Fitch Revises UBS Group AG's Outlook to Positive; Affirms at 'A'
The Outlook on UBS AG's operating subsidiaries UBS Switzerland AG and UBS Limited are also revised to Positive from Stable. Their Long-term IDRs are affirmed at 'A'. A full list of rating actions is available at the end of this rating action commentary.
The Outlooks have been revised to Positive to reflect Fitch's view that further progress in executing the group's strategy should result in a stronger company profile, which could result in an upgrade of the Long-term IDR. Its business model, which concentrates on UBS's strong franchise in global wealth management, should allow the bank to generate robust and stable profitability in a normalised operating environment and once legacy litigation costs are behind it, while maintaining a strong capitalisation.
The rating actions have been taken in conjunction with Fitch's periodic review of the Global Trading and Universal Banks (GTUB), which comprises 12 large and globally active banking groups. Fitch's outlook for the GTUBs is stable as we expect the stable outlook for the groups' commercial banking and wealth and asset management businesses in 2016 to mitigate pressure on earnings from capital markets activities, particularly in fixed income trading.
As globally active universal banks, the 12 GTUBs are among the most affected by evolving regulation, which is bringing capital and resource constraints to some businesses. This means that business models are being adjusted. Specific changes and their timing vary by bank. In the medium term, we believe that the GTUBs with the strongest franchises in their core businesses, sound business models and clear strategies are best placed in this environment, and these company profiles are an important rating factor for many of the GTUBs.
KEY RATING DRIVERS
IDRS, VRS AND SENIOR DEBT
UBS's company profile has a high influence on the VRs and IDRs as we expect that the group's leading global wealth management franchise, together with its domestic retail and corporate banking and global asset management businesses, will enable the bank to generate robust and stable earnings. We expect capital markets businesses to remain an important component of the group's activities and to support wealth management activities. The assessment of UBS's company profile incorporates our view that the group's non-core and legacy portfolio remains a drag on the group's performance, primarily because of legacy litigation and misconduct risk. We expect UBS to continue to work through these issues, which might involve further fines and additional costs.
The group's capitalisation and funding and liquidity are rating strengths. Capital ratios based on risk-weighted assets (RWA) are the strongest in its peer group, with UBS Group AG reporting a consolidated 14.3% fully-applied Basel III common equity Tier 1 (CET1) ratio at end-3Q15. The group's capitalisation based on unweighted leverage, with a 3.9% fully-applied Basel III leverage ratio at end-3Q15, continues to improve, and we expect UBS to meet the expected new Swiss regulatory requirement of a 5% leverage ratio by 2019 as it issues additional Tier 1 (AT1) instruments.
Funding and liquidity remain strong and benefit from the bank's global wealth management operations. UBS holds a large portfolio of liquid assets, which in 3Q15 on average amounted to CHF191bn, while the liquidity coverage ratio averaged 127%. We expect the group to continue to manage capital and funding on a group-wide basis, but regulatory requirements for individual legal entities will, in our opinion, result in an increasing focus on local capital and liquidity requirements. The group's solid capital and funding profiles should enable it to comfortably meet local regulatory requirements.
UBS's operating profitability remained resilient in 9M15, and the group's net income benefited from a CHF1.5bn net upward revision of deferred tax assets in 3Q15, which mainly related to the group's US business. We expect operating performance to remain adequate, but we expect provisions for litigations, regulatory and similar matters are likely to remain material given pending legal cases and regulatory investigations. 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 further misconduct costs.
Fitch has assigned common VRs to UBS AG and UBS Switzerland AG to reflect our expectation that the credit profiles of the two operating entities will remain closely connected, at least for as long as UBS Switzerland AG remains a subsidiary of UBS AG. UBS Switzerland AG's large size, with about CHF300bn total assets under Swiss GAAP, also drives the common VR as we believe that it would be difficult for UBS AG to provide support to this large subsidiary. In Fitch's opinion, the joint and several liability arrangement between UBS AG and UBS Switzerland AG underpins the close integration of the two entities.
