DBRS Morningstar Places UBS AG’s AA (low) Ratings Under Review With Negative Implications Following the Announcement of Credit Suisse Acquisition

DBRS Ratings Limited (DBRS Morningstar) placed the Long-Term Issuer Rating of UBS AG (the Bank) of AA (low) and the Long-Term Issuer Rating of UBS Group AG (UBSG or the Group), the top-level holding company, of A (high) Under Review with Negative implications following the announcement of the acquisition of Credit Suisse. The Bank’s Intrinsic Assessment (IA) is AA (low) and the Support Assessment is SA1. The Group’s Support Assessment is SA3.

See the full list of ratings in the table at the end of this press release.

KEY RATING CONSIDERATIONS

Today’s rating action follows the announcement of UBS agreeing to acquire Credit Suisse further to a crisis of confidence in Credit Suisse which led the Swiss authorities to coordinate negotiations between UBS and Credit Suisse. On March 19, 2023, UBS announced it will acquire Credit Suisse in full, following close coordination with the Swiss Financial Market Supervisory Authority (FINMA), the Swiss Confederation, and the Swiss National Bank (SNB). Credit Suisse shareholders will receive 1 UBS share for every 22.48 Credit Suisse shares held, which is equivalent to CHF 0.76 per share for a total of CHF 3 billion under the terms of the all-share transaction. The extraordinary government support provided as part of the transaction triggers a complete write-down to zero by FINMA of the nominal value of all Additional Tier 1 (AT1) instruments of Credit Suisse totalling around CHF 15.8 billion, and therefore lead to a rise in core capital.

The Under Review with Negative implications considers that at this stage it remains difficult to assess the full capital, financial, and franchise impact of the announced transaction. Whilst UBS has strong financial fundamentals, DBRS Morningstar believes this acquisition also creates potentially significant risks related to the execution of merging a substantial banking institution into UBS. Credit Suisse’s assets were equal to 48% of UBS’s assets at end-2022. In addition, Credit Suisse has a number of outstanding litigation cases and operational risks, largely in its Investment Bank and Credit Suisse’s management was implementing a significant restructuring, including the downsizing and de-risking of its Investment Banking division. The acquisition is supported by the Swiss authorities. Extraordinary government measures were announced to support the transaction, such as very significant liquidity provided by the SNB, as well as CHF 9 billion protection from the Swiss authorities in case of losses going beyond the first CHF 5 billion, which is to be assumed by UBS.

During the review period, DBRS Morningstar will examine the financial plan and strategy which should provide more information on the outlook for P&L items, including the revenues of the combined entity, alongside the already announced cost reduction target of CHF 8 billion by 2027.

RATING DRIVERS

The long term ratings will return to Stable if the combined entities’ credit strength remains well placed in the current rating category in spite of a likely lower capacity to generate earnings during the integration, and if execution risks appear limited.

Negative pressure on the long term ratings would occur if the combined franchise faces concerns from stakeholders, profitability levels significantly reduces, and/or operational risks issues arise.

RATING RATIONALE

Franchise Combined Building Block (BB) Assessment: Very Strong/Strong

UBS is one of the largest international financial institutions globally. The acquisition of Credit Suisse strengthens UBS as the leading Swiss-based global wealth manager with more than USD 3.4 trillion in invested assets on a proforma basis. In addition, the combined businesses will create a leading asset manager in Europe, with invested assets of more than USD 1.5 trillion on a proforma basis, making UBS the 3rd largest asset manager in Europe. The transaction also reinforces UBS’s position as the leading universal bank in Switzerland.

UBS has an Investment Bank (IB) that provides services that includes advisory, equity underwriting and equities and FX trading services, with particular strength in equity derivatives in EMEA and APAC. IB is not expected to grow significantly, with the majority of Credit Suisse’s IB being placed in a separate non-core division. The combined IB businesses will account for approximately 25% of Group risk weighted assets (RWA) over time.

The combined Group is present in EMEA, Asia Pacific, and the US and is particularly focused on the Ultra High Net Worth (UHNW) and High Net Worth (HNW) segments.

Earnings Combined Building Block (BB) Assessment: Strong/Good

UBS’ focus will remain on the execution of its current strategy. UBS has announced USD 8 billion in run rate cost reductions, which compare to CHF 18.2 billion of operating costs at CS as of end-2022. Overall, UBS’ RoCET1 will be negatively impacted by the Credit Suisse integration and restructuring in the near and medium-term.

UBS has been generating solid profitability, benefiting from the strategic initiatives that were implemented to reposition its wealth management business, whilst also taking advantage of its investment banking franchise capability. UBS reported net profit attributable to shareholders of USD 7.6 billion in 2022, stable from USD 7.5 billion in 2021, and in contrast to CS’ net loss. UBS’ reported Return on Equity was a solid 13.3% in 2022, up from 12.6% in 2021, and 11.3% in 2020.

Risk Combined Building Block (BB) Assessment: Strong

The combined Group has a dominant footprint in Switzerland and extensive Wealth Management activities with a good asset quality profile. Nonetheless, DBRS Morningstar is taking into account the execution risks UBS will be facing in turning around the newly acquired Credit Suisse in the midst of renewed market uncertainty.

