UBS AG: new SGD perpetual AT1 issue in the works?

Note: Readers interested in the history and general background of UBS AG may wish to consult 'UBS AG: The Aftermath of a $48 billion Meltdown'.

Introduction

UBS Group AG is a universal bank in Switzerland; it provides the entire spectrum of banking products and services. UBS traces its roots all the way back to 1854 when six private banking members in Basel, Switzerland, resolved to cooperate and pooled their resources to establish the Bankverein, a consortium that functioned as an underwriting syndicate.

In 1917, its name was changed to Swiss Banking Corporation. The present day UBS emerged in its current form after the 1997 merger of Swiss Banking Corporation and Union Bank of Switzerland.

The primary driver of its earnings can be considered to be its Global Wealth Management division, which accounts for over half of total revenue. In essence, Global Wealth Management caters to the banking needs of high net worth individuals around the world, providing them with a wide range of advisory and investment services.

The bank is also active in the traditional Personal and Corporate Banking segment, whose activities are primarily confined to UBS's domestic market in Switzerland. In addition, UBS is also renowned for its Asset Management and Investment Bank divisions. Asset Management offers specific equity, fixed income, and structured products related investment capabilities that are sought after by institutions with unique needs, and Investment Bank provides capital markets advisory, research, and other trading capabilities.

Financial highlights

For the quarter ending 30 Jun 19 ('2Q19'), UBS registered total operating income of USD 7.53 billion, up 4.4% QoQ. On a year-on-year basis, total operating income recorded a marginal decline of 1.5%.

Profit before tax as reported came in at USD 1.76 billion, up 13.8% on the quarter and an increase of 3.1% on a year-on-year basis. Diluted earnings per share in 2Q19 was USD 0.37, from USD 0.30 in 1Q19. Accordingly, tangible book value per share rose from USD 12.67 in 1Q19 to USD 12.72 in 2Q19, an increase of 3.95% QoQ.

During this period, UBS registered a marked improvement in its solvency position. The bank recorded a common equity tier 1 (“CET1”) ratio of 13.3% at the end of 2Q19, 30 bps above the 13.0% figure recorded in the preceding quarter.

The continued strength of the UBS franchise can be seen in the substantial asset inflows that the bank recorded in the second quarter. Its Global Wealth Management and Asset Management divisions reported aggregate invested assets of USD 3.3 trillion, an all-time record.

Industry comparison

Figure 1 lists the CET1 ratios of the major financial institutions in Switzerland, as well as those of some of their European peers.

Figure 1: European banks – CET1 ratio comparison

The reader would observe that UBS is indisputably the leader of the pack in the extent to which it is capitalized. With a CET1 ratio of 13.3%, its financial position can be considered to be somewhat superior to its closest ranked competitor, Credit Suisse.

The financial position of UBS's European competitors outside of Switzerland pale in comparison. For the second quarter, Societe Generale and BNP Paribas recorded CET1 ratios of 11.7% and 11.9% respectively. Deutsche Bank – the German financial powerhouse – was about evenly matched with UBS, with a CET1 ratio of 13.4%.

The potential new UBS SGD AT1 perpetual

We now turn our attention to UBS's potential bond issue.

Market sources indicate that UBS is looking to issue a new SGD-denominated AT1 perpetual bond with a 5 year non-callable period ('PNC5'), after which the coupon rate would be reset (in the event of a non-call). The transaction is expected to launch in the near future, subject to market conditions. We understand that the issue would in all likelihood carry a rating of BBB- from Fitch.

According to the mandate announcement issued by the bookrunners, the potential new UBS SGD AT1 PNC5 will include a 7% CET1 trigger, with the bonds subject to a permanent write-down upon the occurrence of the trigger event. In other terms, should the bank’s CET1 ratio fall below the 7% threshold, perpetual bondholders would suffer a permanent loss of capital. Given UBS’s superior capitalization vis-a-vis its competitors and the significant gap between its current CET1 ratio and the trigger threshold, we view this to be an unlikely occurrence.

We think it worthwhile – at this juncture – to consider what fair value pricing for the potential bond issue should be.

The first point of reference that we should adopt, in our opinion, is the pricing reflected in the UBS 5.875% Perpetual Corp (SGD) . Issued in November 2018, the UBS 5.875% perp has a first call date in November 2023, or about four-plus years from now. It bears a yield to call of 4.51%. Since this issue is expected to be redeemed earlier (if the bank does indeed redeem the issue) than the potential new UBS perp bearing a 5-year non-callable period, 4.51% should serve as the lower limit to the new bond's coupon rate. Given that the potential new issue's non-call period is not significantly longer than the four-plus years that the UBS 5.875% Perpetual Corp (SGD) has remaining, we do not expect it to offer a substantial yield premium.

The next point of comparison that we might wish to adopt is the SOCGEN 6.125% Perpetual Corp (SGD) issued by Societe Generale. With an outstanding amount of S$750m, the SOCGEN 6.125% perp is first callable in April 2024 (about 4.5 years) and bears a yield to call of 5.53%.

It should be quite apparent to the reader that based on our analysis in the earlier section, Societe Generale has a markedly weaker capital position compared to UBS. As such, we would expect any potential issue by UBS that is redeemable at roughly around the same time to yield substantially less than Societe Generale’s outstanding issue.

Taking the above factors into account, we assess the fair value yield of UBS's potential new SGD AT1 PNC5 to rest in the range of 4.7% to 5.3%.