The risks in Credit Suisse's investment banking unit are firmly on the mind of UBS's top management. To address the potential danger, UBS swapped out its CEOs shortly after the takeover. Is it overdoing it?

According to chairman Colm Kelleher, the answer is a resounding «no». The decision to replace Ralph Hamers by bringing back Sergio Ermotti had nothing to do with the color of the passport, Kelleher said at a Wednesday media briefing.

By doing so, Kelleher sought to refute the interpretation that the change of boss at Switzerland's largest bank was a concession to «Swissness». Ticino native Ermotti is coming, while Hamers, a Dutchman, had to go. What convinced the UBS board of directors, the bank president said, was rather Ermotti's «unique experience» and his previous experience of having successfully scaled back investment banking at UBS.

Headache for UBS management

Ermotti has been called back for an encore performance. UBS promised its shareholders it will unwind CS trades, and from day one of the merger, risk-weighted assets from investment banking may not take up more than 25 percent of the new entity's balance sheet. The fact that Ermotti is Swiss on top of that is a nice perk, in Kelleher's view.

If a board of directors takes the risk of changing a chief executive at the beginning of the first merger ever undertaken between two globally systemically important banks, there must be very cogent operational reasons for doing so. Either that or nerves at UBS are on edge.

In favor of the latter argument are the enormous efforts UBS has made since the Credit Suisse bailout to protect itself regarding Credit Suisse's investment bank. As the outgoing Hamers already explained at an investor call, this unit is «a headache» for UBS.

 Controversial Government Guarantees

Hamers said the real challenge that lies ahead is reducing investment banking activities and something that Credit Suisse leadership was wrestling with. Not the same challenge is upon the «new» UBS. For that reason, UBS sought cover from the government as part of the takeover.

The Swiss government and the Swiss Financial Market Supervisory Authority (Finma) have promised UBS downside protection to the tune of 25 billion francs ($27.3 billion). The coverage includes a nine billion francs guarantee from the federal government and an agreement to share any further losses. Also in the deal, Credit Suisse completely wrote off its AT1 convertible bonds, further strengthening its balance sheet by 15.8 billion francs.

Although the explicit state guarantee for the takeover is not a free lunch, it certainly is the most controversial part of the whole bailout, essentially due to UBS's concerns about the Credit Suisse investment bank.

Prophetic Report

Is UBS right to be afraid? A team of analysts from  JP Morgan led by Kian Abouhossein crunched the numbers. Abouhossein's latest report on Credit Suisse proved prophetic when he wrote on March 16 that Credit Suisse was too troubled to survive on its own.

A domestic solution involving UBS would be a solution if the Swiss authorities push for it, he said. In a hypothetical scenario, winding down the remaining investment bank business and an IPO of Credit Suisse Switzerland while retaining asset management is the most likely scenario. Three days later, on March 19, the hypothetical scenario became reality.

Will Restructuring Finance Itself

Abouhossein assumes in the report the exit from Credit Suisse investment banking will be costly. The reduction of a total of 64 billion francs in risk-weighted assets of the investment bank on Credit Suisse's balance sheet would reduce the bank's hard core capital by 3.2 billion francs and calculated the exit cost from the business would be 7.9 billion francs.

UBS would not necessarily have to bear those costs. Abouhossein calculates that the achieved reduction of 64 billion francs in risk-weighted assets would relieve the buyer's account to such an extent that the restructuring would finance itself. So for UBS, it's ultimately a zero-sum game.

The Right Pilot

Whether anyone in the government, at Finma, or the Swiss National Bank made a similar calculation before March 19 will become clear when the posturing to criticize the rescue begins.  For the first time in almost three decades, a parliamentary investigative commission (PUK) is likely to be initiated. In what will be only the fifth PUK in Switzerland's history, members of the National Council and Council of States will investigate in detail the role of the authorities in the Credit Suisse rescue starting this summer at the earliest. 

Given the risk, UBS demanded guarantees worth billions and received them from the state and the supervisory authorities. Kelleher said on Wednesday that UBS is taking great risks in implementing the transaction and needed the «right pilot» to navigate them.

For the UBS chairman, the choice was clear: Sergio Ermotti.