Is UBS Group too big for Switzerland?

The story, regularly popping up over the last few months, goes like this: UBS, Switzerland’s behemoth bank with $6 trillion assets under management (AUM) and a balance sheet exceeding $1.6tn, is too big for a country of nine million inhabitants and an annual GDP of $1tn to be rescued in a crisis. To call it “systematically important”, the key word for onerous regulatory treatment, is an understatement.

The Swiss government is therefore in discussions to demand an additional equity buffer from the bank to increase its resilience. The amount under discussion is CHF20bn, or $25bn, a capital increase of almost 28%.

This has the bank’s management and some shareholders on the barricades. They see it as a violation of the agreement struck with Swiss authorities when the latter had asked UBS to come to the rescue of its collapsing competitor Credit Swiss (CS) in 2023. They argue that it puts UBS at an insurmountable disadvantage internationally, at a time when banking regulations in the US are being softened, rather than strengthened.

They point to JPMorgan, BlackRock, Bank of America and others UBS had to compete with. Its shareholders would be shortchanged, as well as its employees. The fact that Switzerland’s finance minister, Karin Keller-Sutter, and UBS chair, Colm Kelleher and its CEO, Sergio Ermotti are not terribly fond of each other doesn’t help. Arguments go ugly on both sides.

While the government is mulling a possible referendum if UBS does not tone down (putting bankers at the mercy of the electorate), the bank’s shareholders talk loudly about moving headquarters to New York and listing its shares there, where regulations are sold to the highest bidder: Donald Trump, seemingly at peace with the new Fed chair Kevin Walsh, is still aiming to control bank regulation.

The fall of CS Group, a formidable global competitor of UBS with a 150-year-old history, was a black swan event. CS operated as an investment bank (First Boston), asset manager (Warburg), insurer (Winterthur) and forex trader. And it was the global star of wealth management and private banking, the thing Swiss banks are legendary for.

CS fell first slowly and then suddenly. It suffered from the collapse of Greensill, a fraudulent factoring business; then it lost billions with Archegos Capital, a deranged derivative trader who tried to hide margin losses to the tune of $10bn per day. It was found to sit on countless deposits of concentration camp victims, helped to launder vast amounts of money for drug cartels and was fined $2.6bn for its creative support for tax cheats from the US, Brazil to Germany. One CS banker even delivered diamonds hidden in a tube of toothpaste to an American client. It was guilty of Iran embargo violations and at the end of shaky financial reporting.

To keep this in perspective: still in the 1990s, secrecy was Switzerland’s unique selling proposition, until the US killed it. Bank secrecy was enshrined in law. To give bank account access to US prosecutors, the law had to be changed. For Swiss banks, the Trump regime clearly has come too late. But that was then and everyone moved on.

In the second half of 2022 those mishaps mentioned above accumulated and clients started to withdraw their deposits. It did not help that $33bn of embargoed oligarch money had to be transferred to Russia. The final nail in the coffin was a social media rumour that CS was in peril and would bankrupt soon. At the time it was not even close to it but clients took out their money at a rate of $10bn per week. The Swiss National Bank extended an emergency loan, which accelerated the rumour-mill. When Saudi Arabia’s National Bank, CS’s largest shareholder, publicly declared that it was unwilling to provide further financial assistance, time was up.

To avoid global disaster, Keller-Sutter summoned UBS chair Kelleher and offered him a deal. He could take over CS for the token amount of $3.3bn. The government would provide emergency funding (this was paid back soon) and stipulate that CS’s contingent convertible bonds (CoCo), a hybrid between bonds and share capital, would be forced to absorb losses in its entirety. This caused quite some outrage at the time and some lawsuits are still ongoing. It was not best practice to give residual money to shareholders while bondholders suffered in full. As a lawyer, I would say it was all in the small print. CS’s CoCos were quite specific.

As a result, UBS paid three billion for $1.7tn AUM and could, shortly after the merger, book an accounting gain of $29bn. This is the amount it underpaid for CS. So, the Swiss authorities, in a unique emergency, had forced a merger they would have never agreed to in more peaceful times.

To complain loudly now seems ungrateful. Yes, the additional equity demand violates the initial deal. A bid unfair. But the government has a point. There’s no other bank in Switzerland big enough to come to the rescue if UBS went under. And the public purse is hardly deep-pocketed enough to bail out the bankers.

Furthermore, UBS’s arguments are bonkers. Firstly, it is a Swiss brand. This is invaluable. Swiss private banking, more caring and personal than elsewhere, still carries the aura of Swiss confidentiality and reliability. UBS is therefore the most sought-after wealth manager, with almost $7tn AUM. To relocate to NYC would do damage to the brand.

Secondly, I don’t quite get the complaints. UBS’s capital amounts to 5.63% of its balance sheet. Bank of America’s is 8.82%, JPMorgan’s 7.61%. Demands to prop up capital from $90bn to $115bn would increase shareholder equity to 7.1%. To claim that a better capitalised UBS would suffer a competitive disadvantage is disingenuous.

Yes, UBS’s return on equity is more modest than its competitors’ but it is still shouldering the integration costs of the merger. IT systems have to be unified, redundancies have to be paid for, CS’s old skeletons have to be written off. But, very soon, planned cost savings of $13bn will kick in and make the bank vastly more profitable than it is now. ROE will look much more favourably than now, moving from 7% to perhaps 16% next year. Yes, this is not JPMorgan but still better than many.

As a retail investor, I am happy with the gains of my Banco Santander shares lately. It is an entirely different business though. It books 50% of its gains in South America and it is a retail bank, with cheap customer deposits and lucrative personal loans. Its ROE is 16%, the performance UBS is aiming for. Its shares have gained 69.5% year to date.

Note to self: one bank is enough in my portfolio. But UBS is tempting. It has gained 50.5% in the last year. Private wealth management, in times of growing inequality, has still the potential to grow further, as much as this pains me.