Credit Risk Control at UBS Group

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Credit Risk Control at UBS Group
Presentation to NYU
January 25, 2006
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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
Investment Bank
Other
TOTALUBS
Global Wealth Management Business Banking
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Impaired loans and loan loss provisions
Problem loans are low in the Investment Bank ...
and UBS reduced its recovery portfolio in
Business Banking
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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
• to anchor credit policies to ratings and Expected
  Loss

through pragmatic use of modeling techniques
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What we have achieved
Profitable lending activities, ...
New business originated in 4Q99
Real Estate Loans

• Margin on new loans
• "Fully loaded" target margin
• Originated loan volumes

Real Estate Loans
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3
4
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7
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10
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Rating
and very low credit loss expenses
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What has changed in the industry
Paradigm shift in credit risk management

• Active Portfolio Mgmt
• portfolio focus
• risk/return optimization
• credit risk models
• profit center of its own
• increasing liquidity allowing
• for active portfolio mgmt
• (buy, sell, hedge)
• New organization, possibility of specialization
  of individual institutions
• origination
• servicing
• portfolio management

• Risk Quantification
• transaction focus
• credit rating
• expected loss concept
• portfolio analysis
• price differentiation
• some liquidity
• Use of actuarial and
• statistical tools
• probability of default
• loss severity
• exposure at default
• default correlation

Degree of Specialization

• Traditional Model
• balance sheet focus
• "yes/no" decision
• loss avoidance
• no portfolio view
• "one price for all"
• no liquidity
• Gut Feel, expert knowledge

Degree of Sophistication
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Credit Risk Control - The key factors to success
Credit Risk Culture "One strategy - one goal"
Risk Organization "Checks and balances"
Risk Limitation "Focus on risk diversification"
Risk Quantification "Transparent risk assessment"
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Credit Risk Culture
Risk policy must be aligned with corporate
objectives ...
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 GEB Risk Sub-Committee
Group Chief Risk Officer
Group Chief Credit Officer
Risk Policy
Group Head Operational Risk
Corporate Center
Independent Risk Control
Market Risk Control
Credit Risk Control
Operational Risk Control
Risk Management
Wealth Management Business Banking
Functional Leadership for Credit Risk Control
Units within each Business Group
Global Asset Management
Investment Bank
Wealth Management USA
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Credit risk control at UBS ...
is functionally independent from the business
line, ...
Corporate Center
Risk methods
Group Chief Credit Officer
Risk reporting
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Risk systems
Credit authority
Risk review
Functional mgmt
Risk education
CCO Global WMBB
417
CCO WMBB
CCO Investment Bank
321
CCO 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 ...

Client Management
Origination

Business Origination
Risk Management

Loan Book Management
Clients / Market

Risk/return Optimization

Transaction Execution
Operations

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
Credit Risk
Market Risk

• 10 days - 99
• Higher losses are expected more than twice per
  year!
• Mainly factor driven
• Immediate occurrence
• Mostly not a problem

Characteristics of the distribution
Convention of measurement

• 1 year - e.g. 99.98
• Higher losses in out of 5,000 years?
• Mean value is not zero!
• Often firm-specific
• Large time lag, if economy swings
• In many segments very difficult

Significant Loss Events
Availability of data
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Expected Loss
Three key variables determine the outcome but
their estimation is often difficult
PD x LGD x EXP Expected Loss Terminology PD
Probability of Default LGD Loss Severity (given
default) EXP (or EAD) Exposure (at default)
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Rating methods are key
Risk quantification begins with a "correct"
stratification of clients by means of
high quality rating methods
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Risk concentrations drive portfolio risk
the individual Unexpected Loss of each loan
Concentration risk
default
single loan
no default
single default
the common default behaviour of several loans
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 ...

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
• "Tail Risk"

• Scenario analysis
• "What, if" portfolio assessment, e.g.
• Bankruptcy rates
• Asset values

Frequency
m
s
Loss

• Limit setting to avoid
  undue risk concentrations
• Counterparty
• Sector
• Country
• and to protect earnings

m
s
Earnings capacity
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Credit exposure hedging
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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
• 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

for all customer and product classes
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Contact Information

• Philip J. Lofts
• Group Chief Credit Officer
• Stamford
• Tel. [phone]
• e-mail philip.lofts_at_ubs.com