TEXT-Fitch affirms UBS at 'A'; puts viability rating on rating watch positive

Thu Nov 1, 2012 7:17am EDT

RATING DRIVERS AND SENSITIVITIES - VR

The RWP on UBS's VR indicates that Fitch is likely to upgrade UBS's VR by one notch in the short term. In Fitch's view, while UBS has the relevant track record, risk controls and governance framework to run down sizeable legacy portfolios, the restructuring plan still exposes the bank to considerable execution risks. Fitch expects to resolve the RWP once the restructuring is fully underway and details such as RWA exit costs and the underlying profitability of its remaining IB business can be more comprehensively assessed. Fitch aims to resolve the RWP following the release of UBS's Q412 results.

Once fully implemented, Fitch expects UBS's revised IB to strategy to lead to better quality and less volatile earnings, an improved risk profile and more balanced funding position.

UBS's solid capitalisation is already a key driver of its VR. A sharp reduction in Basel III RWA (around 25% in the year to end-Q312) and other capital strengthening measures lifted UBS's "fully-loaded" Basel III common equity Tier 1 ratio to 9.3% at end-Q312 (from 6.2% at end-Q311) and the bank targets a fully-loaded CET1 ratio of 11.5% at end-2013 and 13.0% at end-2014 which compares well with all peers.

As a result of exiting many balance sheet-intensive IB businesses, notably in fixed income, currencies and commodities (FICC), UBS's funded balance sheet will fall by around 30% to CHF600bn by end-2015, improving the bank's leverage ratio and reducing funding needs (and funding costs).

UBS's VR is also supported by positive trends in its operating performance in 9M12.

Adjusted for a CHF3.1bn impairment on goodwill in IB, a CHF863m loss on own credit and minor restructuring charges, UBS reported a pre-tax profit of CHF1.4bn in Q312 with improving or stable underlying profitability in all business divisions.

Both Wealth Management (WM) and Wealth Management Americas (WMA) reported improved pre-tax profits, benefiting from continued sound net new money (NNM) inflows and moderately higher client activity. However, performance indicators for both WM (gross margin) and WMA (pre-tax profit margin) are being negatively affected by the still difficult market and investment environment. In Fitch's view, UBS has potential to improve these indicators once the operating environment improves.

NNM flows in Global Asset Management (GAM) were marginally negative in Q312 but the division's pre-tax profitability benefited from higher performance fees and broadly stable management fees. UBS's Swiss business (Retail & Corporate) continued to perform well with new business volumes picking up and loan impairment charges staying low despite signs of an overheated Swiss real estate market.

IB returned to moderate profitability in Q312 (CHF178m) after a loss in Q212 (CHF178m, negatively affected by processing issues with the Facebook IPO). All IB divisions reported improved (advisory, equities) or stable (FICC) revenue. IB's operating expense base (excluding the goodwill impairment charge) also increased, largely reflecting higher accruals for variable compensation and higher litigation and regulatory charges.

While Fitch expects underlying profitability in Q412 to remain solid in all of UBS's business lines, including its restructured IB, management have given guidance to expect a net loss for Q412 due to a CHF500m restructuring charge (largely in IB), IB revenue loss and a further tightening of UBS's own credit spread.

RATING DRIVERS AND SENSITIVITIES - IDRS, SUPPORT RATING, SRF AND SENIOR DEBT

The Stable Outlook on UBS's Long-term IDR reflects Fitch's view that sovereign support for UBS will continue to be available in the medium term.

UBS's IDRs, Support Rating, SRF and senior debt ratings are sensitive to a change in Fitch's assumptions around the availability of sovereign support for the bank. An upgrade of UBS's IDRs is unlikely given Fitch's expectation of diminishing sovereign support for large, globally operating banks.

Switzerland has made significant progress in implementing specific legislation for the country's two largest banks (UBS and Credit Suisse AG ), which should ultimately facilitate pre-insolvency bank resolution and will eventually lead to a reduction in UBS's SRF. However, this is a gradual and lengthy process and Fitch will take corresponding rating actions when and if deemed appropriate.

As long as the bank's VR remains at 'a-', any downgrade of UBS's Support Rating and SRF would lead to a maximum one-notch downgrade of its Long-term IDR. Should the RWP on the VR result in an upgrade, a downgrade of the SRF would have no impact on the IDRs.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES

Subordinated debt and other junior and hybrid capital issued by UBS and its affiliates are all notched down from UBS's VR in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles, which vary considerably. Their ratings are primarily sensitive to any change in the VR of UBS and have been placed on RWP in line with the RWP on UBS's VR.

SUBSIDIARY AND AFFILIATED COMPANY RATING DRIVERS AND SENSITIVITIES

London-based UBS Limited is a wholly owned subsidiary of UBS whose issuer and debt ratings are aligned with UBS's because Fitch views UBS Limited as core to UBS. UBS Limited's contractual counterparties are irrevocably and unconditionally guaranteed by UBS AG.

UBS Bank USA (UBSB) is a direct subsidiary of UBS Americas Inc., which in turn is wholly owned by UBS. Fitch views UBSB as core to UBS's overall operations; thus its Short-term IDR is equalised with the ultimate parent. Further, while there is no financial support agreement or guarantee from UBS, the '1' Support Rating reflects the extremely high probability that UBS would provide support to UBSB should the need arise. UBS Limited's ratings and UBSB's ratings are sensitive to the same factors that might drive a change in UBS's IDR.

The rating actions are as follows:

UBS AG

Long-term IDR: affirmed at 'A'; Outlook Stable

Short Term IDR: affirmed at 'F1'

Viability Rating: 'a-'; placed on RWP

Support Rating: affirmed at '1'

Support Rating Floor: affirmed at 'A'

Senior unsecured debt: affirmed at 'A'/'F1'

Senior unsecured market linked securities: affirmed at 'Aemr'

Subordinated debt: 'BBB+'; placed on RWP

Tier 2 subordinated notes (low-trigger loss-absorbing buffer capital notes): 'BBB-'; placed on RWP

Commercial paper: affirmed at 'A'/'F1'

UBS Limited

Long-term IDR: affirmed at 'A'; Outlook Stable

Short-term IDR: affirmed at 'F1'

Support Rating: affirmed at '1'

UBS Bank USA

Short term IDR: affirmed at 'F1'

Support Rating: affirmed at '1'

UBS Preferred Funding Trust V Preferred Securities: 'BB+'; placed on RWP

UBS Preferred Funding (Jersey Ltd) Preferred Securities: 'BB+'; placed on RWP

UBS Capital Securities (Jersey Ltd) Preferred Securities: 'BB+'; placed on RWP

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