SUPPORT RATING AND SUPPORT RATING FLOOR
The Support Ratings and Support Rating Floors reflect Fitch's view that senior creditors can no longer rely on receiving full extraordinary support from the sovereign in the event that UBS AG or UBS Switzerland AG become non-viable.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Subordinated debt and other junior and hybrid capital issued by UBS Group AG, UBS AG and its affiliates are all notched down from UBS AG's or UBS Group AG's VR in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles, which vary considerably.
Legacy subordinated lower Tier 2 debt is rated one notch below the VR for loss severity, reflecting below-average recoveries.
Low trigger contingent capital Tier 2 notes are rated two notches below the VR, reflecting loss severity in the form of contractual full and permanent write-down language.
Legacy Tier 1 securities are rated four notches below the VR, comprising two notches for loss severity, and two further notches for non-performance risk, reflecting that coupon omission is partly discretionary.
High and low trigger additional Tier 1 instruments are rated five notches below the VR. The notes are notched twice for loss severity, and three times for non-performance risk, reflecting fully discretionary coupon omission.
HOLDING COMPANY
UBS Group AG's VR and IDRs are equalised with those of UBS AG and UBS Switzerland AG, and reflect UBS Group AG's role as the group's holding company.
We expect the holding company, either directly or through funding entities, to issue the bulk of loss-absorbing debt, including AT1 instruments and senior unsecured long-term debt. At end-3Q15, UBS Group AG had issued CHF5bn AT1 instruments and CHF4.2bn senior debt. Issuance by the holding company will result in a debt buffer building up over time. We do not expect double leverage at the holding company to exceed 120%, a level at which we would consider notching the holding company's VR and Long-term IDR below the bank's ratings. We expect the holding company to maintain prudent management of liquidity, which should be helped by existing policies in place to manage liquidity across a large number of legal entities globally.
SUBSIDIARIES
London-based UBS Limited is a wholly owned subsidiary of UBS AG. Its issuer and debt ratings are aligned with UBS AG's because Fitch views UBS Limited as a key part of the UBS group and integrated into its investment banking activities. UBS Limited's contractual counterparties continue to benefit from an irrevocable and unconditional guarantee by UBS, which underpins our view that it is an integral part of the group's business.
UBS Bank USA is a direct subsidiary of UBS Americas Inc., which in turn is wholly owned by UBS AG through UBS Americas Holdings LCC. The ratings reflect Fitch's view of UBS Bank USA's integration and its important role within the group and its Short-term IDR is therefore equalised with the ultimate parent's.
RATING SENSITIVITIES
IDRS, VRS AND SENIOR DEBT
As we have assigned common VRs, UBS Switzerland AG's VR and IDRs would move in line with UBS AG's.
The Positive Outlooks on UBS AG's and UBS Switzerland AG's IDRs indicates that the ratings would likely be upgraded within the next 12-24 months if the group continues to execute its strategy and achieves its targeted sound profitability while maintaining sound capitalisation. An upgrade of the IDRs would also be driven by further reduction in tail risks, including misconduct and litigation risks in UBS's Non-core and Legacy Portfolio.
We expect the group to continue to generate sound operating profit, driven by stable earnings from its wealth management businesses. We believe that the performance of the Investment Bank business division will remain affected by seasonal factors, but that the bank's modest risk appetite will result in limited earnings volatility in these businesses. The Outlooks would likely be revised to Stable if the bank's earnings demonstrate excessive vulnerability to market volatility, which could be indicated by losses in the Investment Bank business division arising from spikes in market volatility.
If misconduct and litigation costs are higher than our expectations and affect the group's capitalisation with no credible plan for restoring these over a reasonably short period, the Outlook would likely be revised to Stable and ratings could come under pressure. Any material restrictions on the group's ability to conduct businesses, which could be the result of penalties by authorities, would also put the ratings under pressure.
We expect UBS Group AG to achieve the strong capital ratios required under the revised Swiss regulations for the country's two large banks. Achieving regulatory requirements, including requirements for total loss-absorbing capacity (TLAC), could result in upward pressure on ratings, while failure to maintain its sound targets, which we do not expect given the bank's clear strategy, would put ratings under pressure.
