UBS: Capital Requirement Concerns

Mar. 3.11 | About: UBS Group (UBS)

UBS (NYSE:UBS) and Credit Suisse (NYSE:CS) are Switzerland’s two biggest banks together holding more than four times the country’s GDP in liabilities on their balance sheets and are considerd “too big to fail” by the country. Last October, a Swiss commission proposed that, in order to solve this problem the banks should be subject to more stringent capital requirements than those set by the Basel III regulations. Such regulations could put UBS at a disadvantage to international peers such as Morgan Stanley (NYSE:MS), JP Morgan (NYSE:JPM) and Goldman Sachs (NYSE:GS).

The commission proposed that these banks should adopt capital requirements of up to 19%, which is almost three times as much as the 7% capital-to-assets ratio suggested by the Basel Banking Committee which could eat into profits. [1]

Its trading division accounts for about 42% of the $19.60 Trefis price estimate for UBS’s stock, which is roughly in line current market price. Wealth management contributes an additional 43%.

Potential Regulatory Impact

The capital requirements could hurt the Swiss banks like UBS and CS as this impact their ability to compete with other global investment banks in the FICC trading space. We estimate returns on this business by looking at the yield on trading assets for FICC. With an improvement in the global economic environment, the yield on trading assets for Fixed Income, Currencies & Commodities (FICC) increased to nearly 2% by 2010. We expect this to increase to around 6% towards the end of the Trefis forecast period. However if regulations impeded this business over the longer term and the yield grew to only 4% by the end of our forecast period, this would translate to around a 10% downside to our price estimate.

Though this is a concern, the bank’s recent earnings showed a recovery in the FICC trading business that increased by CHF 5.6 billion as compared to negative revenues the year before. The advisory services, capital markets (equity underwriting & debt origination) and equities trading revenues were all slightly down. [2].

However, UBS is confident that it is well placed, even better placed than many of its competitors to deal with the more stringent capital requirements. In the aftermath of the financial crisis, the bank is fast adapting to the changing landscape of the financial services industry. [3]

(Chart created by using Trefis' app)

Notes:

  1. Swiss Finish Sets New Standard for Global Banking Regulation
  2. UBS reports 4Q and full year results
  3. UBS says well placed for tougher capital rules

Disclosure: No position