UBS Gives Haircuts
Vidya Ram, 03.28.08, 5:00 PM ET
In its advertising, UBS tells clients “it’s you and us,” but on Friday it told investors “you’re on your own.”
The Swiss bank told clients it was reducing the value of auction-rate securities in their accounts, by an average amount of 5%. It also refused to buy the bonds back from investors who bought the securities, thinking they were getting an easy-to-sell, higher-yielding alternative to money market funds but instead found themselves stuck with illiquid securities and capital losses, courtesy of the global credit crunch that began in the U.S. subprime mortgage market.
“This is the right thing to do,” said a UBS spokeswoman. “This is in the best interest in our clients regarding our accounts. Given the current market dislocation this the next logical step for any committed wealth manager.”
Auction-rate securities are long-term bonds issued by local governments, agencies, or corporations but sold in periodic auctions, say every 7 to 28 days, to set the interest rate. Firms that handle the auctions, like UBS and most of the big Wall Street concerns, used to step in an buy in the auctions if there weren’t enough bidders.
But that all went by the wayside in January and February as investors fled the bond markets. Auctions failed after no buyers showed up and the banks refused to step in as they had previously done. That meant the auctions failed, leaving brokerage customers holding the bag and issuers paying much higher penalty interest rates. The Port Authority of New York and New Jersey, for example, saw its rate skyrocket to 20% from 4% when its auction failed in February.
As a consequence of paying soaring penalty rates, many issuers are converting their auction rate bonds to fixed-rate bonds, putting more pressure on the remaining auction-rate securities that still haven’t started selling again. The bonds cost more than the issuers were paying on the auction-rate securities but yield far less than the penalty rates.
The banks backed off supporting the auctions because they didn’t want to risk taking more illiquid assets on their books after collectively writing off more than $100 billion in mortgage and credit derivatives. UBS has been among the hardest hit of the banks, already writing down $17 billion worth of credit holdings and facing another $11 billion in write-downs in the first quarter, according to analysts at Oppenheimer.
Its problems don’t stop there. Massachusetts securities regulators subpoenaed UBS, Merrill Lynch and Bank of America about their sale of auction -ate securities to customers, particularly bonds sold in closed-end mutual funds. The state is looking at what the banks disclosed about the possible risks of the securities.
“We received calls from a young saver whose house down payment is now frozen; two siblings whose family trust is now frozen; and small business owners who find their business interrupted because money they thought was liquid is tied up in these frozen securities,” said William Galvin, the Massachusetts secretary of the commonwealth, in a statement.
UBS wouldn’t say how much its brokerage customers own in auction rate securities, but the market is about $330 billion. The timing of UBS’s decision is perhaps telling. American investors are facing tax time, when many will need access to cash to pay Uncle Sam.
The Swiss banking giant previously told customers who were unable to sell the securities in scheduled auctions that the bonds would retain their full value and receive enhanced interest rates, according to TradeTheNews.com.
After falling 2.4% in Switzerland, to 28.98 Swiss francs, before the announcement, UBS American depositary receipts slid further in New York, dropping to $27.80, a loss of $1.33, or 4.6%, on the day. Less than a year ago, the stock had been above $66.
Investors who feel betrayed are likely to sue, adding to the pressures on UBS from the global liquidity crisis that began in the U.S. subprime mortgage market. UBS was the first major global bank to be hit by a lawsuit over losses related to the subprime crisis.