The $10 billion Governmental Guarantee from UBS Works
Jun 07, 2023
A state backup that neither party wants to deploy was negotiated by the Swiss government and UBS. Sergio Ermotti, the bank's chief executive, could still find it to be quite helpful as he desperately needs funds.
A "loss protection agreement" is likely to be completed by UBS on Wednesday, according to a file made public on Tuesday. As part of the plan, which was created to smooth the Credit Suisse rescue, the government would pay $10 billion in damages on previous Credit Suisse assets after UBS had already swallowed the first $6 billion.
The strange thing is that everyone will want to keep the backstop as it is. Karin Keller-Sutter, the finance minister, faces political risk if she continues to support UBS because Swiss citizens and lawmakers accuse the government of handing the company an excessive amount of control over Swiss banking. It is up to Ermotti to calm the irate crowd. A reduction in UBS's size has been suggested by Switzerland's Social Democrats. Such improbable notions might become real if the government actually deposited money in the bank.
The incentives favor an agreement that isn't meant to be activated, therefore. One possibility would be for the government to solely guarantee the assets that UBS intends to sell off, such as fixed-income derivatives, as well as a small subset of the assets that were formerly owned by Credit Suisse. If the Swiss bank ever uses the program, the government might potentially demand limitations on dividends or buybacks.
However, because of how regulators determine capital needs, even a hypothetical backup fulfills a purpose for UBS. A lender must have a reserve of equity to cover its own costs that is equal to the total value of its assets, risk-adjusted. The covered assets are safer for UBS because the government has granted a loss guarantee, even if it hasn't been used, thus regulators should approve a reduced risk weighting. In all other respects, this immediately raises UBS's capital ratio. The common equity Tier 1 ratio for the Swiss bank is projected to rise by 0.2 percentage points, according to RBC analysts.
It helps Ermotti to boost. According to calculations by Breakingviews based on information as of March 31, the merged group may initially achieve a CET1 ratio of about 14% according to the recent UBS disclosures. With limited room for manoeuvre for one of the trickiest bank mergers in history, that is very similar to UBS's level prior to the merger. It's beneficial if he can obtain a promise that will never be tampered with in order to receive some more padding.
For both parties, there is a chance that Credit Suisse's assets are significantly worse than they seem, which could result in significant losses. Ermotti would then be in a difficult situation where he would have to decide whether to charge the taxpayer and risk political backlash or pass the burden to the shareholders.
