Giving credit where credit receives its due: An Interview with Marco Suter

RMA Journal, The,  March, 2002  by Nicholas Hayes,  Beverly Foster

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For most banks, the biggest challenge for 2002 will be to find the optimal operating leverage and operating capacity. Given the rather difficult economic outlook, banks are faced with the task of adjusting their cost base (including risk cost) to hard top-line revenue estimations. Cutting too deeply into cost and capacity could potentially lead to substantial opportunity costs, whereas maintaining too high a cost base could seriously harm the bottom line.

On the credit side, I believe that 2002 will again prove and reinforce that the credit fundamentals of free cash flow and liquidity cannot be neglected. We might experience a rebound in some stock markets, including the technology sectors. I would hope, however, that banks have learned from their previous mistakes and that this time around they will refrain from enterprise value lending. I do not see 2002 as being as risky as 2001, keeping in mind that the worst risks come from the unexpected surprises. We do expect more defaults, but because they are expected, the risk element is much lower.

For many companies, liquidity and access to borrowed funds will be key. Total level of debt, leverage ratios, free cash flow, and bottom-line profitability will be the factors to influence liquidity. I know of very few companies that do not rely heavily on short-term borrowings. We very closely watch all companies that have high debt levels and are heavily exposed to short-term financing or that have substantial refinancing needs in the next one to two years.

We have identified 18 out of 56 industries to be vulnerable in the present recession scenario. The first vulnerable industries are those immediately affected by the September 11 events--air transportation, hotels and restaurants, travel, and the insurance sector. The second group of industries includes those already suffering from the significant slowdown of the economy--the chemicals industry, machinery and equipment manufacturers, and, particularly, technology and communications. In one of our stress scenarios we also model the impact that a sharp drop in consumer confidence would have on manufacturers, wholesalers, and retailers of consumer durable goods as well as real estate. We have also further reduced our exposures to the automotive sector, including their finance subsidiaries. The peak of the auto cycle three years ago means a lot of used cars are coming back to finance companies, and the resale values of these cars are under pressure.

With regard to your question of what we do that is different, I don't believe that we do things fundamentally different from what we did two or three years ago. We require an in-depth analysis of a client's business, its projected cash flow, and a sound structure of the credit itself. Our sources of repayment are not the "dream cash flows" of an ambitious management; it is the cash that can actually be earned under circumstances that are not always very beneficial for the enterprise. We use sustainable cash flow as a key driver in our decision making. While in some cases the rapid deterioration of corporate credits came as a real surprise, not all of these "fallen angels" we observed in recent months were so unexpected. The surprise element can best be taken out of the equation if any lack of transparency in a credit relationship is overcome. We have made great efforts at UBS to ensure that we really know our borrowers and the risks that they are exposed to, but there are obviously limits to due diligence an d to predicting the future. That is why--in addition to the high credit and due diligence standards--we place so much emphasis on risk diversification and are increasingly using credit derivatives to actively manage our portfolios of credit risk.