UBS: Can It Get Any Worse?

In the movie Die Hard, the evil villain Hans Gruber says that after stealing $20m in bonds from a Japanese bank on Christmas Eve, he planned to store them in a Swiss bank account and retire “sitting on a beach collecting 20%”. Nowadays, he might not be quite as smug with that strategy.

After four consecutive quarters of losses and writedowns, the question outstanding is “Can it get any worse for UBS (UBS) and thus its share price?”

The question begins with recent rumors that HSBC (HBC) will call a bottom to the carnage and make a run at buying UBS.  Yet why would HSBC want to buy a firm leaning over a cliff with their arms flailing?

There are host of current problems with UBS will need to contend with before it is attractive to any suitors…

1) "We have hedges. They sit in front of my house."

In lawsuits between UBS and Paramax, a hedge fund, it was disclosed that UBS purchased credit protection for a CDO knowing the counterparty was too lightly capitalized to pay in full.  Exemplifying the hazards of the OTC swap market, if this was prevalent occurrence, expect that of much of UBS claims of "net exposure" are seriously under estimated.

2) Unquantified bond insurer exposure

UBS still owns a lot of mortgage securities, many hedged with monoline bond insurer protection that is now significantly reduced in value.  For the details, just look what UBS is willing to tell us in their reports. Oh Nelly, this is not good.

UBS said, however, that its as-yet-unspecified second-quarter write-downs were mostly linked to its monoline insurance exposure.

(Click on "Shareholder Report on Writedowns" [PDF file].)  

3) UBS still holds $400B in repurchase agreements for funding

Analysts also fear bank will continue to bleed capital from a massive 400 billion franc portfolio of repurchase agreements.  This area is very hard to quantify because it involves transactions with private equity, hedge funds and other OTC parties that do not require exposure.

The attempt to sell the bank is a desperate attempt to save remaining shareholder value.  I don't think anyone wants all of those problems right now.

4) Efforts to sell assets for cash failed

Dilutive capital raising, now totaling over $30B, have been the most reliable way of addressing the leveraged losses.  UBS is selling assets just at the same time everyone else is.

• Paine Webber brokerage arm to raise cash

Swiss bank UBS, another bank suffering from the credit crunch, recently shopped its PaineWebber brokerage unit in an effort to drum up cash but failed to find the right buyer. (BofA (BAC), Wells Fargo (WFC) and Barclays (BCS) all declined)

• Subprime sold at fire sale prices

UBS will give an update on its subprime exposure in a report on the second quarter due August 12. The exposure probably has fallen after UBS sold about $15 billion in assets to BlackRock Inc. in May.

When Citibank (C) performed a similar transaction for leveraged loans, they actually had to provide over 90% of the funds to induce the hedge fund to purchase the assets.  I would not be surprised if UBS structured as similar arrangement.  jIn such case, this does not eliminate exposure, just shifts the exposure to another part of the balance sheet.

6) Prime Brokerage is a liability, not an asset

Hedge funds rely on firms like UBS for loans, servicing, execution.  UBS has been at the forefront of the prime brokerage business for years and has a cozy relationship in many of the players.  At a time like this, that could be huge liability.  In Q1 UBS marked higher prime brokerage revenue, noting European trading firms as the prime drivers.  With the increasing volatility of that period, it is understandable that revenue from trade execution improved.  But UBS, just as all of the major investment banks do, has major equity stakes or leveraged exposure to many of the hedge funds they support through prime brokerage.  This will continue to be a huge exposure as the market swoon from insolvent banks and exploding oil prices.

7) UBS will require continued dilution of the shareholders

There is no sign of a real turnaround in UBS business right now.  The initial release on the Q2 reports close to a $3B loss that was erased due to tax credits from previous losses.  Not a strategy to make money, but it got them through this time.

In the Q1 report UBS reported that one of their key performance indicators, net new money, declined CHF 12.8B.  With the efforts to close down the municipal securities activities and deconstruction of the 16B (written down now to under 10B) referenced link note program within the Global Asset Management group, UBS will have significantly curtailed key service offerings that have provided solid fee streams for the bank.

Management has noted the significant impairment of the reputation of the wealth management business. 

With all these risk elements outstanding, UBS has a risk profile for major problems in the future.  UBS has already tapped current investors and SWF with no returns to show for it yet.  At this point any continued deterioration of the companies performance should directly impact the credit rating of the company.  Fitch Ratings has already put UBS on watch with an AA- rating with a negative outlook. One nasty leveraged hedge fund slip up or continued losses in propriety trading arena could create a scenario where HSBC can get the firm at half of the current price with a Bear Sterns like sweetheart deal from the ECB with less hassle and all the upside.

