BREAKINGVIEWS-Swiss government puts best spin on UBS $26 bln hit

By Liam Proud

LONDON, June 6 (Reuters Breakingviews) - UBS’s UBSG.S regulatory day of reckoning has finally arrived. According to the Swiss government, long-anticipated new capital measures announced on Friday aren’t necessarily a big deal for the bank’s CEO Sergio Ermotti. Investors seem pleasantly surprised too, sending the wealth manager’s shares briefly up 6%. A rosy assessment, however, looks wrong.

The core of the Federal Council’s package, designed to prevent another Credit Suisse-style failure, is a plan to force systemically important banks to fund their foreign subsidiaries entirely with equity. The current practice, which involves using a dollop of debt and is known as double-leverage, made it tricky for the collapsed lender to sell off or radically restructure its U.S. investment bank as the group careened towards disaster.

Friday’s proposal is most relevant for $108 billion UBS, which after absorbing Credit Suisse in a 2023 rescue deal is now the sole Swiss banking behemoth with giant overseas operations. Using just equity to fund its foreign subsidiaries, the largest of which is UBS Americas, could raise the group’s core common equity Tier 1 (CET1) capital requirement by $26 billion, according to government estimates which also factor in some other planned rule changes. The bank puts the number at $24 billion.

The debate is whether that’s painful or manageable. Finance Minister Karin Keller-Sutter seems to think it’s the latter. The government suggested on Friday UBS could end up with an overall CET1 ratio of 15% to 17%, which nicely straddles the roughly 16% levels for Morgan Stanley MS.N and JPMorgan JPM.N in 2024. At the low end, it would be barely higher than the 14.6% analysts are pencilling in for UBS next year, based on Visible Alpha data. The implication is that Ermotti should just swallow the ostensibly tame measures and move on.

That’s unlikely. A government-commissioned report by Alvarez & Marsal puts the CET1 ratio number after full equity foreign-subsidiary funding at 17% to 19%. UBS put out a statement estimating the figure at 19%. At that level, according to Breakingviews calculations using Visible Alpha data, the group’s return on CET1 in 2028 could be about 12.5% rather than the targeted 15%. To get the return up, Ermotti might have to deploy more radical measures like shrinking capital-intensive investment banking activities and potentially even selling some foreign businesses.

The gap between the UBS, Alvarez & Marsal and government figures partly relates to the scope of the exercise: Keller-Sutter’s number crunchers have factored in the broader suite of measures, which include changes to the way the rules treat software or deferred tax assets, while Alvarez & Marsal’s haven’t. That’s no comfort for Ermotti. UBS reckons even after making those adjustments, the right figure is 17%. Getting down to the government’s assumed 15% implies that UBS can take more mitigating actions like freely shifting capital out of subsidiaries, which may not be easy.

The next question is whether Ermotti can nudge lawmakers to agree with his view of things, resulting in an easier final law in parliament. That may take years. But the starting point is about as bad as UBS could have imagined.

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CONTEXT NEWS

The Swiss government on June 6 said that the country’s systemically important banks should fully deduct the carrying value of foreign subsidiaries from the parent bank’s common equity Tier 1 capital (CET1).

For UBS, the country’s largest lender, the package of new measures would equate to an extra CET1 requirement of up to $26 billion, according to a government-produced factsheet. The group’s overall CET1 capital ratio could hit 17%, the same document estimated, though it also said that UBS could reduce that to 15% through “management decisions”.

Shares in UBS were up 6% as of 1347 GMT on June 6.