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How 'badwill' created a windfall of over half a billion for a private bank
17/03/2017 , Ian Orton

Here is an apparent paradox. A bank purchases another bank and then almost immediately books additional net income of over CHF 500 million to help boost profits.

This is counter-intuitive to say the least. Mergers and acquisition (M&A), especially in the banking and financial services sector often have a negative impact on profitability, if not income and revenue. This stems from the tendency of acquirers to pay “goodwill” or a premium over the book value of the purchase.

“Goodwill” may reflect the additional earning power of the assets acquired as a consequence of, amongst other factors, the power of its brand.

In many instances, however, this fails to materialise and, as a consequence, the acquirer has to write the goodwill off. This has obvious implications for profitability.

So how has Zurich-based EFG International managed to book income of CHF 530.8 million in its consolidated income statement as a consequence of its purchase of BSI, another Swiss bank based in Lugano, within months of consolidating the business?

Ever since EFG announced that it intended to purchase BSI the Lugano-based bank has been mired in controversy, not least because of its involvement in the 1MDB affair and other disputes with clients and regulators, including the US Department of Justice.

The answer seems relatively straightforward. According to EFG it is paying far less than the book value of BSI’s assets.

In other words instead of paying “goodwill” EFG is effectively the recipient of its opposite, which should be surely be called “badwill”. 

And this certainly helped boost EFG’s reported or IFRS profits as Piergiorgio Pradelli, EFG deputy chief executive and chief financial officer explains in the Swiss bank’s latest annual report and accounts.

“IFRS profit attributable to owners of the group at CHF 339.3 million was positively impacted by the BSI acquisition, and reflects an underlying profit of CHF 82.3 million (which includes the operating results of the BSI business for the last two months of the year of CHF 8.8 million) and non-underlying profits of CHF 257.0 million,” he writes.

“The underlying profits were CHF 82.3 million, of which CHF 91.1 million arose from the existing EFG businesses (stable year on year), whilst the inclusion of the BSI business for the final two months of 2016 resulted in underlying losses of CHF (8.8) million.

“The non-underlying profit of CHF 257.0 million was positively impacted by the BSI acquisition, specifically the “bargain purchase on business acquisition” of CHF 530.8 million we recorded. This reflects the difference between what we believe will be the final purchase price for the business and the fair value of the net assets acquired on 31 October.

“The profit arising on the acquisition may ultimately change as we finalise the purchase price with the seller, in line with the terms of the Sale and Purchase Agreement and the seller has raised objections to the proposed price adjustments (see Note 31 to the consolidated financial statements). Any conclusions that may be reached by an independent expert on potential unresolved asset valuations may have an impact on the final profit we realise.”

There may be contingent liabilities to be met as a consequence of the BSI purchase.

As Note 31 to EFG’s consolidated financial statements BSI is involved with the ongoing investigation by US and Swiss legal authorities in the bribery and money laundering allegations surrounding FIFA, as well the “Malaysian Matter”, i.e. 1MDB.

In addition BSI is currently involved in two civil proceedings in Italy arising from its role as a trustee of trusts associated with three families that owned an Italian shipping company that went bankrupt.

Furthermore BSI has entered into a non-prosecution agreement with the US Department of Justice, the outcome of which has not been determined.

But EFG claims it is entitled to indemnification against any losses that may arise.

EFG has not escaped the costs of goodwill entirely, however. It make charge-offs of CHF 199.5 million against the goodwill associated with the acquisition of Harris Allday, a UK private investment manager and stockbrokers, Banque Edouard Constant, another Swiss bank, and PRS Group, a Florida-based investment manager over 10-years ago.

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