2020-10-15

“Well early in the morning, I'm a giving you the warning
Don't you step on my blue suede shoes
Hey diddle diddle, I'll play my fiddle
Ain't got nothing to lose
Roll over Beethoven
And tell Tchaikovsky the news”
Roll over Beethoven – The Beatles

Citing unidentified people inside the 2 banks, Inside Paradeplatz, an online finance newspaper, is speculating that the chairman of UBS & Credit Suisse are exploring a potential merger, nicknamed Signal, to create one of Europe’s largest banks. The rumour, emerged mid-September and I’ve been asked the whys & hows, the validity of such a plan, etc. Before I give you my present take on this, I should like you to look at my past take on this when I wrote the following 7 years ago, based on the news at that time.

“A Tale of Two Sisters is a 2003 South Korean psychological horror film written and directed by Kim Ji-Woon. The plot focuses on two sisters who, after returning home from a psychiatric hospital, experience increasingly disturbing events involving both them and their stepmother. 
Ignoring the geography & the stepmother, this plot reminds me of the horror stories of UBS and Credit Suisse, the Two Sisters. Recently, the Swiss banking policeman, the Swiss Financial Market Supervisory Authority (FINMA), blocked one Sister, UBS, from paying a dividend to her shareholders in 2014 so that Sis UBS could boost her capital ratio by CHF 28 bn.  At the same time, Qatar Holding could become, through the conversion of its “coco’s” or so-called contingent convertible bonds (no, nothing to do with coconut or cocoa) by far the largest shareholder of the other Sister, Credit Suisse, with 5.2% in shares & 16.53% purchase rights. In other words, if the capital buffer of Sis Credit Suisse falls under a certain level, FINMA could force the bank to issue more capital and the “coco’s” would be converted automatically. This mechanism would put 60% of the bank’s shares in the hands of 8 foreign shareholders, including Qatar Holding. I am not implying that it is a negative development, I am just stating, in the words of Bob Dylan, that “The times, they are changing”. By the way, last year, the bank was severely admonished by the Swiss National Bank with respect to the same subject, namely the inadequacy of its capital ratio.
What we know is that in the past the Two Sisters took on too many risks for too long: they indulged in sub-primes, structured products and other financial weapons of mass destruction.  And I haven’t even mentioned the US Justice Department clamping down on Swiss Banks for their alleged role in helping US citizens to dodge taxes. We are not invested in the two sisters now, but loyal to our contrarian approach we think we found an interesting value play in the banking sector.”

That was back in 2013 and for the Fund, we invested in Valiant (www.valiant.ch), the eponymous Swiss “plain vanilla” retail bank serving Mr. & Mrs. Mueller from Aarau to Nyon and Basel to Zell in some 80 branches, some of them now digital. Valiant is a solid, no nonsense bank (“we’re simply a bank” is their logo), connecting the dots & ticking most of the value investor’s boxes, and, even though the strategy & its execution is mostly on track, the ZIRC (Zero Interest Rate Capitalism) environment is hampering the stock performance, despite a very attractive dividend pay-out & yield. Although pedestrian, the performance is positive.

What about the Two Sisters? Over the period from 1995 to 2015, UBS shares compounded 2.0% per annum, including dividends, while Sis Credit Suisse produced 1.3%. Hardly exciting! During the same period the best corporates we have in the Fund, such as Geberit, Emmi and Kuehne & Nagel have returned 15% per annum. With respect to Valiant, over the 7 years we have owned it, the performance is flat, so not exciting either, but an annual dividend yield of around 4% was paid over the period.

What about the Two Sisters during the same period?  UBS stock halved, and Credit Suisse lost 2/3 of its value. And now, they are rumoured to merge. In my humble opinion, this will hardly bring any shareholder value. In fact, it made me think about the effects of consanguinity. I am far from a scientific, just an observer of (human) nature. Consanguineous marriages have been practiced for hundreds of years in many parts of the world. But science has proven that the rate of congenital malformations among the offspring is 2.5 times higher than that among the offspring of unrelated parents, mainly due to the expression of autosomal-recessive disorders. Hospitalization, for these reasons, causes a major financial burden. I don’t know much about autosomal-recessive disorders, but a merger between the Two Sisters could be a misconceived, malformed & sick child, that could in time cause a major financial burden for all stakeholders.

So, dear Sirs, Chairmen of UBS & Credit Suisse, let me please Signal you what Victor Hugo said about reason & imagination!

“Reason is intelligence taking exercise. Imagination is intelligence with an erection.”

I was listening recently to Piano Concerto No. 5 from Ludwig van Beethoven, a powerful piece of music called the “Emperor”. Already affected by (surdity) deafness, the great composer wrote it in the period Vienna was devastated by the war with Napoleon. He declared at the time: “The whole course of events has affected my body & my soul. What a disturbing, wild life around me. Nothing but drums, cannons, men, misery of all sorts.”
It’s in this environment of utter adversity that he wrote the masterpiece.
I’m afraid, dear Sirs  you need to go back to the drawing board & dig a little deeper!

Well, you may say I’m a dreamer, but “a dreamer is one who can only find his way by moonlight, and his punishment is that he sees the dawn before the rest of the world.” (Oscar Wilde)