Another Swiss miss at UBS
Investors shrug off a $19 billion writedown and other ominous signs as strong demand for a Lehman stock sale boosts Wall Street.
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NEW YORK (Fortune) -- UBS investors are paying a princely sum for the Swiss bank's real estate ambitions.
With Tuesday's $19 billion writedown, UBS (UBS) has taken a total of $37 billion in charge-offs on real estate-related securities and structured products. If you're keeping score at home, UBS has now vaulted ahead of Citi (C, Fortune 500) to the top of the mortgage writedown chart.
Yet for a day, there was no shortage of buyers for the latest version of the troubled UBS turnaround story. Its shares surged 14% as a hugely oversubscribed preferred share issue at Lehman Brothers (LEH, Fortune 500) suggested the market is still willing to stand by hard-hit financial firms.
The rally came even as UBS announced a $15 billion rights offering designed to restore its depleted capital base, about a third of which was wiped out with the latest charge. UBS' leadership ranks took another casualty, as the bank announced the departure of Chairman Marcel Ospel, who has long been the face of the bank to its global investor base.
Of course, change is nothing new at UBS. Over the past year, the firm has sent its chief executive, chief financial officer and investment banking chief packing. On Tuesday, it took another step, suggesting that its portfolio of distressed mortgage assets may be sold.
Barely a decade old in its present form, and seeking to compete with established bond-bond market players like Goldman Sachs (GS, Fortune 500) and Lehman Brothers, UBS used its massive balance sheet to build relationships with institutional investors. The strategy worked for a long time, with UBS frequently ranking in recent years among the top three mortgage bond underwriters. The firm reaped hundreds of millions of dollars in fees and trading profit.
So how much balance sheet muscle did UBS use to shoulder its way into the mortgage party over the past five years? In an era of excessive leverage, UBS has been no exception - which is why, even after the latest round of writedowns and asset sales, shareholders may be facing still more pain.
Seeking to maximize its profit potential, UBS found higher-margin subprime mortgages particularly attractive, given the bank's massive balance sheet, low cost-of-funding and (presumably) its ability to globally distribute subprime structured products. While the attractiveness of subprime assets declined sharply after the market for those securities collapsed last summer, UBS and others weren't able to empty their shelves in time.
Its trading desks and asset management portfolios held almost $61 billion in U.S. residential mortgage assets as of Dec. 31 - even after $19 billion in earlier writedowns and asset sales. As of year-end, the bank had $27.6 billion in subprime bonds, after having written down $14 billion, according to a CreditSights report. At the end of the year, UBS also held $11.4 billion in leveraged loans and $7.7 billion in commercial real estate interests.
In Tuesday's announcement, UBS announced that it has continued a vigorous effort to reduce exposure, with $16 billion now remaining in Alt-A mortgage paper, down from $26.6 billion. The bank also reported $15 billion in various pieces of collateralized debt obligations (CDOs), down from $27.6 billion at the end of the year. The reductions reflect asset sales as well as writedowns
The sharp reductions in the size of UBS' portfolio of investments backed by Alt-A mortgages, which are residential mortgages that fall between prime mortgages and sub-prime mortgages on the credit-quality scale, jibes with trading desk gossip: the firm is said to have traded as much as $10 billion to one unknown buyer earlier in the month.
Needless to say, UBS has not been alone in drinking from this trough. The trading desk rumor mill has two other perennial favorites, Citi and Merrill Lynch (MER, Fortune 500), slated for another bout of writedowns as well. Citi, which until now was seen as the biggest loser in the mortgage meltdown, has taken $20 billion in writedowns of subprime holdings and CDOs so far. The bank's first-quarter report due out later this month is expected to add substantially to that toll.
Perhaps more telling is the pain being felt at one of the better-managed firms, Deutsche Bank (DB). Deutsche's trading desks have been widely praised for alerting clients to the likely decline of wide swaths of the mortgage universe - yet the firm just announced its own $3.9 billion charge.
Along those lines, arguably the most important news in the UBS release was the observation that trading conditions in March were awful. Had the firm's trading desks seen indications of customers returning to the market, or stability in pricing, the press release would likely have noted it.
The fact that UBS made no effort to sugarcoat its horrid performance suggests financial investors haven't seen the last of the mortgage writedowns. 
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