UBS pays the price

Could the worst be over? That was the question investors asked yesterday as UBS revealed its worst-case scenario for the effects of the credit crunch.

Switzerland's largest bank wrote down SFr4bn (£1.67bn) at its fixed-income business, took an axe to its executive team and announced 1,500 investment banking job cuts.

UBS said the write-downs would mean a loss of up to SFr800m for the third quarter. Credit Suisse, UBS's biggest rival in Switzerland, also felt the pain but said it had a profitable third quarter and was still in line for record profits for the full year.

The quarterly loss will be UBS's first since it wrote off its investment in Long-Term Capital Management in 1998.

The write-downs included $1bn (£489m) of direct investments in sub-prime mortgage-backed securities and $900m on securities due to be turned into collateralised debt obligations (CDOs), pools of assets that investors are now shunning.

In a classic warts-and-all exercise, UBS's new chief executive, Marcel Rohner, got the bad news out of the way and let everyone know where the blame lay.

Huw Jenkins, the head of the investment bank, has been ousted and for the time being will advise Mr Rohner, who will run investment banking himself. Clive Standish, the bank's finance director, retires after the use of the bank's balance sheet was allowed to get out of control. The shake-up follows the departure in July of Peter Wuffli, the previous chief executive, who was replaced by Mr Rohner.

"We focused a lot on very illiquid, long-dated risk and at the same time let our balance sheet grow rather rapidly, and provided our funding resource almost freely," Mr Rohner said. The ousting of Mr Jenkins and Mr Standish displayed "the principle of management accountability" , he added.

As the credit boom gathered pace, UBS tried to expand the investment bank's fixed-income division to compete with the giants of Wall Street. It had taken credit from investors for expanding the investment bank into a European challenger to the top US firms in mergers and acquisitions and wanted to get its share of the action in the racy new products that were driving investment banking profits. But the Swiss bank got its timing wrong when in June last year it launched Dillon Read Capital Management, a hedge fund that invested in mortgage-backed securities, just as defaults were increasing on home loans to risky US borrowers.

Dillon Read Capital Management lost SFr150m in the first quarter and SFr230m in the second, and soon after it was closed in May, Mr Wuffli was out.

"Expanding the Dillon Read operations at the peak of the cycle was the core of the problem. They were so late in doing that," said Folkert Jan Van Der Veer, a credit analyst at Dresdner Kleinwort.

Mr Rohner took over just as defaults on US sub-prime mortgages were reverberating throughout the world financial system, causing direct losses for investors and tightening of belts by lenders after a boom fuelled by years of cheap money.

Mr Rohner, who was head of the bank's successful private banking business while the problems were building at the investment bank, has every incentive to take the most pessimistic view possible, clear the decks and blame his predecessors.

There has been huge uncertainty about how to value untested derivative products for which there is no longer a market. Credit Suisse said it could only predict its third-quarter profit with a 20 per cent margin for error.

But Mr Rohner said the write-downs at UBS were based on very conservative valuations and that the bank was content to hold the assets at the values it had given them.

Mr Rohner had already flagged up the problems, saying in August that if they persisted there would be a "very weak trading performance in the investment bank".

UBS has been a major concern for investors since the early stages of the credit crunch because it seemed to get things very wrong.

Confidence in the bank was also knocked by the apparent chaos of Mr Wuffli's departure, which was announced in the middle of the night in July. The bank's chairman, Marcel Ospel, baffled investors by saying Mr Wuffli had left against Mr Ospel's wishes because the board did not think he was the right person to take over as chairman.

UBS's shares had suffered badly but they rebounded yesterday as the market took the view that if this was as bad as it could get then things were not so bad.

Bankers have reported a gradual easing of market conditions as investors have started to differentiate between different assets that they once viewed as of similar quality.

US investment banks, including those such as Bear Stearns that were thought to be highly exposed to sub-prime, have reported better-than-expected third-quarter results in recent weeks. But those banks' quarters finished at the end of August. Concern had been growing about bad news from banks like UBS and Citigroup whose third quarter ended in September.

In the US, Citigroup admitted that profit would fall by 60 per cent in the third quarter as it declared $3.3bn of expected losses in its investment bank from the credit crunch.

Citigroup was also hit by sub-prime mortgage-backed securities, but its biggest investment banking write-down was $1.4bn on commitments for leveraged finance lending, which totalled $57bn at the end of the third quarter.

It is harder for Chuck Prince, Citigroup's chairman and chief executive, to pass on the blame and he said the expected results were "a clear disappointment". He must now regret his words in July, just before the credit crunch took hold, when he was asked about the market for leveraged finance to fund private equity buyouts.

"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing," Mr Prince replied.

Yet Citigroup shares also rallied yesterday. Other gainers included Merrill Lynch and Deutsche Bank. Both those banks' stocks had suffered in recent weeks on concerns about their exposure to the credit crunch.

"Banks are writing down their books and taking the pain," said Blue Oak Capital analyst Simon Maughan. "What we are seeing from all the banks is write-downs in specific areas. They are exposed to sub-prime and leveraged loans, but the general message beyond that is that everything else is pretty good."

However, Mr Maughan warned that the worst being over is not the same as a return to the growth of recent years. Many looking at the banks' lost billions and reflecting on the panic of the recent months may hope we do not see that kind of growth for a long time.