UBS has a conservative risk profile reflecting the credit and market risk characteristics of its main businesses, especially in wealth and asset management, with sound asset quality. At end-2022, UBS had low levels of gross impaired loans (stage 3). Stage 3 loans to customers and financial advisors totalled USD 2.5 billion, down from USD 2.6 billion at end-2021, and still below USD 2.6 billion at end-2019. Impaired loans in Personal and Corporate Banking was 0.8% at end-2022 down from 0.9% at end-2021. DBRS Morningstar does not expect Credit Suisse’s credit risk profile to be a concern given similarly solid asset quality metrics. For example, CS’s Swiss Bank loan book remains strong with an impaired loan ratio of only 0.6% at end-2022.

We will also continue to monitor the Group’s operational and reputational risks. UBS remains subject to certain investigations, albeit largely provisioned for. UBS Group had total provisions for litigation, regulatory and similar matters of approximately USD 2.6 billion at end-2022, of which approximately USD 1.3 billion within Global Wealth Management. Meanwhile, Credit Suisse had significant operational issues including a number of outstanding litigation cases, largely in its IB activities. Credit Suisse’s management was in the process of addressing these issues while implementing a significant restructuring, including the downsizing and de-risking of its IB division. DBRS Morningstar understand UBS has taken some reserves to account for these risks in its calculations.

Funding and Liquidity Combined Building Block (BB) Assessment: Very Strong/Strong

The Swiss National Bank (SNB) is granting Credit Suisse and UBS very significant access to a LT secured liquidity facility. This means that UBS will have substantial liquidity available to carry out the integration and winding-down process of Credit Suisse. The liquidity provided by the SNB will include a loan covered by a federal guarantee. The Swiss Confederation will also provide guarantees for potential losses of certain assets that UBS will acquire as part of the transaction, if these losses exceed a specific threshold.

DBRS Morningstar considers UBS’s funding and liquidity is robust, supported by a large and stable deposit base, benefiting from the Global Wealth Management (GWM) business and the strength of UBS’s banking franchise in its home country. Customer deposits totalled USD 525.1 billion at end-2022 (vs. USD 542.0 billion at end-2021), largely supported by deposits in GWM and P&CB. The Group has well-diversified funding sources across various markets, products, and currencies. At end-2022, the Group reported a sound liquidity coverage ratio (LCR) of 163.7% (vs. 155.5% at end-2021), and a Net Stable Funding Ratio (NSFR) of 119.8% (vs. 118.5% at end-2021). More recently, DBRS Morningstar notes UBS benefited from a flight to safety given its leading position and strong financial fundamentals.

Capitalisation Combined Building Block (BB) Assessment: Strong

Despite likely reduced earnings further to the acquisition of Credit Suisse, we expect UBS's capital position to remain strong. DBRS Morningstar notes UBS is temporarily suspending its share repurchases while maintaining a progressive cash dividend policy.

UBS reported a fully-loaded Basel 3 CET1 ratio of 14.2% at end-2022, vs. 15.0% at end-2021, and well above the approximately 13% CET1 ratio guidance from the Group, which compares well to peers. Meanwhile, Credit Suisse Group’s CET1 ratio was 14.1% at end-2022

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/411456

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Governance (G) Factors

DBRS Morningstar views Business Ethics and Corporate Governance as Relevant rating factors for UBS’ ratings.

DBRS Morningstar notes UBS is taking on Credit Suisse’s liabilities/outstanding litigations but that they have been reportedly adequately reserved for. At present, there are two major outstanding cases for UBS: (i) the French tax case and (ii) the RMBS case in the US. (i) In February 2019, a French court found the Group guilty of unlawful solicitation of clients on French territory and aggravated laundering of the proceeds of tax fraud. The Group has appealed the case twice. The fine and confiscation imposed by the Court of Appeal are suspended during the appeal. At end-2022, The Group has provisioned EUR 1.1 billion (up from EUR 450 million initially) for this case. (ii) The second one is related to legacy RMBS in the US. In November 2018, the US Department of Justice filed a civil complaint relating to the issuance, underwriting and sale of 40 RMBS transactions in 2006 and 2007. Our expectation is that the final economic and reputational impact of these cases will be manageable for the Group.

There were no Environmental or Social factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (17 May 2022)

Notes:

All figures are in USD unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations https://www.dbrsmorningstar.com/research/398692/global-methodology-for-rating-banks-and-banking-organisations (23 June 2022). In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (17 May 2022) in its consideration of ESG factors.

The sources of information used for this rating include Morningstar Inc. and Company Documents, UBS Group AG Annual Report 2022, UBS Group AG Full Year and Fourth Quarter 2022 Financial Results Presentation, Swiss Financial Market Supervisory Authority (FINMA): “FINMA approves merger of UBS and Credit Suisse”, SNB: “Swiss National Bank provides substantial liquidity assistance to support UBS takeover of Credit Suisse”, The Swiss Federal council: “Safeguarding financial market stability: Federal Council welcomes and supports UBS takeover of Credit Suisse”. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

With Rated Entity or Related Third-Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

DBRS Morningstar does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar's outlooks and ratings are under regular surveillance.

This rating is under review. Generally, the conditions that lead to the assignment of reviews are resolved within a 90-day period. DBRS Morningstar reviews and ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/411457

This rating is endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Vitaline Yeterian, Senior Vice President, Global FIG
Rating Committee Chair: Elisabeth Rudman, Managing Director, Head of Global FIG
Initial Rating Date: 17 May 2010
Last Rating Date: 14 November 2022

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