Credit Risk Control at UBS Group
Presentation to NYU
January 25, 2006
Who we are …
UBS is one of the world's leading financial firms.
We are
– one of the world's leading wealth management
businesses
– a global investment banking and securities firm
– a leading asset manager
– the market leader in Swiss retail and
commercial banking.
Our first priority is our clients' success. As
an integrated firm, UBS creates added value for
clients by drawing on the combined resources
and expertise of all its businesses. As an
organization, UBS combines financial strength
with a global culture that embraces change.
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Gross Credit Exposure by Business Group
Global Wealth TOTAL
Management & Investment Bank Other
UBS
Business Banking
2
Impaired loans and loan loss provisions
Problem loans are low in the Investment Bank ...
Impaired Loans (gross value) Loan Loss Provisions
25 14
12
20
10
CHF billion
CHF billion
15 8
10 6
4
5
2
0 0
1999 2000 2001 2002 2003 2004 Q3-05 1999 2000 2001 2002 2003 2004 Q3-05
Investment Bank GWM&BB (and other) Investment Bank GWM&BB (and other)
… and UBS reduced its recovery portfolio in Business Banking
3
Credit Risk Quantification - where we came from …
Swiss bankruptcy rates increased
dramatically, …
… real estate prices tumbled …
… and loan losses surged
(from a 1997 presentation to the BIS [FSI])
The mandate was to upgrade our risk control tools with a view to
– detecting weak customers and ensure proactive "work out" measures
– implementing a risk grading system for the "good portfolio"
– ensuring implementation of risk adjusted pricing across the portfolio
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What we concentrated on …
Rapid implementation of behavioral change ...
Set-up of a framework
to estimate the credit losses and introduce a comprehensive rating system for all
portfolios
to "allocate" the risk costs including a return on risk adjusted capital to individual
transactions
6.00%
5.00%
Costs in %
4.00%
3.00%
2.00%
1.00%
0.00%
Funding Expected loss Operating Risk premium
expenses
Cost Elements
to anchor credit policies to ratings and Expected Loss
… through pragmatic use of modeling techniques
5
What we have achieved …
Profitable lending activities, ...
New business originated in 4Q99
Corporate Loans Margin on new Real Estate Loans
Real Estate Loans
loans
"Fully loaded"
target margin
Originated loan
volumes 1 2 3 4 5 6 7 8 9 10 11 12
1 2 3 4 5 6 7 8 9 10 11 12
Rating Rating
… and very low credit loss expenses
Credit Loss Expenses in CHF million
1997 1998 1999 2000 2001 2002 2003 2004 Q3-05
-1,278 -951 -956 130 -498 -115 -72 241 243
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What has changed in the industry…
Paradigm shift in credit risk management
Degree of Specialization
Active Portfolio Mgmt
portfolio focus
risk/return optimization
credit risk models
Risk Quantification profit center of its own
transaction focus increasing liquidity allowing
credit rating for active portfolio mgmt
expected loss concept (buy, sell, hedge)
Traditional Model portfolio analysis
price differentiation New organization, possibility
balance sheet focus some liquidity of specialization of
"yes/no" decision
individual institutions:
loss avoidance Use of actuarial and
no portfolio view origination
statistical tools: servicing
"one price for all"
probability of default
portfolio management
no liquidity
loss severity
exposure at default
Gut Feel, expert knowledge
default correlation
Degree of Sophistication
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Risk Organization
"Checks and balances"
Risk Quantification
"Transparent risk assessment"
Credit Risk Culture
"One strategy - one goal"
Risk Limitation
"Focus on risk diversification"
Credit Risk Control - The key factors to success
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Credit Risk Culture
Risk policy must be aligned with corporate objectives ...
Business
Independent
M anagement
Cont rols
Account abilit y
Earnings Reput at ion
Risk Disclosure
Prot ect ion Prot ect ion
Risk Risk
Ident if icat ion M easurement
Risk Policy Risk Report ing Risk Cont rol
… and be adopted "top down" by the Bank's origination and
risk management functions
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Corporate Governance and responsibilities
Board of Directors
Group Internal Audit
Chairman's Office
Group Executive Board
Risk Policy
Group Chief Risk
GEB Risk Sub-Committee Officer
Group Chief
Independent Risk Control
Credit Officer
Group Head
Corporate Center Operational Risk
Risk Management
Market Risk Operational Credit Risk
Control Risk Control Control
Wealth Management &
Business Banking
Functional Leadership for
Global Asset Management
Credit Risk Control Units
within each Business
Investment Bank
Group
Wealth Management USA
10
Credit risk control at UBS ...
… is functionally independent from the business line, ...
Corporate Center
Risk methods
Group Chief Credit Officer Risk reporting
Credit authority Risk systems 102
Functional mgmt Risk review
Risk education
CCO Global WM&BB 417
CCO WM&BB
321
CCO
CCO Investment Bank
Investment Bank
Business groups
… but an integrated partner of the business groups
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Business Management and Risk Control
"Separation of power" is key to successful ...
Origination Client Management
Business Origination
Clients / Market
Risk Management Loan Book Management
Risk/return Optimization
Operations Transaction Execution
Loan Disbursement
Risk Control Model Certification
Risk Limits and Control
… optimization of risk and reward
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Statistical Loss: "Value-at-risk"
...
