The $44bn bank bailout bonanza

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UBS’s second-quarter results last week included the impact of June’s “shotgun marriage” with archrival Credit Suisse. Its $29 billion profit was the bank’s best three-month performance so far.

The accounting gain from this seemingly “deal of the century” actually contributed to all of these gains. UBS bought the battered CS company on the cheap at a time when it was likely to collapse, in what was effectively a cooperation requested by the Swiss government.

With this consolidated accounts closed, we now have official data on quarterly reports and securities filings for all four major bank M&A rescues since the crisis in early spring:

• New York Community Bank/Signature Bank (March)

• First Citizens/Silicon Valley Bank (March)

• JP Morgan/First Republic Bank (May)

• UBS/Credit Suisse (June)

In any M&A transaction, so-called purchase accounting will require the buyer to allocate an “excess purchase price” to all acquired assets and liabilities. Typically, the purchase price (the present value of future cash flows) will still exceed the revised balance sheet valuation.

This gap is called “goodwill”.usually considered to be i don’t know what Goodwill is ultimately an arithmetic output derived mechanically to ensure that the pro forma balance sheet is indeed balanced.

But with these four deals, the calculations are much more interesting. The deals are extraordinary and authorities are desperate to find a buyer quickly and prevent a wider spread. As a result, buyers can largely dictate the terms of the deal.

In each of these cases, the buyer took over the target company at an effective purchase price that was substantially less than the book equity value (also known as net asset value) of the target company (the fair value of the assets minus the fair value of the liabilities).

As a result, buyers don’t need to raise expensive and potentially dilutive equity to close the deal. (By comparison, look at the recently announced merger between PacWest and Bank of California, a conventional deal that required a $500 million private equity infusion.)

All four deals created unusual “negative goodwill” as the net asset value exceeded the purchase price. Negative goodwill is a term in IFRS. Under U.S. GAAP, this concept is known as “bargain purchase earnings.” In both cases, earnings are recorded and run through the income statement to generate revenue, which then increases equity capital at essentially no cost.

(Note that when the deals were announced, the buyers each shared preliminary calculations of their expected payoffs, which are now largely confirmed by the final purchase accounting.)

Here’s an example from JPMorgan/First Republic:

Alphaville attempted to show the size of the gains for four buyers:

These four green bargain purchase prices/negative goodwill add up to a collective gain of $44 billion. Next we can see how large these gains are relative to the size of the bank before the transaction, as measured by shareholder equity recorded in the previous quarter.

JPMorgan paid a relatively high price for First Republic, including writing a $10.6 billion check to the FDIC and writing off a $5 billion deposit it made with First Republic earlier this year. For a bank with $300 billion in shareholders’ equity, the bargain gain is less than $3 billion.

First Citizens, a relatively small bank, just bought a majority stake in Silicon Valley Bank for $500 million, doubling its equity base.

More precisely, return on equity (profit divided by average shareholder equity) shows how efficient these deals are for buyers.

First Citizens, UBS and NYCB all had RoEs between 9% and 11% last quarter. Then they each won a gold medal.

Accounting issues aside, what may matter most is how these deals are received by shareholders.

Shares of First Citizen have nearly doubled. NYCB rose 43%, followed by UBS. JPMorgan, up just 9%, is a minor player compared to FRB, but still leads the KBW Bank Index by nearly 30 points, which has lost nearly a fifth of its value this year.

Taking advantage of regulators’ desperation basically means easy money for buyers. Former shareholders of the failing banks, non-depository creditors, and deposit insurance schemes, which are broadly funded by the banking industry, have all suffered heavy losses.

As evidenced by these acquirers, these failing banks have viable assets. Why the returns on these assets can only be captured by opportunistic parties remains a public policy question.