UBS Capital Strategy Converges With Credit Suisse in Fortress Switzerland
UBS AG (UBSN) and Credit Suisse Group AG (CSGN), Switzerland’s largest banks, are finding that the advantages of Europe’s toughest capital requirements are helping offset the costs as the region’s sovereign-debt crisis escalates.
The two lenders shrank their balance sheets the most among Europe’s 15 biggest banks since 2007, even as rivals grew, data compiled by Bloomberg show. Both are further scaling down their securities units to lift capital ratios.
While UBS and Credit Suisse, based in Zurich, initially resisted Swiss regulators’ efforts to introduce stricter capital and liquidity measures starting in 2008, arguing they wouldn’t be able to compete with international rivals, they now say the more prudent capital and cash reserves are beneficial.
“In a market like this one, investors are looking for solidity and safety,” UBS Chief Executive Officer Sergio Ermotti said in an interview last month. “To have a buffer of capital above our peers is something we think is a competitive advantage. But at the end of the day, what is also a competitive advantage is the solidity of Switzerland as a country.”
Ermotti, 51, announced plans last month to cut UBS’s risk- weighted assets by 130 billion francs ($139 billion), or 33 percent, by the end of 2016. He’s following predecessor Oswald Gruebel, who made building up capital an “overriding priority” when he joined UBS in 2009, four months after the Swiss government and central bank bailed out UBS.
Credit Suisse CEO Brady Dougan, 52, who led the company through the subprime-mortgage crisis without a state rescue, said last month the bank will eliminate 85 billion francs, or 23 percent, of risk-weighted assets by the end of 2014.
Luring Wealthy Clients
Ermotti and Dougan say fatter capital buffers help them attract funds from wealthy clients. UBS, which got 53 percent of pretax profit from wealth management in the first nine months of the year, added 30.7 billion francs of net new funds in the period. Credit Suisse, which generated 27 percent of earnings from wealth management, attracted 33.8 billion francs.
The Swiss banking regulator and the Swiss National Bank began pushing the lenders to clean up their balance sheets, cut assets and boost capital amid the 2008 crisis. That gave UBS and Credit Suisse a head start on European peers, who are now deleveraging. Twenty-two European lenders plan to cut risk- weighted assets by a combined 1.2 trillion euros ($1.6 trillion), or about 15 percent, according to Kian Abouhossein, an analyst at New York-based JPMorgan Chase & Co.
From the end of 2007, when the U.S. subprime crisis was claiming its first casualties, through this September, UBS and Credit Suisse had already reduced their risk-weighted assets by 44 percent and 35 percent, respectively, company reports show. The rest of the 15 largest European banks have, on average, increased such assets by 12 percent in the period, according to Bloomberg data.
UBS and Credit Suisse, which put up “a large amount of initial resistance” to the regulators’ demands, became more amenable to the changes after the September 2008 bankruptcy of Lehman Brothers Holdings Inc., according to the Swiss Financial Market Supervisory Authority’s report on lessons from the crisis published in September 2009.
Philipp Hildebrand, then SNB vice president, proposed limiting the banks’ leverage, or the ratio of total assets to capital, in June 2008 after the central bank’s analysis of financial system stability showed that cumulative assets of UBS and Credit Suisse in 2007 exceeded the country’s annual gross domestic product by seven times while their capital-to-assets ratio had fallen to about 2.5 percent from 7 percent since 1995.
The banks protested that such a capital requirement was too crude because it didn’t take into account the riskiness of assets. Less than two weeks after the SNB’s proposal was made public, Credit Suisse Chief Risk Officer Tobias Guldimann rejected the idea, saying: “We manage banks according to Basel II, not Hildebrand I.”
The regulators’ influence increased after UBS had to turn to the Swiss government for a capital injection of 6 billion francs to spin off illiquid assets to an SNB fund in October 2008. The following month, the banking regulator signed into law requirements for UBS and Credit Suisse to limit their gross assets in proportion to capital and tighten the rules for reserves compared with risk-weighted assets by 2013.
In 2009, the banking regulator put forward proposals for stricter liquidity rules, and by the end of June 2010 the two banks were required to hold enough “first-class” liquid assets to cover at least 30 days of expenditures during a crisis. This year, both chambers of the Swiss parliament approved law changes to require the two banks to hold capital equal to at least 19 percent of risk-weighted assets by 2019.
Few financial regulators in Europe acted as fast, waiting instead for international rules from the Basel Committee on Banking Supervision. France and Germany led efforts to weaken regulations from the committee, which softened its original proposals and gave lenders about a decade to comply.