UBS Switzerland AG's ratings are sensitive to a change in the subsidiary's integration in the group. Should it become less integrated, which could occur if higher-than-expected amounts of regulatory capital are trapped in the subsidiary, UBS Switzerland AG's VR would become based on its standalone profile. We expect capital in excess of regulatory requirements and a management buffer to be up-streamed to UBS AG, at least for as long as the group entities remain strongly investment-grade.
Changes to UBS's group structure, including changes to UBS Switzerland AG's ownership structure, could also result in rating differentiation if Fitch concludes that this reduces UBS Switzerland AG's, UBS AG's and other group entities' integration with each other. The group announced that it is considering further changes to its legal structure, which could include the transfer of operating subsidiaries of UBS AG to become direct subsidiaries of UBS Group AG and the creation of additional subsidiaries.
Despite UBS's significant layers of subordinated debt, this is not sufficient to warrant an uplift of UBS AG's Long-term IDR relative to its VR, leaving the ratings on a par.
UBS AG's and UBS Switzerland AG's Long-term IDR could be rated above their VRs and UBS Group AG's Long-term IDR if Fitch concludes that junior debt buffers and pre-positioned total loss-absorbing capacity buffers are sufficiently large to absorb potential losses in order to restore UBS AG's and UBS Switzerland AG's viability and therefore protect the operating banks' senior creditors. This IDR uplift would be limited to one notch.
SUPPORT RATING AND SUPPORT RATING FLOOR
An upgrade of the Support Rating and upward revision of the Support Rating Floor would be contingent on a positive change in the sovereign's propensity to support its banks. While not impossible, this is highly unlikely in Fitch's view.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The ratings of UBS AG's and UBS Group AG's subordinated and hybrid debt issues are primarily sensitive to a change in the respective VRs. 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.
HOLDING COMPANIES
UBS Group AG's VR and IDRs are sensitive to the same factors as UBS AG's and UBS Switzerland AG's. Its VR and IDRs could be notched down from UBS AG's ratings if double leverage at the holding company increases above 120% or if the role of the holding company changes. Together with the creation of separately capitalised subsidiaries, over time further expected debt issuance by UBS Group AG could change the relative position of creditors of different group entities, which would be reflected in different entity ratings, including the holding company's VR and IDRs.
SUBSIDIARY AND AFFILIATED COMPANIES
The ratings of UBS Limited and UBS Bank USA are primarily sensitive to a change in their ultimate owner's IDRs. In addition, should regulatory developments, notably in the UK and the US, lead to these 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. These subsidiaries' IDRs could be upgraded above their ultimate parent's Long-term IDR if pre-placed internal debt, including internal TLAC that is junior to external senior obligations effectively, protects the subsidiaries' senior creditors.
The rating actions are as follows:
UBS Group AG
Long-term IDR: affirmed at 'A'; Outlook revised to Positive from Stable
Short-term IDR affirmed at 'F1'
Viability Rating: affirmed at 'a'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
Tier 1 subordinated notes ('high-trigger'): affirmed at 'BB+'
Tier 1 subordinated notes ('low-trigger'): affirmed at 'BB+'
UBS AG
Long-term IDR: affirmed at 'A'; Outlook revised to Positive from Stable
Short term IDR: affirmed at 'F1'
Viability Rating: affirmed at 'a'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
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 Switzerland AG
Long-term IDR: affirmed at 'A'; Outlook revised to Positive from Stable
Short term IDR: affirmed at 'F1'
Viability Rating: affirmed at 'a'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No Floor'
UBS Limited
Long-term IDR: affirmed at 'A'; Outlook revised to Positive from 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 Group Funding (Jersey) Limited
Unsubordinated notes: affirmed at 'A'
UBS Preferred Funding Trust V Preferred Securities: affirmed at 'BBB-'
UBS Capital Securities (Jersey Ltd) Preferred Securities: affirmed at 'BBB-
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