Humiliation of UBS
UBS is famed for being one of the world’s most conservative financial institutions. So it is both humiliating for it and troubling for us that it is the first of the world’s top-flight banks to disclose a substantial loss from this summer’s turmoil in credit markets.
Take it as a warning that the relatively strong performance disclosed last week by some of the leading Wall Street investment banks does not mean all banks will emerge almost unscathed from the debacle triggered by the collapse of the market in US sub-prime residential loans.
The mess is doubly embarrassing for UBS since it took a substantial hit in the dry-run for this summer’s market mayhem, the crisis afflicting the giant hedge fund, Long Term Capital Management, in 1998.
The statement that UBS put out this morning is a little opaque, but the headlines are:
1) It will make a pre-tax loss for the quarter of just under $700m, its first quarterly loss for nine years;
2) The main culprit is the fixed-income, rates and currencies division of its investment bank, which made “negative revenues” of around $3.4bn;
3) The source of the losses are the “legacy positions” of its now-closed hedge-fund and proprietary trading business, Dillon Read Capital Management, together with holdings in its mortgage-backed securities trading business;
4) It has taken significant though unspecified write-downs on positions in “super senior AAA-rated tranches” of collateralised debt obligations.
The losses on CDOs are particularly piquant and are further proof that these manufactured securities do not always do what they say on the label: triple-A rated bonds are not supposed to incur “significant” losses.
Here’s UBS’s predictable explanation. It says that the underlying cause of most of this mess is “the deterioration in the US sub-prime residential mortgage-backed securities market” which was “more sudden and more severe than in recent history” – and the ensuing illiquidity that led to “substantial valuation losses”.
To its credit, UBS is doing less of the “not our fault, guv” routine than you might expect of a famously stuffy global bank. The chairman and chief executive of the investment bank, Huw Jenkins, is stepping down, to be replaced “for the foreseeable future” by the chief executive of the whole bank, Marcel Rohner. Jenkins will however be retained as “senior advisor” to Rohner. And there are various other senior management changes, all designed to improve the bank’s control of risk.
Also, it has begun that process of shedding staff which I warned about a few weeks ago (see Scything the City). UBS’s employee numbers will be cut by 1,500 before the end of the year.
And there is an ill-augury for its competitors. It has taken a loss on its relatively small exposure of loans to private-equity buyouts. With somewhere between $300bn and $400bn of these loans sitting on other banks’ books, that implies its rivals may be sitting on losses of between $20bn and $40bn just on the private-equity or leveraged buyout debt they have been unable since July to place in the market.
UBS is big enough to more than weather this storm. For the year as a whole, it will make a substantial pre tax profit of somewhere around $8.5bn. But other banks likely to be damaged by the sub-prime fallout are not quite as big and robust.
UPDATE 12.50: Citigroup has now joined UBS in the roll-call of sub-prime shame. It has announced that it expects third quarter post-tax profits to slump by 60 per cent. Why? Well there is $1.3bn of losses on sub-prime mortgage backed securities and $600m of losses on fixed-income trading.
But the big story, which I hinted at above, is $1.4bn of pre-tax writedowns on private equity loans. This is cringe-making for Citi’s chief executive, Chuck Prince, who in July told the FT – using notoriously hubristic language – that his bank was “still dancing” in the private equity market, long after it was obvious that the private-equity bubble had been pricked and was deflating at an alarming rate.