UBS’s $26 billion capital hit may be less severe than initially perceived
The $26 billion headline capital charge aimed at safeguarding Swiss taxpayers from the potential failure of UBS Group AG is more severe than anticipated. UBS’s shares experienced a notable increase of up to 8% following the news on Friday – what accounts for this movement? Investors are not yet fully aware of the implications of Switzerland’s enhanced “too big to fail” regulations, which were implemented in the wake of Credit Suisse’s collapse in 2023. Significant ambiguity surrounds the ultimate shape of the draft legislation. It is probable that UBS shares have surged as investors assess that the ultimate financial obligation will be reduced, coupled with the understanding that full payment is not expected until at least 2034.
The bank is dissatisfied. “UBS strongly disagrees with the extreme increase in capital requirements that has been proposed,” the firm stated. The proposed capital increase, while receiving general support for most changes, is characterized as “neither proportionate nor internationally aligned.” The draft law encompasses numerous provisions that are rational and garner consensus from UBS and the majority of experts. The introduction of a Senior Managers’ Regime akin to that of the UK aims to establish accountability among top executives for the bank’s actions, allowing for the recovery of their compensation in instances of misconduct. The new framework enhances the authority of Swiss regulators, enabling them to take action in instances of poor bank management. This previously absent capability left oversight bodies inactive during the protracted decline of Credit Suisse. The central bank acquires enhanced capabilities to provide emergency liquidity, among other measures.
The contentious and costly aspect for UBS lies in the requirement to fully capitalize its foreign subsidiaries, a demand that the government and independent advisors have estimated will necessitate up to $23 billion in additional common equity tier one capital. The additional $3 billion referenced in the headline arises from alterations in capital quality that influence the accounting treatment of deferred tax assets and certain other intangible assets by banks.
UBS has ample opportunity to negotiate this change during the forthcoming parliamentary consultation and debate, set to commence later this year. The pace of progress is likely to be slow; the draft law is anticipated to come into effect only at the beginning of 2028. At present, UBS requires capital at the group level to account for approximately 60% of the equity value of its foreign subsidiaries, with only 45% mandated to be in common equity; the remainder may be satisfied through additional tier one bonds. In the draft, it is stipulated that 100% must consist of common equity. UBS may have the opportunity to negotiate a combination of equity and additional tier one, or it could potentially secure a reduction in the coverage level — however, this will ultimately result in the most significant impact. As previously articulated, this approach is also justifiable from a policy perspective.
The bank will retain a period of six to eight years following the enactment of the law before it is obligated to comply with the forthcoming requirements, establishing 2034 as the earliest legal deadline. Andrew Coombs, an analyst at Citigroup Inc., indicated that the extended lead time suggests that the projected billions in share buybacks over the next three years remain feasible; the bank confirmed on Friday that it will proceed with this year’s payouts as scheduled. UBS may contend that bank investors will assess its capital requirements in relation to the complete target once the legislation is enacted. Such was the situation for banks following the 2008 financial crisis, during which many were perceived as too fragile and were compelled to raise capital rapidly. I remain skeptical; analysts and investors are inclined to perceive it as a technicality rather than an essential obligation, allowing the bank time for adaptation. That does not imply that UBS’s long-term profitability will remain unscathed, which will consequently influence the valuation of its shares. However, the bank possesses mechanisms for adaptation; these, however, entail certain tradeoffs.
The most extreme response could involve disaggregating its operations in some manner, such as divesting its US division or partially floating its primary Swiss entity while relocating its headquarters to a jurisdiction with a more advantageous regulatory environment. It may also alter its holding company-parent bank legal structure in manners that could enhance capital efficiency; however, this would entail forfeiting certain funding costs and tax advantages. “We expect that UBS might commence work to study the feasibility of strategic actions such as these,” wrote advisers at Alvarez & Marsal in a technical study commissioned by the government to support the draft law. In my assessment, significant alterations to the firm’s structure or a relocation are improbable and extreme, unless UBS derives no benefits from the consultation process whatsoever. “UBS remains committed to its diversified business model and its unique regional footprint,” the bank stated. UBS might consider increasing its risk transfers or altering its loan-centric strategy in international wealth management to mitigate capital requirements. This would consequently impact its revenue and returns, potentially in both favorable and unfavorable manners.
Even before all this, there are reasons to think the headline figure of 26 billion won’t last or be as costly as it seems. The bank intends to repatriate approximately $5 billion of capital from its international subsidiaries, a move that could effectively lower the carrying value of these entities and consequently reduce their capital requirements at the group level, as highlighted in the Alvarez and Marsal report. The headline from UBS emphasized the advantages associated with this repatriation. Additionally, modifications in the legislation have reduced the additional tier one capital that UBS requires by $8 billion, resulting in a lesser net increase in overall capital obligations, as reported by Bloomberg Intelligence. There is much to consider before UBS and its investors can thoroughly assess the ramifications of this proposed law — however, it is likely that the outcome will be less detrimental for the bank than the prominent figure indicates.
