What’s CHF3.47 billion ($3.66 billion) between friends? That’s the sum UBS has set aside to cover fines and civil lawsuits. But if the bank’s long term profits and capital reserves stay intact, it's not such a problem. Is that the case with UBS and Switzerland’s other big bank?
The financial crash plus evidence of mis-selling, market rigging and tax evasion have resulted in an era of litigation for the banking sector. UBS is expecting more legal trouble than its rival Credit Suisse, as evidenced by the CHF1.86 billion and CHF390 million the pair set aside in the third quarter alone.
Analysts calculate that Credit Suisse has a “mere” CHF1.3 billion in stockpiled legal provisions, but the bank has already shelled out $2.8 billion this year to settle a United States tax evasion prosecution. These are eye-watering figures to the person on the street, but how damaging are they for multinational banks?
Credit Suisse booked a CHF700 million second quarter loss after the US fine in May but bounced back with a CHF1 billion profit in the next three months. UBS posted a CHF1.9 billion loss in the last quarter of 2012 after paying out a $1.5 billion fine for Libor rigging, but has stayed nicely in the black since then.
Compared with some of the fines being thrown about like confetti by multiple countries for numerous offences, the two Swiss banks do not seem too badly affected. In fact, their legal costs pale in comparison to the $13 billion, $9 billion and $8.5 billion paid out by JP Morgan, BNP Paribas and Bank of America for a range of misdemeanors in recent years.
Practically all international banks have been stockpiling reserves to help cope with the fallout, which is tipped to continue for a few more years.
Occasionally a particularly big fine will result in a quarterly loss. But markets look most keenly at how legal costs affect the capital reserves that each bank is now compelled to set aside to buffer against future financial shocks. This is measured in capital ratios: how much rock solid equity the bank has against its riskier trades.
The more liquid capital that pours out of a bank to cover fines, the less it has to boost its benchmark ratio. The balancing act between stockpiling legal provisions and more general capital buffers can at times operate on a knife edge.
Take Credit Suisse that was fined $2.6 billion by the US in May. The bank’s capital ratio plunged from 10% to 9.5% from one quarter to the next as a result. It has since recovered to 9.8% but the bank has to boost that further to achieve the 10% ratio demanded by regulators by the end of the year.
Fortunately for Credit Suisse, it now seems to have put the worst of its litigation problems behind it. Unlike UBS, Credit Suisse does not appear to be deeply implicated in global investigations into alleged Libor and foreign exchange market rigging.
Globally, currency-rigging fines could reach $41 billion in the coming years, according to analysts at Citigroup bank. UBS could be up to its neck to the tune of CHF4.5 billion, Citigroup calculates.
Furthermore, UBS has been dragged back into tax evasion litigation - this time by France. In September a Paris court ordered the bank to pay a CHF1.1 billion bond in anticipation of a criminal case. UBS chief executive Sergio Ermotti said at a recent media conference that the case is likely to last years rather than months.
It’s just as well then that UBS has one of the best capital ratios (13.7%) of any of its international peers. “It was a surprise that UBS managed to increase its capital ratio [from 13.5% the previous quarter] despite having to set aside quite a large provision,” Bank Vontobel analyst Andreas Venditti told swissinfo.ch.
Credit Suisse would struggle to deal with such hefty legal problems, according to Andreas Brun, an analyst at Zurich Cantonal Bank.
“Credit Suisse’s capital ratio [9.8%] is a lot lower than at UBS,” he told swissinfo.ch. “It would be horrible for Credit Suisse if they had the same size of legal issues hanging over their heads as UBS.”
Another factor weighing in UBS’s favour is that it is still claiming income tax credits built up from sustaining massive losses during the financial crisis. The bank announced a CHF1.3 billion tax rebate on the same day it said it would put CHF1.86 billion aside to cover legal costs.
The outstanding civil and criminal rap sheet of both banks, although unproven, remains lengthy and will probably prove a headache for some years to come. Only days ago, both were fined by European regulators for taking part in a cartel to rig Swiss franc interest rate derivatives.
Andreas Brun believes that Credit Suisse will have to set aside another CHF1 billion in provisions by the end of 2016 and that UBS will need to increase its pot to more than CHF4 billion in the same time frame.
No end in sight
This state of affairs is more than annoying for some investors. The Swiss-based Ethos Foundation, which manages ethical investments for large scale corporate clients such as pension funds, voiced its frustration ahead of the annual general meetings of both banks earlier this year.
An Ethos statement bemoaned the fact that both banks had put aside a sum in provisions that more than doubled the total dividend payout to investors in 2013.
“New evidence was also revealed in relation to the sale of financial products and the management of tax issues in the United States,” the April statement read. “Several investigations are pending on possible manipulation of foreign exchange rates [UBS]. All this demonstrates that the two boards of directors have difficulty controlling the banks' operations.”
However, the news does not seem to get any better for shareholders looking for signals of dividend increases.
“In view of the current regulatory and political climate affecting financial institutions, and because we continue to be exposed to a number of significant claims and regulatory matters, we expect charges associated with litigation, regulatory and similar matters to remain at elevated levels through 2014,” UBS said in a statement when announcing Q3 results in October.
US tax evasion cases
A number of Swiss banks are still involved in legal issues in the United States surrounding allegations of tax evasion.
Some 14 private banks, including Pictet and Julius Baer, are under criminal investigation.
More than 100 others are facing financial penalties after joining a non-prosecution programme arranged between the Swiss and US authorities that would spare them from damaging court cases in exchange for them spilling the beans on their US activities.
Some 73 of the Swiss banks on the programme recently sent letters to the US Department of Justice asking clarification on the small print of the deal, including an item that requires them to pass on information to other countries.
Peter Kübli, chairman of Saanen Bank in Gstaad, labelled the programme “unspeakable” and “unpredictable” in the bank’s annual report this year.
On top of this, former UBS wealth management boss Raoul Weil is currently fighting for his freedom in a Florida court, accused of masterminding a multi-billion dollar tax dodging racket whilst working for Switzerland’s largest bank.end of infobox