UBS Can Afford a Legal Brawl With the Justice Department

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The typically reserved chief executive of UBS, Sergio Ermotti, is ready to take a pop at the U.S. Department of Justice.

The Swiss bank has been accused of defrauding investors by selling residential mortgage-backed securities during the run up to the 2008 financial crisis. The Department of Justice said in a complaint filed with the federal court in Brooklyn that the bank misled investors about the quality of more than $41 billion of subprime and other risky mortgage loans backing 40 securities offerings in 2006 and 2007.

The lawsuit came after UBS rejected a government proposal that it pay nearly $2 billion to settle, according to Reuters, which cited unidentified sources.

UBS’s spurning of the settlement is partly based on a wager that the courts will decide that the bank was foolish rather than dishonest. As well as losing money that belonged to investors, the bank also itself invested in 39 of the 40 mortgage-backed securities cited by the Justice Department, and suffered $900 million of its own losses, according to the bank. All told, UBS eventually suffered $45 billion of losses in the market. And it never originated the mortgages but merely packaged and sold them on.

So UBS joins a small club of European lenders that have pushed back against U.S. prosecutors. Barclays gives it some hope: it also spurned a settlement before negotiating a lower fine.

An ongoing trial in France over whether UBS helped French clients evade taxes adds piquancy to Mr. Ermotti’s U.S. rebuttal. French prosecutors have called for a 3.7 billion euro fine.

Given UBS’s Tier 1 capital ratio, a common measure of a bank’s financial health, stands at a robust 13.5 percent and its shares trade above the tangible book value of the company, Mr. Ermotti can arguably afford to be confrontational. Still, if authorities in France and the United States get half of what they called for, amounting to around 3.1 billion Swiss francs, then UBS’s capital ratio would drop to 12.3 percent — healthy enough, but below its 13 percent target. More worrying, its leverage ratio would drop to the regulatory minimum of 3.5 percent, imperiling a 2 billion Swiss franc share buyback.

Mr. Ermotti is confident enough that won’t happen, not least because HSBC settled its own French tax evasion probe last year for just 300 million euros. Besides, UBS is on track to generate around 2 billion Swiss francs of organic capital this year, potentially providing some additional loss-absorbing protection.

As the genteel Mr. Ermotti almost certainly wouldn’t say: bring it on.

Christopher Thompson is a columnist at Reuters Breakingviews. For more independent commentary and analysis, visit breakingviews.com

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