Fitch Ratings has affirmed UBS AG's (UBS) Long-term Issuer Default Rating (IDR) at 'A', Short-term IDR at 'F1', Viability Rating (VR) at 'a', Support Rating (SR) at '1' and Support Rating Floor (SRF) at 'A'. The Outlook on UBS's Long-term IDR is Stable. A full list of rating actions is provided at the end of this rating action commentary.
The rating actions have been taken as part of a periodic review of the Global Trading and Universal Banks (GTUBs), which comprise 12 large and globally active banking groups. On balance, Fitch's outlook for the sector is stable. The 12 banks have continued to strengthen their balance sheets in 9M14. Capitalisation has improved materially over the past two years and liquidity remains sound. This strengthening balances continued pressure on earnings, particularly in securities businesses, and remaining material but unpredictable exposure to conduct and regulatory risks.
Fitch forecasts weak growth in the eurozone during 2015 while growth in the US and UK is expected to be somewhat stronger, which should help the GTUBs with a significant presence in these regions. Spikes in market volatility, most recently in October 2014, show that uncertainty remains over how expectations of rising interest rates in the US will affect financial markets. Our expectation is that rises in interest rates will be gradual and would follow improved prospects for the economy, which should help business volumes. Sharp and unexpected hikes in US interest rates would likely result in increased market volatility and, consequently, additional pressure on banks' earnings, although we believe that the GTUBs' risk appetite has declined.
Lower risk appetite should help the banks avoid material losses on trading positions but an adverse operating environment could result in a change of our outlook if earnings prospects suffer materially. For eurozone-focused banks, a prolonged deflationary scenario would put pressure on earnings and could result in a changed outlook.
KEY RATING DRIVERS - IDRs, VIABILITY RATING (VR) AND SENIOR DEBT
UBS's VR and IDRs are based on the bank's leading global wealth management and dominant domestic retail and corporate franchise, which should enable the bank to generate robust risk-adjusted returns. They also reflect adequate underlying profitability, solid funding and liquidity, strong capitalisation and improving balance sheet leverage.
The ratings also factor in UBS's sizeable non-core and legacy portfolio - accounting for 19% of fully-applied Basel III risk-weighted assets (RWA) at end-3Q14 - and its exposure to litigation risk, both of which could, in our view, lead to some earnings volatility in the short- to medium-term. The Stable Outlook on UBS's Long-term IDR reflects our view that UBS's profitability and its capital buffer will be sufficiently strong to absorb expected further litigation-related charges.
UBS's risk profile has been improving since the bank significantly reduced the scope of its investment banking (IB) activities in 2012. Non-IB businesses together accounted for around three-quarters of UBS's adjusted pre-tax profit in 9M14 (excluding corporate centre and the CHF1.8bn litigation provision in 3Q14, of which CHF1.7bn was in IB). UBS has a world-leading franchise in global wealth management (WM), and a strong presence in wealth management in the US (WMA), global asset management (GAM) and domestic retail and corporate banking (R&C). We expect these businesses, whose earnings volatility is moderate compared with IB, to continue to generate good recurring earnings. Excluding the CHF1.7bn litigation provision booked in 3Q14, UBS's IB reported satisfactory returns in 9M14 (25% pre-tax return on allocated equity), underscoring that the bank's revised IB model is performing adequately.
We expect UBS's WM franchise (invested assets of CHF966bn at end-3Q14; 31% of 9M14 adjusted pre-tax profit excluding corporate centre losses and the CHF1.8bn litigation provision in 3Q14) to perform well in 2015, supported by continued net new money (NNM) inflows in Asia Pacific and the bank's ultra-high net worth segment. NNM outflows in its western European offshore business have abated and should, in our view, remain more moderate than in previous years. However, as long as interest rates and the average client risk appetite remain broadly unchanged, it will be challenging for UBS to meet its assets under management (AuM) gross margin target of between 95bps and 105bps (86bps in 3Q14). WMA continued to perform solidly, with a 35% return on attributed equity in 9M14, although NNM inflows during this period were lower than in 2013.
UBS's capitalisation and funding and liquidity are rating strengths. The bank's fully-applied Basel III common equity Tier 1 (CET1) ratio was 13.7% at end-3Q14, the strongest ratio in its peer group. Total loss-absorbing capacity is further supported by high (0.4% of RWA at end-3Q14) and low (4.5%) trigger loss-absorbing capital notes. Due to fairly low risk-weights in many of its businesses, for instance Swiss residential mortgage lending and WM's Lombard lending, the bank's capitalisation on a leverage ratio basis is weaker than its risk-weighted ratio but still within its European peer group range. At end-3Q14, its leverage ratio stood at 4.2% including Tier 2 instruments, according to Swiss regulation (3.1% excluding Tier 2 instruments).
UBS's funding and liquidity is strong due to its global WM franchise and sharp balance sheet deleveraging since 2012. The bank's liquidity coverage and net stable funding ratios stood at 128% and 107% respectively at end-3Q14.
