Monday, December 10, 2007

Controlled bleeding or cauterization...?

Agreed, not so upbeat title for an Economist story with no hemal touch. But as an opener, it isn’t entirely out of place either. The metaphor fits in water tight. Excerpts -

"That was the unappealing choice facing UBS, a Swiss bank which has been badly hurt by the carnage in America’s mortgage market. Today, the bank opted for the latter. First it opened the wound, by announcing a hefty $10 billion write-down on its exposure to subprime infected debt. UBS now expects a loss for the fourth quarter, which ends this month. It may end up in the red for the entire year. Then came the hot iron: news of a series of measures to shore up the bank’s capital base, among them investments from sovereign-wealth funds in Singapore and the Middle East."

[It started with Merryl Lynch, then Morgan Stanley and Citi Group bringing up the rear.] "Why then did this new batch of red ink still come as a shock? The answer lies not in the scale of the overall loss, more in UBS’s decision to take the hit in one go. The bank’s mark-to-model approach to valuing its subprime-related holdings had been based on payments data from the underlying mortgage loans. Although these data show a worsening in credit quality, the deterioration is slower than mark-to-market valuations, which have the effect of instantly crystallising all expected future losses."

Will this bloodbath end, ever…? Loss of reputation for a conservative bank like UBS is deep enough cut. What is worse is the impact that has exposed the fluidity of its capital adequacy ratios at the tier 1 level. Of course, it has rich friends ready to pitch in. The white knights include sovereign-wealth funds (GIC, Singapore) and rich middle east investors that have pledged support to shore up its bottomline by infusing SFr 19.4 billion. Marrying bigger-than-expected write-downs with bigger-than-expected boosts to capital looks like the right treatment in this environment. But UBS still cannot be sure that its problems are over.

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