UBS kitchen sink has protection from further leaks

LONDON, May 17 (Reuters Breakingviews) - New bosses often like to get the bad news out quickly, a time-honoured practice known as kitchen sinking. UBS (UBSG.S) late on Tuesday released a regulatory filing showing what the bank's accounts may look like after its roughly $4 billion acquisition of Credit Suisse (CSGN.S). It almost fits the bill. But CEO Sergio Ermotti has protection if it doesn't.

The key numbers in the mammoth document are the haircuts Ermotti applies to Credit Suisse's balance sheet, and the charge he's taking to cover possible future legal bills. UBS is marking down the target's assets by about $10 billion, mostly in the loan book, while inflating its liabilities by about $3 billion – a reflection of funding commitments already made to Credit Suisse's clients. The buyer is also taking a $4 billion provision to cover future litigation charges. In sum, it amounts to a roughly $17 billion hit to the combined group's all-important common equity Tier 1 (CET1) regulatory capital, effectively wiping out the boost from cancelling Credit Suisse's funky capital instruments back in March.

While there's a kitchen-sink feel to those numbers, it's far from clear that Ermotti has vanquished all the bad news. For starters, the filing is peppered with caveats, including that UBS still hasn't managed to complete detailed valuations of the assets. That means any future markdowns could be larger. At roughly 2% of Credit Suisse's overall loans and financial assets, the haircuts do seem rather modest. Jefferies analysts had been expecting a 3% discount on the loans and 10%-15% on the trading and investment assets, implying an overall downward adjustment almost $5 billion steeper than the one UBS currently expects to book.

The $4 billion legal charge is undoubtedly chunky, at roughly three times the most recent Credit Suisse estimate of likely future losses from cases that it hadn't yet provided for. But it's hard to judge how much the controversial deal itself has affected the combined group's exposure. The filing's risk factors note that UBS might inherit future court cases that could stem from the cancellation of Credit Suisse's Additional Tier 1 bonds, for example.

Still, Ermotti's $4 billion purchase price is miles below the $49 billion net asset value he's buying. Meanwhile, the implied CET1 ratio of the group, after deducting all the relevant hits, is roughly 14%. That's according to Breakingviews calculations that don't reflect the impact of UBS's markdowns on risk-weighted assets, which means the real ratio may be higher. Ermotti may also be able to reverse some of the asset haircuts, for example on Swiss mortgages that he is planning to keep, potentially freeing up room for more aggressive writedowns elsewhere. Finally, the Swiss government has also offered $10 billion of loss protection, though the details are unclear, which isn't reflected in any of UBS's numbers so far. Ermotti might not have performed a total kitchen sink, but his investors needn't be too concerned.

Follow @liamwardproud on Twitter

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

CONTEXT NEWS

UBS on May 16 said it would write down the value of Credit Suisse's loans and financial assets by $9.9 billion, as part of a takeover of its Zurich-based rival. It also plans to increase the smaller group's liabilities by $3.1 billion, implying a $13 billion hit to the combined group's equity capital.

The Swiss bank, led by returning CEO Sergio Ermotti, is also taking a $4 billion charge for future legal bills, which is about three times greater than the $1.3 billion of future litigation losses that Credit Suisse estimated it could face over and above its existing stock of provisions.

Swiss authorities on March 19 announced that UBS would buy its arch-rival for about $3 billion in stock.

On May 17, the share prices of both banks were flat.

Our Standards: The Thomson Reuters Trust Principles.