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UBS shows value in loan hedging
Creditflux Ltd. (December 20, 2002)
UBS's recent third quarter results offer the latest proof of the bank's leading position in active loan portfolio management and the use of credit derivatives to hedge loan exposures. At a time when many European banks are experiencing rising rates of loan loss provisioning, UBS comes top of the class for the least damage inflicted on the loan book.
The results show credit loss provisions of Sfr95 million ($64 million) in the third quarter, against total loan exposure of Sfr210 billion - far better than the industry norm.
But the news for UBS's shareholders gets even better when credit derivative activity is taken into account. Some 30% of the bank's loan book is hedged in the credit default swap market. In the third quarter, that resulted in a mark-to-market gain of Sfr321 million.
"These are exceptionally good numbers, even before you take into account the positive impact of credit hedging," says Otto Dichtl, senior credit analyst at BNP Paribas. "Even the bank itself says provisioning is lower than expected."
Simon Harris, head of commercial banking at consultancy firm Oliver Wyman says there are strong arguments for banks to separate loan origination from portfolio management and to tie back-office P&L to portfolio performance. But although UBS provides a good advert for active loan portfolio management, few European banks are following suit. Credit Suisse, for example, which announced large credit loss expenses for the third quarter, is regarded by some as lagging not only UBS but most other European banks in this area. Credit Suisse announced provisioning of Sfr973 million in the third quarter, against total loan exposure of Sfr196 billion.
Despite the widespread rise in bad loan, hedging using credit default swaps is usually regarded as too expensive by commercial lenders. "Credit derivatives are perceived to be expensive, but they are always cheapest at the beginning," says Harris. "Even at this point in the cycle, although you might already have been burgled, it still makes sense to have house contents insurance, even though the premium has gone up."