Oct 10 - Fitch Ratings has affirmed UBS AG's
(UBS) Long- and Short-term Issuer Default Ratings (IDR) at 'A' and 'F1' respectively. The Outlook on the Long-Term IDR is Stable. At the same time, the agency has affirmed UBS's Viability Rating (VR) at 'a-'. The rating actions have no impact on the ratings of the outstanding covered bonds issued by UBS. A full list of rating actions is at the end of this rating action commentary.
The rating affirmations were taken in conjunction with Fitch's Global Trading and Universal Bank (GTUB) periodic review. Fitch's outlook for the industry is stable on balance. The positive rating drivers include improved liquidity, funding, capitalisation and more streamlined businesses, all partly driven by regulation. Offsetting these positive drivers are substantial earnings pressure, regulatory uncertainty and heightened legal and operational risk.
RATING ACTION RATIONALE UBS's IDRs are on the bank's Support Rating Floor (SRF) of 'A' and are underpinned by Fitch's view that the probability of support from the Swiss authorities for UBS, if required, remains extremely likely due to the bank's systemic importance for the Swiss financial sector and the Swiss economy as a whole. UBS is Switzerland's largest domestic bank by most measures, one of the largest global wealth managers and one of the ten largest globally-active investment banks.
The affirmation of UBS's VR is underpinned by the earnings stability provided by UBS's dominant wealth management and leading Swiss domestic banking franchises. Fitch views positively the bank's progress in improving its core capitalisation which compares well with its GTUB peers. The VR also reflects the challenging operating environment for UBS's still sizeable investment banking operations which continue to expose the bank to a degree of earnings volatility.
Fitch believes that the earnings capacity and franchise in some of UBS's investment banking activities, particularly in the US, may not be sufficient to cover the additional costs of funding, higher capital charges, increasing regulatory expenses and on-going infrastructure investments. While Fitch recognises that UBS is restructuring its investment banking franchise to focus more on its areas of strength, further progress in the restructuring process would be needed before Fitch would consider upgrading UBS's VR.
RATING DRIVERS AND SENSITIVITIES - VR UBS's VR is primarily sensitive to changes in UBS's capitalisation and risk appetite in its investment bank. The progress made in both these areas could lead to an upgrade of the VR if the bank continues its progress as planned.
Improvements in UBS's capitalisation have largely been driven by a significant risk-weighted assets (RWA) reduction in its investment bank, including its legacy portfolio. Basel III RWA in its investment bank, estimated at CHF300bn or 75% of total Basel III RWA at end-Q311, have been reduced to CHF223bn (CHF53bn relating to the bank's legacy portfolio and CHF170bn relating to the investment bank) at end-H112 and management targets Basel III RWA of around CHF135bn in its investment bank by end-2013. While some of the RWA reduction has related to model improvements and has not directly resulted in lower economic capital consumption, Fitch believes that UBS's resized investment bank will be more aligned in size and risk appetite to the overall group.
As a result of the RWA reduction, the bank's fully-loaded Basel III common equity Tier 1 ratio improved to around 8.8% at end-H112 from 6.2% at end-Q311, which compares well with the capitalisation of the bank's global peers. UBS has stated that it will continue to strengthen its capital base with the aim of complying with its high 13% common equity Tier 1 ratio target early in the 2013-2018 phase-in period.
In late 2011, UBS decided to base its investment banking offering on core client needs, capital efficiency and areas where it already has a meaningful franchise. Successful execution of its investment banking strategy as well as further progress towards its investment banking RWA target while building up a track record of resilient and well-balanced earnings, including in its resized investment bank, could lead to an upgrade of UBS's VR.
A significant delay in its capital build-up plan or higher risk appetite in its investment banking operations, both currently considered unlikely by Fitch, could lead to a downgrade of UBS's VR. Inability to adjust the bank's cost base to the still challenging operating environment in investment banking would also put the bank's VR under pressure.
UBS's VR is also supported by positive trends in UBS's remaining businesses, notably in its dominant wealth management franchise. Despite continued pressure on European off-shore banking and a depressed gross margin in H112, UBS's wealth management businesses have since mid-2010 reversed previous net new money outflows and given its leading franchise, UBS is in Fitch's view well-placed to improve wealth management earnings once market conditions improve.
Overall, UBS's risk and funding profile benefits from its dominant wealth management and to a lesser extent from its leading domestic franchises which provide stable and predictable earnings to mitigate earnings volatility inherent in its investment bank.
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 GTUBs.
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 less sovereign support being factored into UBS's IDRs. 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 'a-' VR is maintained, any downgrade of UBS's Support Rating and SRF would lead to a maximum one notch downgrade of its Long-term IDR.
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 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, notably its investment banking franchise. 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, Fitch's '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: affirmed at 'a-' 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: affirmed at 'BBB+' Tier 2 subordinated notes (low-trigger loss-absorbing buffer capital notes): affirmed at 'BBB-' Commercial paper: affirmed at '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: affirmed at 'BB+' UBS Preferred Funding (Jersey Ltd) Preferred Securities: affirmed at 'BB+' UBS Capital Securities (Jersey Ltd) Preferred Securities: affirmed at 'BB+'
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The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research: Global Financial Institutions Rating Criteria Rating Bank Regulatory Capital and Similar Securities (New York Ratings Team)