Swiss banks take separate routes to stronger balance sheets

UBS accepts a government rescue and will transfer $60 billion of illiquid assets to a dedicated fund, while Credit Suisse raises $9.1 billion in fresh capital from existing shareholders.
On the back of commitments earlier this week by European central banks to reinstate confidence in their banking systems, Credit Suisse and UBS both announced far-reaching measures to improve their balance sheets yesterday.

However, the two Swiss banks chose opposite routes to achieve this, reflecting their different levels of exposure to illiquid subprime-linked assets. This was evident earlier this year as well, with UBS already forced to raise billions worth of new capital, while Credit Suisse has until now not seen a need to recapitalise.

And Credit Suisse, albeit a lot smaller, continues to look the stronger of the two. Yesterday it said it had refused the measures offered by the Swiss authorities, choosing instead to go it alone and raise fresh capital from a small group of its existing shareholders. UBS, on the other hand, having failed to reach a deal with third-party investors, accepted the governmentÆs offer for a bailout that will see it transfer up to $60 billion of illiquid securities to a separate fund run by the Swiss central bank and raise SFr6 billion ($5.3 billion) of new capital through the issuance of mandatory convertible notes to the Swiss Confederation. The latter will end up holding 9.3% of UBS upon conversion û in line with the trend of part-nationalisation of major banks that is now ongoing in both Europe and the US.

However, at SFr10.4 billion, Credit SuisseÆs capital raising exercise is sizeable and suggests that all is not well there either. Indeed, the bank said it expects its third-quarter results (due for release next Thursday) will show a net loss of approximately SFr1.3 billion ($1.1 billion), including a pre-tax loss in the investment banking division. The latter will reflect write-downs of about SFr2.4 billion in its leveraged finance and structured products businesses, as well as the ôexceptionally adverse trading conditions in Septemberö, the bank said in a statement.

Even so, Credit Suisse was portraying the capital injection, which was finalised on Sunday and is based on FridayÆs closing price, as a sign of strength and proof that its shareholders still have confidence enough in the bank to commit more capital. That said, Credit Suisse helped the deal along by providing financing for a portion of the investments for an ôinterim periodö and, according to top Credit Suisse officials speaking with global media last night, only three investors participated in the fund raising. The largest of them was a wholly owned subsidiary of Qatar Investment Authority.

Still, the deal was completed in what can only be described as highly challenging conditions and will put Credit Suisse in a stronger position than many of its US competitors. The bank said the new capital will increase its tier-1 capital ratio to about 13.7% (as of the end of the third quarter) from 10.4% previously. This means that it already exceeds the new capital targets and leverage requirements set by the Swiss Federal Banking Commission for as far out as 2013. These requirements and targets û agreed on a bilateral basis between SFBC and individual banks and not disclosed û have been tightened over the past week as part of the authoritiesÆ efforts to ensure stability in the banking system. Credit Suisse said it had reached an agreement on the levels, but declined to comment on what they were.

According to the announcement, the fund raising has three parts: a sale of 93 million treasury shares resulting in net proceeds of SFr3.2 billion; the issuance of SFr1.7 billion of mandatory convertible bonds with a one-year maturity; and the issuance of non-dilutive perpetual, subordinated, hybrid tier-1 capital resulting in net proceeds of Sfr5.5 billion. The latter will have a Swiss franc tranche that will pay an annual dividend of 10% and a US dollar tranche that will pay 11%, which is in line with the cost of the preference shares issued by Goldman Sachs and Morgan Stanley in recent weeks. The loan is callable after five years.

The bank provided few details on the other two portions, except to say that the treasury shares and the shares issued through the CB will together account for 12% of the outstanding share capital. The CB will pay a coupon, but the size wasnÆt disclosed, and nor was the conversion price. Based on the number of treasury shares sold and the net proceeds, this portion of the capital raising seems to have been done at a price near FridayÆs closing price of SFr34.26.

UBS too stressed the positives of yesterday's move, saying the transfer of its dodgy assets to a separate fund will cap future losses, and thus reduce the uncertainty for its shareholders. It said it feels confident that it has created the conditions necessary to reverse the outflow of client assets. In a telephone conference yesterday, CEO Marcel Rohner said the transaction will leave UBS with ``essentially zero'' risk related to US subprime, Alt-A, prime, commercial real estate and mortgage-backed securities, as well as student loan-backed securities and reference-linked notes.

At the same time, it will enable its shareholders to participate û together with the Swiss National Bank û in the potential recovery of these assets. It will also reduce the bankÆs risk-weighted assets and allow it to reduce the size of its balance sheet.

ôThis transaction gives comfort in UBSÆs future,ö said Rohner, adding that the extremely difficult market environment made the bank accelerate its risk reduction with a definitive move. ôOur aim is to protect our clients from the impact of the crisis to the fullest extent possible and to provide shareholders an opportunity to renew their confidence in the bank,ö he said.

UBS said it will provide equity capital of up to $6 billion for the fund to which it will transfer its illiquid assets, while the Swiss National Bank will finance it with a loan of up to $54 billion. The loan will be secured on the assets, will be non-recourse to UBS and will pay interest of 250bp over Libor. It will have an initial maturity of eight years, but can be extended to 10 or 12 years. SNB will take full control of the fund by buying the UBS assets for $1, while UBS will act as the investment manager (under the oversight of the SNB).

UBS has an option to buy back the equity of the fund once the $54 billion loan has been fully repaid at a price of $1 billion plus 50% of the equity value exceeding $1 billion. UBS said it estimates that the transaction will result in a charge against earnings of about SFr4 billion that will be taken in the fourth quarter and will leave it with a tier-1 capital ratio of approximately 11.5% - up from about 10.8% at the end of September.

The convertible notes, which need approval from UBS shareholders, will pay a coupon of 12.5% and must be converted within 30 months at a 17% premium above the volume-weighted average price on October 15 (SFr20.24), or the average of the daily VWAP in the three days leading up to the shareholders meeting in November û whichever is the lowest. This means the initial conversion price will be no higher than SFr23.68. It can also not be lower than Sfr18.21.

UBS reiterated an earlier estimate of a small net profit of Sfr296 million in the third quarter, but added that its investment banking division produced a pre-tax loss of SFr2.75 billion, including write-downs and losses of $4.4 billion on risk positions. The bank said it reduced its risk positions by about $13.5 billion during the quarter, mainly through the sale of assets. In the second quarter the investment banking business lost Sfr5.2 billion.

The re-capitalisation efforts by the two Swiss banks came as US banks began to report third quarter earnings, revealing further write-downs of illiquid subprime-linked assets, which pushed the total losses and write-downs by banks globally in the past year to more than $650 billion. Citi announced a further $13.2 billion of losses and write-downs of investments yesterday, bringing its total write-downs in the past 12 months to $51 billion. The bank reported a net loss of $2.8 billion for the third quarter.

Merrill Lynch, which is in the process of merging with Bank of America, posted a $5.2 billion loss for the quarter and announced $9.5 billion of write-downs and credit losses. It said it will issue $10 billion of non-voting preferred stock and related warrants to the US Treasury under a $250 billion bailout programme announced earlier this week. A day earlier, JPMorgan made a $6.66 billion provision for credit losses in its third quarter earnings, including net markdowns of $3.6 billion due to mortgage-related positions and leveraged lending exposures in its investment banking division, but reported a net profit of $527 million overall.

The Credit Suisse stock had a volatile session after the recapitalisation news, fluctuating between SFr41.70 and SFr49.50, before ending down 0.9% at Sfr45.50. UBS fell 4.9% to Sfr19.09.

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