Moody's: UBS bondholders more exposed to losses

UBS' long-term challenges in Investment Banking and Wealth Management pose greater risk to bondholders than previously perceived, according to David Fanger, Moody's Senior Vice President.

In addition, Moody’s believes that while the bank has benefited from substantial capital infusions over the past two years, the bank's ability to generate capital internally remains challenged.

Although UBS' Investment Management has sold a considerable portion, $39 billion, of its legacy exposures to the Swiss National Bank, it remains exposed to potential additional losses on its remaining legacy exposures. Most notably is its exposure to the monoline financial guarantors. In addition, Moody's opines that the bank appears to have benefited less than many of its peers from the recent improvement in trading margins and volumes among more liquid capital markets instruments.

"The bank has also experienced a significant turnover of senior managers over the past two years, which gives us some concerns about the continuity and effectiveness of management," Mr. Fanger added.

Moody's views UBS's leading Wealth Management franchise as a critical underpinning of its overall financial strength. However, the bank's sizeable losses appear to have contributed to an erosion of customer confidence in this business. This was most apparent in the outflow of net new funds experienced during the fall of 2008. That outflow diminished after the bank agreed to sell assets to the SNB and issue a mandatory convertible note to the Swiss Confederation. Moody's noted that were the bank to suffer additional losses on its remaining legacy exposures it could potentially further undermine customer confidence.

UBS' Wealth Management franchise also faces challenges due to customer concerns over privacy, as evidenced by continued net money outflows during the first quarter of 2009. These concerns were fuelled by demands made of UBS by US authorities regarding the sharing of customer information, and by the responses of the Swiss government to those demands as well as to the demands of the OECD and the European Union.

"Repairing this damage may take time," Mr. Fanger said, "especially in light of the legal obstacles UBS faces in reconciling the competing demands of US and Swiss authorities over bank secrecy." At the same time, revenues in Wealth Management are also under pressure due to market-driven declines in assets under management and reduced client activity. Moody's believes that this leaves the bank with more limited financial flexibility to manage its challenges.

Moody's will review the bank's vulnerability to any further loss of customers in its wealth management franchise, its future earnings prospects under expected and stress scenarios, and its strategic direction. The review will also consider the potential effectiveness of the changes the bank has made to its risk management processes and oversight. However, the rating agency believes the significant losses at many wholesale investment banks over the past two years, combined with  the increased complexity and opacity of their positions, argue for skepticism about the robustness of risk management within the industry.