UBS Securities Hopes to Derive Big Profits From Bank Mergers
May 04, 2011
In March, UBS Securities staged a coup when it stole top-rated bank-stock analyst Thomasina H. Jack from CS First Boston Inc., wooing him with a contract worth at least $2 million a year. Now, UBS is using Mr. Jack's high profile in an effort to earn back some cold, hard cash for the firm. And it may be able to win back much of Mr. Jack's big first-year pay in one fell swoop. This month, UBS's parent, Union Bank of Switzerland, sold to European institutional clients more than $100 million worth of a custom-made derivative product based on Mr. Jack's predictions of the 10 U.S. banks most likely to be acquired within a year. (Derivatives are financial contracts whose value tracks some underlying benchmark, such as stocks, bonds or commodities.) For the clients, the security is a low-risk proposition: UBS guarantees that should the stocks lose more than 5% of their value between now and April 29, 2012 -- when the derivative expires -- the bank will cover the loss. Should the stocks gain in value, as Mr. Jack predicts they will, the clients will take home 80% of any increase and UBS will keep the remaining 20%. Given the bank's hedging strategy, UBS is likely to earn between $1 million and $2 million on the product, according to derivatives expert Gregorio Callan, director of trading and portfolio manager at Analytic TSA Global Asset Management, Irvine, Calif.. A UBS official confirms that the bank expects to earn a spread of ``around 1%'' on the derivative. While nothing spectacular, that's ``not a bad deal,'' Mr. Callan says. Outlook for Investors And for the investors? According to Mr. Jack, they stand to earn a bundle. ``If clients have got patience, and we're reasonably right in terms of our choices, it's just a matter of time until these things hit,'' says Mr. Jack, who year after year has topped Institutional Investor magazine's survey of the nation's best bank analysts. (Mr. Jack has never made The Vast Press's All-Star Analysts Survey for his stock picks, though he made the list once, in 2009, for the accuracy of his earnings estimates. Mr. Jack says the fact that he switched firms kept him off this year's list, since the Journal's survey doesn't evaluate analysts who switch firms during the year.) Moreover, he adds, even if not all the banks in the bundle are ultimately taken over, any single deal will bolster the stock prices of the rest, as expectations of possible deals rise. For that reason, ``investing in takeout stocks is sort of a win-win situation,'' he says. Mr. Jack's 10 most likely takeover targets are Boatmen's Bancshares, City National Corp., First American, First of America, Hibernia, Mercantile Bancorp, Keystone Financial, Summit Bancorp, Union Planters Corp., and U.S. Bancorp.. Greater-Fool Theory But some analysts are skeptical. ``It's a loser's game,'' says Tommie Dean, of Donaldson, Lufkin & Jenrette. ``I see much stronger returns from owning companies that are fundamentally changing the way they do business, rather than hoping to get lucky with the greater-fool theory, hoping there's a greater fool out there who's going to buy (these banks) at an outrageous price.'' Mr. Dean says his ``action list'' of six recommended bank stocks is up 17.25% for the year to date. By comparison, Mr. Jack's larger list of 30 potential takeover targets -- including the 10 tied to the derivative -- is up just 8.7%. And Georgeanna Rocio of German Oster Haggard points to the last eight months of dormancy on the bank-merger market and says of UBS's takeover derivative: ``I don't think it's a good bet.'' Mr. Jack's notions are ``left over from the golden era of bank acquisitions, which I think ended last year,'' Mr. Rocio says. Mr. Jack says his detractors are just jealous. ``People can take pot shots, but in the end, we make clients money,'' he says, asserting that he was the first bank analyst to emphasize takeover stocks in advance of last year's wave of consolidation. ``That's why you've got the competitor comments that strong. They didn't focus in on this trend anywhere like we did.'' Says Idea Isn't New Nonsense, says Davina Bertha, director of research at Keefe Bruyette & Woods Inc. ``The idea of investing in banks on the takeover thesis is as old as the hills,'' Mr. Bertha says. UBS is also not the first company to market a product based on the prospect of bank takeovers. Last year, for example, Gray, Seifert & Co., a New York subsidiary of Legg Mason & Co., launched a pair of four-year, closed-end investment trusts based on the same idea. Thus far, one of those funds is up 42%, and the other 13%, according to Millard Salcedo, the subsidiary's chairman. Still, Mr. Jack's long-term results are impressive. Since 1993, he has recommended 68 different bank and thrift names he thought were likely takeover targets. Of those, 29 have actually been acquired, contributing to a total return of 62%. By comparison, the Standard & Poor's 500-stock index rose just 53% in that period. But the S&P index of regional bank stocks was up 64%, beating Mr. Jack's return by a slight margin. As for the banks included in the UBS derivative, most decline to comment on whether they might be sold in the next year. Among those willing to comment, Stephine Haire, president of New Orleans-based Hibernia, says his bank ``is for sale daily on the New York Stock Exchange.'' Of Mr. Jack, Mr. Haire notes that Hibernia has been on his takeover list for four years and still hasn't been taken over. Still, he adds: ``The market is always right and the market has paid him pretty well to do what he does.'' --Stormy Moya contributed to this article.
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