UBS is shaking off the shackles of Credit Suisse's previous wrongs
Imminent half year results will reveal whether the new Swiss bank is a hastily patched monster or a new financial powerhouse
Although through wrongs not of its own doing, UBS finds itself entangled in problems inherited from the hastily arranged takeover of its cross town rival Credit Suisse in March. But despite the heavy burden, the Swiss bank is fast shedding problems as it looks to rise above the scandalous practices of its ex-arch rival.
In fact, rather than succumb to the pressures of past failures, the Swiss bank is firmly on the right track to attaining global prominence in its new post-merger form, and future expansion is on the cards.
Like it or not, during the combination of the two banks, UBS inadvertently inherited the negative market reputation from the many scandals disgracing Credit Suisse in recent years, and the financial penalties that they bring. One clear cut example is the $268m fine the Federal Reserve slapped on UBS at the end of July as it concluded its investigation of Credit Suisse’s involvement in the failed US-based hedge fund Archegos.
To make matters worse, the UK’s Prudential Regulation Authority also imposed an £87m ($119m) fine on the bank in regards to CS’ risk management failures. A lack of internal controls and governance led to the loss of $5.5bn from total return swap trades tied to Archegos, and a subsequent fine from the regulator.
Credit Suisse is thought to have set around Sfr35m ($39m) aside to pay fines related to the Archegos case. But even if provisions were far less than what UBS had to pay, Credit Suisse was likely to have factored in the need for the majority of its litigation needs and regulatory penalties. After all, in its final hours, it was not lack of capital but loss of confidence that led to its quick rescue — engineered by the Swiss government — at the hands of UBS.
The combined results of the two banks on August 31 will do more than just offer an insight into the financial system in Switzerland, it will offer a peak into the annals of the newly created national financial superpower.
But while doom sayers may expect things to be poor for UBS, there are certain signals that things are on the up. For example, the fact that that UBS recently opted to cancel a loss guarantee from the Swiss government as part of its takeover agreement can be seen as the single biggest sign that the new bank is emerging as a stronger player.
To sweeten the takeover amid uncertainties in March, the Swiss government and UBS agreed to a SFr25bn loss protection from valuation and restructuring arising from CS’s balance sheet. The lion’s share of around Sfr16bn-equivalent stemmed from the complete write down of CS’s additional tier one bonds, a bank’s most junior debt capital.
But there was also a further Sfr9bn of loss guarantee provided by the government on any losses UBS takes on CS’s non-core portfolio exceeding Sfr5bn. This was not a free lunch, however. UBS paid an initial fee of Sfr40m for establishing the Sfr9bn loss protection schemes. But separately, CS also paid a total of Sfr690m to use up to Sfr100bn of liquidity under the Swiss National Bank’s Public Liquidity Backstop and Emergency Liquidity Assistance Plus arrangements.
UBS has also paid back the Sfr50bn emergency liquidity provision that CS borrowed, and terminated the Sfr100bn facility. A flex of confidence that highlights the combined entity has no liquidity concerns, despite globally tighter monetary conditions. Moreover, all parties involved can now freely declare that, formally, taxpayers are off the hook for CS’s past misadventures. This is very important as the bank tries to rebuild confidence and the damaged reputation of the stability of the Swiss banking sector.
The decision to drop the guarantee early most likely came because UBS has deemed that CS’s assets are far more solid than many was initially expected. And because terminating state support brings practical advantages, there will be savings on future fees.
But the bank is already reaping the benefits in other ways too.
On August 11, when UBS voluntarily terminated the state support, the cost of protecting against its senior debt defaulting was 75bp. This was a far cry from the credit default swap that peaked and closed at 164bp on March 20. Swiss banks’ bond spreads have also contracted, largely thanks to UBS’s perceived strong standing. On the same day that UBS announced the termination of the state support, the iBoxx € Banks Switzerland Index, measuring the credit spreads of the country’s banks in euros, closed 1.7bp lower at 126.6bp. This meant a tightening of 12bp over the past month and far below the 307bp level from March 20.
Even in the past two weeks of receding risk taking and bank spread widening, UBS has reeked of confidence. Something Credit Suisse had been lacking in recent years.
The move sends a strong signal across all parts of the financial market: from the primary market for future funding, to trading and derivative costs with counterparts, institutional investors, depositors and all sort of other clients who might want to use UBS’s investment banking services.
Moreover, the combination the two banks' separate wealth management businesses will create a new European behemoth in asset management with more than $1.5trn in assets under management. That will make the new UBS a bigger investor too.
All in all, the August 31 results will provide future guidance about whether UBS has managed to partially cleanse itself of the scandals that had led to continuous losses at CS. Or whether the failings of its former rivals will end up being a cross it has to bear in perpetuity.