Banks worldwide will be required to hold capital of at least 10.5 percent of risk-weighted assets by 2019. The committee last week was weighing changes to a proposed liquidity requirement, similar to the one Switzerland implemented last year, under pressure from banks that argue it will stymie lending. A leverage ratio requirement is still under review.
Finma Chairman Anne Heritier Lachat said the Swiss regulator is vindicated for pushing through tougher requirements.
The credit crisis of 2008 showed that “self-regulation doesn’t work,” she said at a Dec. 1 event of the British-Swiss Chamber of Commerce in Geneva. “We had to act because Switzerland was in a very specific situation. The risks were high. We had really no choice.”
Thanks to stricter rules, UBS and Credit Suisse have cleaner and more transparent balance sheets than their rivals, said James Breiding, who this year co-authored the book “Wirtschaftswunder Schweiz” (Swiss Made -- The Untold Story Behind Switzerland’s Success) with Gerhard Schwarz.
“The idea of requiring more capital is a crude way of risk control, but it’s effective and easy to measure,” said Breiding, a co-founder of Zurich-based asset manager Naissance Capital Ltd. who doesn’t hold UBS and Credit Suisse shares. “During the last crisis, UBS’s problems caught everyone completely by surprise, but in terms of how the Swiss responded and dealt with that, I think it was very rapid, decisive and exemplary.”
While bigger capital buffers haven’t made UBS and Credit Suisse immune to the market rout as investors shun financial companies, they may have helped lessen the impact.
UBS dropped 29 percent this year in Zurich trading, and Credit Suisse tumbled 41 percent, compared with a 35 percent decline in Bloomberg’s European banking index. (BEBANKS) The two banks trade at price-to-book ratios that are only surpassed by HSBC (HSBA) Holdings Plc and Nordea Bank AG among the 15 biggest European lenders.
The cost of insuring against default on UBS’s debt with credit-default swaps more than doubled in 2011, while Credit Suisse saw a 64 percent increase. Among the region’s 15 biggest banks, only contracts tied to London-based HSBC and Nordea of Stockholm are less expensive, Bloomberg data show.
The Swiss lenders also have less risk tied to Southern European bonds than some competitors. UBS’s net exposure to the sovereign debt of Italy, Belgium, Greece, Iceland, Spain, Portugal and Ireland was 1.34 billion francs at the end of September, while Credit Suisse’s net exposure to sovereign debt of Portugal, Italy, Ireland, Greece and Spain was about 900 million francs.
UBS and Credit Suisse fare better than French banks, Deutsche Bank AG and Barclays Plc in terms of their liquidity profile, said Andrew Lim, an analyst at Espirito Santo Investment Bank, in a September note. He analyzed the banks’ high-quality liquid assets as a proportion of wholesale funding maturing within one year.
“The liquidity profile of a bank is the risk metric that investors should be most concerned about, since the absence of liquidity quickly leads to a bank’s demise regardless of how strongly capitalized it is,” London-based Lim wrote. “UBS and Credit Suisse could theoretically fund themselves for about four-fifths of a year without having to resort to the wholesale funding markets.”
Credit Suisse’s dependence on short-term funding is down 34 percent since 2007 and its long-term liabilities exceed long- term assets by 110 billion francs as the bank had “substantially completed” its debt funding plan for this year, the company said on Nov. 1.
Customer deposits and long-term debt make up more than 50 percent of UBS’s funded balance sheet, up from about 40 percent in 2007, Chief Financial Officer Tom Naratil told investors on Nov. 17. The bank also has a surplus of “well over” 100 billion francs when comparing assets and liabilities with maturities of more than one year, he said.
While the finances of Swiss banks are being strengthened, shareholders need to prepare for lower profits and constrained dividend payments, said Dirk Becker, a Frankfurt-based analyst at Kepler Capital Markets.
Investment-bank downsizing will lead to lower revenues and possible losses, while profitability in wealth management will be squeezed as nations seek to repatriate non-declared funds from Switzerland and clients trade less, Becker said.
He said he expects Credit Suisse to cut dividends for this year and next to 50 centimes a share from the 1.30 francs the bank paid for 2010. UBS said last month it plans to pay 10 centimes a share for 2011, its first cash dividend in five years.
“Fortress Switzerland is being built at the expense of shareholders, at least in the short term,” said Becker. “In the long-term it’s of course good when you have a stable banking system and there might be advantages coming from that at some point. Right now the banks are only positioned well on capital, nowhere else.”
Pain for investors is unlikely to dissuade regulators seeking to protect stability in a country with a population of less than 8 million sandwiched between Germany, France, Italy and Austria. Daniel Zuberbuehler, Finma’s departing vice chairman, told newspaper Finanz und Wirtschaft this month that even the toughened capital requirements for UBS and Credit Suisse are “too mild.”
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