Government demands for the bank to set aside more capital shouldn’t threaten its share buyback plans.
The big question for UBS Group AG shareholders is how badly its share buyback promises will be knocked by the Swiss government’s desire to pursue higher capital requirements. The answer isn’t clear yet, but the truth might be: Not much.
Chief Executive Officer Sergio Ermotti said during UBS’s first-quarter results on Tuesday that the bank itself was in the dark and hadn’t been consulted on the government’s thinking, leaving some uncertainty hanging over its longer term goals. But in the here and now, UBS is seeing fine progress. Results for the first three months put the bank well on course to beat its targets for integrating Credit Suisse and returning capital to investors this year. The shares rose 10% in morning trading.
UBS’s rescue takeover of Credit Suisse last spring has inflated its balance sheet to more than double Switzerland’s gross domestic product. The government is worried it’s way too big to fail and that the country’s financial watchdog doesn’t have enough powers — or resources — to oversee it properly. UBS supports many of the regulatory changes being proposed, but not the demands for increased capital that the government is apparently leaning toward. These new requirements haven’t been detailed, but Finance Minister Karin Keller-Sutter has said that an extra $15 billion to $25 billion was plausible.
Ermotti repeated UBS’s mantra that it was Credit Suisse’s unsustainable lossmaking business model, rather than overly-easy capital requirements, that ruined its former rival. He also said that the enlarged group was already increasing its capital by nearly $20 billion as part of the takeover.
This number isn’t as hard and fast as it might seem, however. About half of it is already in UBS’s current, more-than-ample capital ratio and should be reduced later, while the other half won’t start being applied until 2026 and won’t be fully required until 2030. The impact on its payout capacity then looks minimal.
To explain briefly, the first roughly $9 billion relates to the previous under-capitalization of Credit Suisse subsidiaries. UBS has a more conservative approach for the calculations involved, so has already met the higher capital levels it needs for these. But this shouldn’t last because one of UBS’s key objectives this year is to simplify the enlarged bank by slashing the number of different legal entities it’s acquired around the world. That means fewer units that must be separately capitalized in the first place.
The full $20 billion that Ermotti referenced is also already baked into its aims and forecasts and so shouldn’t affect its target of paying out more than $7.3 billion in buybacks and dividends in 2026. The bank also isn’t too worried about the potential for stress tests to be used to add an extra chunk of what the government called forward-looking capital in its announcements last month.
The plans outlined by the Swiss government so far could mean that Keller-Sutter’s plausible additions more or less match with Ermotti’s number. What UBS is worried about is an even stricter treatment of foreign subsidiaries than Switzerland had previously proposed. There’s a reasonable chance that the government could turn round and say its demand for more capital have been satisfied.
UBS wants to move the debate away from equity capital alone and onto the full amount of loss absorbing capital the bank already has, including CoCo bonds and senior debt that are designed to be zeroed in the event of a major crisis. Together, these three forms of capital amount to $197 billion, or slightly more than 12% of its entire balance sheet.
That seems like a lot, but there are legitimate questions as to whether regulators would be able to write off the senior loss-absorbing debt in particular in the event that UBS was sunk by a major crisis. The pain caused to the owners of this debt might mean taxpayers end up footing some of the bill after all – this has happened before with more junior debt in previous failures elsewhere.
Ultimately, the main objective should be avoiding this question arising in the first place. That’s why the strengthening of the powers and culture of oversight at the main financial watchdog, rather than how UBS treats its overseas units in its accounts, is the more important change that Switzerland needs to get right.