Similar to many of its GTUB peers, UBS has material exposure to conduct risks. UBS is subject to various legal disputes and proceedings including the bank's cross-border WM businesses in France, the sale of US residential mortgage-backed securities and UBS's foreign exchange business. Total reserves for litigation, regulatory and other matters amounted to CHF3.5bn at end-3Q14, around half of which related to UBS's IB business and the rest largely to its non-core and legacy portfolio. While the extent of further litigation costs is hard to predict, UBS's ratings factor in our assumptions that the bank's litigation reserves and capitalisation, if required, could absorb sizeable conduct costs.
RATING SENSITIVITIES - IDRs, VIABILITY RATING AND SENIOR DEBT
UBS's VR and IDRs are principally sensitive to the winding down of its non-core and legacy portfolios and to litigation-related costs.
Upside potential for UBS's VR and IDRs remains limited, as long as RWA in the non-core and legacy portfolios continue to account for a large proportion of overall RWA and the litigation exposure remains elevated. Further progress in reducing risks related to the non-core and legacy portfolios and in improving performance further could lead to upward pressure on UBS's VR.
Should non-core and legacy portfolio exit costs and/or litigation provisions be higher than our expectations, affecting UBS's capital ratios with no credible plan for restoring these over a reasonably short period, this could lead to a downgrade of UBS's VR.
KEY RATING DRIVERS - SUPPORT RATING AND SUPPORT RATING FLOOR (SRF)
UBS's Support Rating and SRF are based on Fitch's expectation that there remains an extremely high probability that Switzerland (AAA/Stable) would support UBS, if required, until the mechanism for resolving a large global systemically important bank (G-SIB) becomes operational. This expectation primarily reflects Switzerland's (AAA/Stable) extremely high ability to support its large banks. Specific to UBS, our view of support likelihood is based mostly on its systemic importance in Switzerland as the country's largest bank, its global interconnectedness given its size and operations in WM and IB, significant deposit market share and its position as a key provider of financial services to the Swiss economy.
However, legislative, regulatory and policy initiatives are reaching a point where a resolution of a G-SIB can be achieved without excessive disruption to financial markets, and it is probable that senior creditors will incur losses ahead of the state should such a resolution scenario arise. Fitch considers the bank resolution agenda in Switzerland to be well-advanced compared with most other developed countries and once finalised we expect the Financial Stability Board's (FSB) November 2014 proposals for total loss-absorbing capacity (TLAC) to be implemented swiftly in Switzerland given the Swiss authorities' continued focus on revising the country's "too big to fail" legislative framework. In a move signalling further progress in making the bank "resolvable", UBS is establishing a bank holding company and has announced the establishment of a separate legal entity for its Swiss businesses.
RATING SENSITIVITIES - SUPPORT RATING AND SUPPORT RATING FLOOR UBS's SR and SRF are primarily sensitive to legislative and regulatory developments in Switzerland. Once resolution tools and mechanisms are put in place, they will become an overriding factor in our support-driven ratings, and we expect to downgrade UBS's SR to '5' and revise its SRF to 'No Floor' during the first half of 2015. The revision of the bank's SRF will not affect UBS's Long- and Short-term IDRs of 'A' and 'F1', respectively, as these are based on UBS's VR of 'a'.
KEY RATING DRIVERS - SUBORDINATED DEBT AND 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.
RATING SENSITIVITIES - SUBORDINATED DEBT AND HYBRID SECURITIES
The ratings of UBS's subordinated and hybrid debt issues are primarily sensitive to a change in UBS's VR. The securities' ratings are also sensitive to a change in their notching, which could arise if Fitch changes its assessment of the probability of their non-performance relative to the risk captured in the issuers' VRs. This may reflect a change in capital management in the group or an unexpected shift in regulatory buffer requirements, for example.
KEY RATING DRIVERS - SUBSIDIARIES
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 and integrated into its IB activities. UBS Limited's contractual counterparties continue to benefit from an irrevocable and unconditional guarantee by UBS AG, which underpins our view that the subsidiary is core to UBS's strategy.
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 and important to its US franchise; thus its Short-term IDR is equalised with the ultimate parent's. Further, while there is no financial support agreement or guarantee from UBS, the '1' SR reflects the extremely high probability that UBS would provide support to UBSB should the need arise.
RATING SENSITIVITIES - SUBSIDIARIES
The ratings of both UBS Limited and UBSB are primarily sensitive to a change in UBS's VR and IDRs. In addition, should regulatory developments, notably in the US and the UK, lead to UBS's subsidiaries becoming less integrated within UBS, e.g. through restrictions on intragroup funding flows, then this could lead to UBS subsidiaries' IDRs no longer being equalised with the parent bank's IDRs.
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 'A-'
Tier 2 subordinated notes (low-trigger loss-absorbing notes): affirmed at 'BBB+'
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: affirmed at 'BBB-'
UBS Preferred Funding (Jersey Ltd) Preferred Securities: affirmed at 'BBB-'
UBS Capital Securities (Jersey Ltd) Preferred Securities: affirmed at 'BBB-'
Additional information is available on www.fitchratings.com
