Citi do a Whitney on UBS - “A major reversal of fortune”

According to a note sent out to clients by Citi analysts today, we can “realistically” expect a further $12bn writedown from UBS in the next quarter.

UBS shareholders should also expect to see the dividend slashed, and the value of their equity diluted by a rights issue of up to $7bn. UBS, Citi’s Jeremy Sigee say dryly, will almost certainly need to recapitalise.

In other words, Citi are giving UBS the Meredith Whitney treatment. Is it true what they say - every bully was once bullied?

The difference, of course, is that Citi cut to the chase in disclosing its subprime losses - releasing details of its exposure and a breakdown of the figures. Not that it did Chuck Prince any good.

UBS, however, have been far more circumspect. Consider this table of banks’ disclosed exposure and writedowns on ABS CDOs:

While UBS have the second highest ABS CDO exposure, they have taken one of the lowest writedowns.

Clearly, UBS are not marking their assets at current market prices, and are still heavily relying on marked to model prices. Consider also the fact that many of the CDOs UBS arranged and sponsored have been some of the worst hit - like the appropriately named Vertical Capital, a CDO whose AAA debt was slashed 14 notches to junk in one fell swoop.

Consider this table from Citi, which neatly summarises the price declines on MBS and CDOs (measured respectively by declines in the ABX and TABX indices from Markit) It’s pretty clear that UBS’s average writedown so far is paltry:

Citi outline three possible scenarios for UBS:

First we assume markdowns similar to Merrill Lynch. Under that scenario, UBS would need to take markdowns of SFr 6.7bn in 4Q07. Translating this revenue shortfall one-to-one to PBT (thereby assuming no clawback on the cost side), the group’s PBT would be -SFr 3.2bn for a net loss of SFr2.3bn. The Tier 1 ratio would be 9.5% under Basel I and 9% under Basel II. This is below the group’s target. However, cancelling the dividend (SFr4.2bn) would bring back the ratio to 10% under Basel II.

The second scenario takes conclusions from our Fixed Income credit strategists, assuming 30% writedowns on HG ABS CDOs and 60% on mezzanine ABS CDOs. UBS would report a loss of SFr 7.9bn in 4Q07, its Tier 1 ratio would drop to 8.1% (Basel I) and 7.6% under Basel II. The Tier 1 would remain below target even if the dividend were cut, raising the possibility of a capital shortfall.

The third scenario is a worst-case scenario. Under this scenario (50% writedowns on HG ABS CDOs and 100% on mezz ABS CDOs), UBS would end up with a substantial SFr22bn writedown. The group’s Tier 1 ratio would drop to 5.8% (Basel II). Even after cutting the dividend and accounting for a lower group Tier 1 ratio of 9% (Basel II), a capital shortfall of SFr 8.5bn would remain, raising the prospects of a large capital increase/rights issue.