8) The era of Switzerland as an isolated, elite investment havens in Zurich is coming to an end

The mystic of privacy secured by a Swiss account has been a core tenant of Swiss superiority in wealth management.  That is now under attack with the recent US Federal ruling. 

 

A federal judge's order on Tuesday clears the way for the US Internal Revenue Service to demand that UBS (NYSE:UBS) provide information about US clients who may be using the Swiss bank's accounts to evade income taxes.

But it also signals a much wider clampdown on offshore tax evasion. Doug Shulman, IRS commissioner, says: "People with hidden foreign accounts can no longer rest easy".

Hans would be quite upset with this development even though he was a German citizen. I imagine many of the wealthiest clients would be disturbed by this development. 

This probe could lead to indictments of the bank or even specific bankers.  This is an additional threat for a bank trying hard to retain talent during tough times.

In the end, the Swiss will lose UBS and there will be one Swiss bank remaining from the bygone era of European aristocratic fortunes stashed in anonymous safety deposit boxes in the Alps.  The company will continue unwind the mortgage exposure, repos, leveraged loans, and lost prime brokerage business for the foreseeable future, and eventually will be acquired by a more solvent entity.

Disclosure: At the time of publication the author currently owns UBS $35 Jan 09 and UBS $30 Jan 09 put contracts.

Comments

[bbzz24:]

yoU & uS > UBS ad campaign morphed into UBS.What a Mess!!!

2008 Jul 10 07:00 AM

[johnhaskell:]

UBS is not now and never was a good place for US citizens to stash cash that they didn't want to report to the IRS. However it was and remains a good place for non US citizens to stash money they don't want to report to their home countries' tax authorities. Have you looked at demographic trends in Europe? Pension taxes are not scheduled to fall any time soon and tax havens may become more attractive.

None of this of course is to say that UBS will necessarily thrive in such an environment as there are many other banks- particularly those that operate only in CH and so can't be leaned on by other countries- that are probably better havens.

2008 Jul 10 11:31 AM

[Cora1:]

Congratulations. You did everythring wright in the past. Do not forget to close your position: A rising share price and falling volatility will hurt :o)

2008 Jul 10 12:05 PM

[Serge Birbrair:]

UBS - what's not to like!?

sergebirbrair.com/UBS....

Tax cheats heaven, incompetence temple, lawsuits galore,
United Bandits of Switzerland

2008 Jul 10 01:23 PM

[scimitar:]

I disagree with your eighth point - if you have a significant need for privacy and asset protection, Switzerland is the place to be. The Swiss banks have a long history of standing up to the IRS, and Swiss law considers tax evasion a misdemeanor. The US courts can rule all they want - they have no jurisdiction on Swiss soil.

I have to laugh at the people who were stupid enough to put their assets in UBS or even Credit Suisse, though. What kind of moron fails to recognize that the Swiss banks with international exposure are also the easiest targets for the IRS? If these wealthy clients had anything other than rocks for brains, they would have gone to a local Swiss bank, plunked down $100k and gotten a numbered account to ensure a modicum of security.

The IRS is going to have a field day now with the UBS clients, and I'm happy for them. There's nothing better than increasing government revenue off the back of worthless tax cheats.

2008 Jul 10 02:10 PM

[Shell Gamed:]

You forgot the thousands of angry former customers defrauded by auction-rate security sales, and all of the resulting lawsuits and arbitrations that UBS will lose. And let's not forget the great State of Massachusetts, where Secretary Galvin is now actively prosecuting UBS for fraud in ARS. And there's Attorney General Cuomo in NY, also investigating UBS.

2008 Jul 10 06:51 PM

[Ames Tiedeman:]

They are all going lower, even this name.

2008 Jul 11 09:47 PM

[Seeing Eye Dog:]

Gosh, Lockstep, you got it all wrong. Didn’t anybody tell you about a recent TownHall meeting where employees were reassured by the head of UBS Wealth Management that:

1. Wealth Management is actually having a record year. (He’s just not free to disclose any numbers.)

2. The press is printing bad things about UBS because that’s how they make their money. Pay no attention.

3. Layoffs? What layoffs? Only 28 people were let go, on top of a couple hundred okayed for voluntary severance packages. Too bad about the hundreds who applied but were refused. Next time, the application will have big letters at the top: NO GUARANTEES!

See? It's all good.

2008 Jul 12 09:55 AM