Market risk and credit risk measures are different
Market Risk Credit Risk
Characteristics of
Frequency
the distribution
Loss
Convention of
10 days - 99% 1 year - e.g. 99.98%
measurement
Higher losses are expected Higher losses in out of
more than twice per year! 5,000 years? …
Mean value is not zero!
Mainly factor driven Often firm-specific
Significant Immediate occurrence Large time lag, if
Loss Events economy swings
Mostly not a problem
In many segments very
difficult
Availability of
data
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Expected Loss
Three key variables determine the outcome but their estimation is
often difficult
LOSS SEVERITY
PROBABILITY OF DEFAULT
M oody's Default Statistics 1983 - 2004 M ore Inf erior
collat eral st ruct ure
12.00%
10.00%
Observed Defaults
8.00%
6.00%
4.00%
2.00%
25% 50% 75%
0.00%
83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04
Year
Investment Grade - Avg 0.07% Speculative Grade - Avg 4.99% All Issuers - Avg 1.68% EXPOSURE AT DEFAULT
OTC Derivat ives St and-by lines
PD x LGD x EXP = Expected Loss E xp ect e d
E x po s ur e Total
Line
Performing Defaulting
LEQ*=x/y
Terminology: y
PD = Probability of Default x
LGD = Loss Severity (given default) Usage
EXP (or EAD) = Exposure (at default) W e Owe 0
M ar k t o M a r k et V al u e
They Ow e
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Rating methods are key
Risk quantification begins with a "correct" stratification of clients
by means of …
100.00%
1 2 3 4 5 6 7 8 9 10 11 12
10.00%
Default Rates
1.00%
0.10%
0.01%
Int ernal Rat ing Grade
PD min PD max Observed DR
… high quality rating methods
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Risk concentrations drive portfolio risk
the individual Unexpected
Loss of each loan default
= Concentration risk single
loan
no default
the common default single
behaviour of several loans default
= Loss Correlation several
loans common
default
no default
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Credit Risk Modeling
All transactions with their attributes are entered
into a simulation model that causes clients to default ...
Value Rat ing Collat eral Exposure Diversif icat ion
Drivers
Statistical LGD EXP
PD x x Correlat ion
M easures
M odel Output
Loss
Frequency
Result
Loss
Result
Loss
Result
Repayment Impairment
Repayment Impairment
Repayment Impairment Loss
Single Transaction Level Portfolio Level:
M odelling of Possible Outcomes
… and produces a distribution of possible
portfolio losses
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Extreme events and stress testing
Stress testing and limit setting are based on several analytical
methods
Statistical analysis
Scenario analysis
"Tail Risk"
Frequency
"What, if" portfolio
assessment, e.g.
Bankruptcy rates
Asset values
Loss
Limit setting to
avoid undue risk
concentrations:
Counterparty
Sector
Earnings capacity Country
and to protect earnings
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Credit exposure hedging
Exposure Exposure
Funded Risk Allow ances Nominal af t er after
Part icipat ions, f or Credit Amount of Applicat ion Application
Gross Risk Transf ers Loss and Adjusted Credit of Credit of Credit
Credit and Cash Loan Loss Credit Prot ect ion Hedges Hedges
1) 2) 3)
(All amount s in CHF mn) Exposure Collat eral Provisions Exposure Bought 4) 30.09.05 5) 30.09.04 5)
Banking product s 116,136 (3'664) (178) 112'294 30,972 88,633 48,665
M oney M arket 18,145 - - 18'145 - 18,145 9,344
Subt ot al BP+M M 134,281 (3'664) (178) 130'439 30'972 106,778 58,009
Traded product s 119,329 - (191) 119'138 6,805 114,117 110,974
Total credit exposure 253,610 (3'664) (369) 249'577 37,777 220,895 168,983
1)
Gross Credit Exposure includes loans, money market deposits, contingent claims, unutilized commitments, nostro and current balances
2)
Includes provisions on contingent assets
3)
Columns cannot be totalled
4)
Notional amount of credit protection bought on adjusted credit exposure positions includes Credit Default Swaps (CDS) and the funded portion of structured
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Credit risk control measures
Credit events have many causes, are difficult to predict ...
… and can create substantial losses
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Credit risk mitigation
Risk taking capacity with many clients would be limited, ...
Credit derivative transactions to reduce economic exposure
UBS Invest m ent Bank
Credit Hedging of Banking Product s
Basic Credit Net
(in CHF million as of 31.12.2004) Exposure Hedges Exposure
Investment grade 54,987 -19,041 35,946
Sub-investment grade 30,193 -2,806 27,387
Impaired and defaulted 391 391
Total banking products 85,571 -21,847 63,724
Collateralization and netting agreements for OTC derivatives
… if risk mitigation could not be effectively used
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Active credit portfolio management
Active portfolio management is not equally available ...
Markets for retail portfolios have existed for a very long time: individual names are
irrelevant
Rapid growth of sophisticated risk management tools for large corporates:
individual names are known
The challenge is for the middle market segment where individual names matter but
are not really known
M arket
Ret ail SM E Large Corporat es
Segm ent
… for all customer and product classes
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Contact Information
Philip J. Lofts
Group Chief Credit Officer
Stamford
Tel. 203-719-3320
e-mail: philip.lofts@ubs.com
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