built a profitable business in convertible bonds from Japanese banks and complex, long-dated options, bringing in so much revenue that it had virtually no risk oversight from anyone outside of the department. But in 1996-1997, as Japanese banks lost up to 70% of their value and the UK government changed the way dividends were taxed, UBS watched the division’s profits turn to dust. In early 1998, The Economist reported insiders as putting UBS losses at SFr1bn ($689m), though figures of SFr2bn-SFr3bn were also bandied around. Just as Nick Leeson brought down Barings by trading and doing his own books, so UBS was caught short by failing to have in place an independent risk management structure.
Some believe that it was this hole in the balance sheet that drove the merger with the Swiss Bank Corporation (SBC), a much smaller, upstart, outfit. Certainly, heads rolled, including Mathis Cabiallavetta, former UBS CEO. It was SBC executives who largely took control as the old UBS guard were edged out. With them, they brought the state-of-the-art derivatives expertise and risk management excellence of O’Connor, the Chicago commodities and derivatives firm that SBC had teamed up with in 1988.
The merger changed the entire culture of the bank. “[UBS] got a bunch of very talented, young, mobile people that it could spread all over the group to get the culture right, and this is one of the intangibles you need if you want to succeed in investment banking – a soft factor,” explains Mr Becker.
The losses also prompted UBS to move into lower risk, more stable, high-volume businesses, where margins might be thin but money is made through sheer volume of trades. In FX, for example, UBS is now a global leader, executing about 12% of all currency trades worldwide. The approach has been replicated in equities, where UBS is now one of the biggest share traders in the US and, according to data provider Thomson Financial, accounts for one in nine of all equities trades worldwide.
“It’s a low risk business, it’s extremely high volume, extremely low margin. But in the end it’s a commission business, it’s not a trading business,” says Mr Becker.
