Investment in UBS by GIC – a Chronicle of a Disaster in the Making

February 8 2010

It was mid-December 2007 [A] when the Government of Singapore Investment Corp. (GIC) made a whooping 11 billion Swiss francs (S$13.8 billion) investment in UBS.

There was news earlier in the summer of 2007 about how the US housing market was showing signs of slowing down, but some of the major financial institutions were still raking in record profits and numerous equity indices were nearing their all-time highs.

UBS was amongst the first of the banks to show signs of cracking. A day before GIC announced its investment, the bank had just announced a write-down of US$10billion[1] and the money raised was necessary to maintain its capital ratio and ease market fears of its stability.

As GIC became the largest single shareholder of the Swiss giant (circa 9%), deputy chairman and executive director Dr Tony Tan said in a statement that GIC had “confidence in the long-term growth potential of UBS’s business, particularly in the global wealth management business”.[2]

The word “long-term” does not have a fixed definition, but in the world of finance and markets, anything longer than five years is generally considered “long-term”.

With UBS it never rains – it pours

Since that fateful day for GIC, UBS’s fortunes had gone from bad to worse.

Throughout 2008, rival banks began to report massive losses, but very few had worse results than UBS. The Board reacted by changing the management team and the new management team introduced cuts across the board, from staff numbers to bonuses.
All the cuts had very little impact and in April 2008 [B], the bank’s ratings were downgraded by major rating agencies. This essentially increased the bank’s borrowing costs in the open market and further damaged its reputation of being a stable Swiss bank. The losses were mainly from its investment banking and trading arm, but alarmed customers in its wealth management division were leaving the bank.

In October, the bank had little choice but to turn to the Swiss central bank for assistance. [C] In an unprecedented move, the usually non-interventional Swiss Central Bank technically bailed out UBS via an agreement to ‘ring-fence’ US$60billion of UBS’s illiquid (and poor quality) assets.[3]

By then it was clearer to the markets – UBS has dabbled in the US sub-prime mortgage markets more actively than any other of their European rivals and was hurting from it.

For the entire 2008 financial year, the bank lost a total US$17billion, the largest loss in Swiss corporate history. Only Citibank, Wachovia, Merrill Lynch and Bank of America had lost more in this crisis.[4]

An Imminent Collapse?

While the losses were staggering, it still can be said that with the backing of the Swiss government, UBS remains stable financially, at least in the short term.

However, the viability of the bank’s business model in the long run was thrown into uncertainty in Feb 2009.[D]

It was announced that that the bank had been made liable to pay a $780million to the taxman in the United States to settle an investigation into its operations.[5] They had also initially agreed to divulge the identities of some of their clients who had used the bank to park their wealth offshore to evade taxes in the US.

Since the Middles Ages, Swiss banks had leveraged on their reputation to protect identities of their clients to lure wealthy customers, who are willing pay huge fees to the bank. UBS, in particular, was a massive player in the murky world of private wealth management. By helping rich Americans set up offshore accounts right under the noses of the taxman, the bank had approximately earned over $200million annually.

At time of writing, the case between the US tax authorities and UBS is still ongoing. The American government wants the bank to reveal all of the clients they had ever helped to evade tax, but UBS is negotiating to only disclose some of these Americans and not all. This high profile case had involved the governments from both countries and is now turning into a diplomatic issue.

This is a classic case of a catch-22 for UBS. On one hand, if they do back down and hand in the details of their clients to the US government, they will lose more customers in its wealth management business. They can no longer charge higher fees than their rivals because they no longer have that competitive edge over them. In business terms, the bank’s critical success factor will be lost. The bank may almost have to restart its wealth management business from scratch, in a market already saturated with other banks.

On the other, if UBS decides not to co-operate, the US Courts may revoke their banking licence in the country all together. No statistics and figures are required to show how a global bank like UBS will suffer if they are not allowed to trade and operate in the world’s largest economy.

Last week, Swiss Justice Minster warned that UBS may fail if no agreement was reached.[E][6] The headlines may be sensational, but he may not be exaggerating. If UBS does not suggessfully negotiate past this hurdle in the short-term, there will be no “long-term” future to talk about and Dr Tony Tan’s words will haunt GIC forever.

GIC has no management involvement in UBS, so will not be directly implicated in this court case. However, if UBS does fail, the entire S$13.8bn invested will likely go down the drain (less any amounts recovered upon liquidation).

S$13.8bn. That is nearly S$3,000 for every man, woman and child from Tuas to Changi in the island of Singapore.