New UBS Writedown Dents Credibility

The Swiss bank's latest hit takes its total subprime losses to $18 billionand counting. Will its wealth management business suffer?

The $4 billion writedown announced by UBS (UBS) on Jan. 30 doesn't come as a huge surprise. As far as is known, UBS has the largest exposure among European banks to U.S. subprime mortgages and collateralized debt obligations (CDOs), and the value of these securities is continuing to deteriorate—hence the need to acknowledge further losses. Other banks also are expected to take further hits.

"European banks involved in U.S. subprime will be making further writedowns," says Simon Adamson, an analyst at debt specialists CreditSights in London. Other European banks with potential for additional subprime losses include Royal Bank of Scotland (RBS.L), Deutsche Bank (DB), Crédit Agricole, Credit Suisse (CS), and Barclays (BCS), Adamson says.

UBS's foray into the U.S. mortgage markets has turned into an absolute nightmare. The bank, which had been considered one of Europe's best-managed financial institutions, has now written off a staggering $18 billion in exposure to subprime and other risky securities—comparable to the $16.7 billion in losses taken by Merrill Lynch (MER) and the $18 billion hit taken by Citigroup (C). With UBS's overall exposure to potentially toxic debt estimated by Adamson at $29 billion, this may well not be the last such announcement from the bank's stone-fronted Zurich (Switzerland) headquarters. UBS now acknowledges that on Feb. 14 it will report a loss of about $4 billion for 2007.

Loss Announcement Lacks Details

Of course, the crucial question is whether the bank's pratfalls in the U.S. mortgage market will alienate the wealthy clients who trust the bank with their funds. UBS's world-leading wealth management business has more than $1 trillion under management and is a steady earner, even in hard times. In the third quarter alone, this global business had pretax profits of $1.6 billion. UBS's losses create doubts about whether high-risk investment banking and trading belong at the same institution as private banking and wealth management.

The terse announcement from UBS did not make clear exactly how the new losses came about. Unanswered questions, according to Adamson, include whether the new losses occurred because of concerns over the viability of bond insurers and whether credit problems are spreading into mortgages not classed as subprime. If the bank is writing down higher grades of mortgage debt, that would be a worrying development. In late afternoon Zurich trading UBS N shares were down 2.3%.

The oceans of red ink already have led to the removal of Chief Executive Officer Peter Wuffli (, 7/6/07), who was replaced by Marcel Rohner last year. Rohner is also temporarily doing the job of investment banking chief Huw Jenkins, who was also sacked. There is speculation in the financial markets that Marcel Ospel, the wily chairman and key architect of the series of deals that created UBS, looks increasingly vulnerable.

Upcoming Shareholder Showdown

In normal times the World Economic Forum meeting at Davos, about two hours' drive from Zurich, is an occasion for the top brass of UBS, the largest Swiss bank, to preen. Ospel did host his traditional private dinner on Jan. 25 at the National Hotel in Davos for the great and the good, including HSBC (HBC) Chairman Stephen Green; Jacob Wallenberg, Sweden's leading industrialist; and Barclays Chairman Marcus Agius. Attendees said the fete included a soporific presentation by World Bank Chief Robert Zoellick.

Where did UBS go wrong? The bank was unfortunate in trying to be a big player in U.S. mortgages at the top of the cycle. In addition, it is still paying for the fiasco that resulted from creating an internal hedge fund unit called Dillon Read Capital Management under a former investment banking chief, John Costas, in 2005. According to UBS sources, the U.S.-based unit, which was shut down last year, failed to attract new client money. In addition, the traders Costas took with him from the bank replicated the bank's own positions, leading to a high degree of risk at just the wrong time. Moreover, the bank's risk management systems did not flash red. "The technical indicators did not pick up risk," says a UBS source.

UBS now faces the twin tasks of repairing its balance sheet and placating angry shareholders. Bank management is concerned that reduced capital ratios caused by the losses might lead to ratings downgrades and alienate clients of UBS's most important business: wealth management.

In December, UBS announced that it was raising nearly $12 billion (, 12/10/07) in the form of 9% convertible notes from the Government of Singapore Investment Corp. and an unidentified Middle East investor rumored to be a senior Saudi prince. These moves will need to be approved at an Extraordinary General Meeting on Feb. 27 in Basel by shareholders, some of whom have already indicated their annoyance. For Ospel & Co., it is unlikely to be a happy occasion.

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