The anatomy of the losses

Super senior tranches and the logic of the carry trade

The largest part of the losses arose from a product whose name suggested maximum safety. Collateralised debt obligations (CDOs) pooled asset-backed securities, many of them backed by American residential mortgages, and divided the resulting cash flows into tranches of different seniority. The most senior tranche, known as the super senior tranche, ranked above even the tranches rated AAA and was therefore considered almost free of credit risk. Acting as arranger of such structures, UBS retained large amounts of super senior paper on its own books. According to the Shareholder Report, the bank’s super senior inventory grew from low levels in February 2006 to about USD 50 billion by September 2007, of which some USD 27 billion consisted of positions that were only partly hedged or not hedged at all.¹

The report distinguished three types of position. So-called negative basis super seniors were hedged in full through credit protection bought from a counterparty, often a monoline insurer. Positions of the second type, called AMPS after the “Amplified Mortgage Portfolio” hedging strategy, were protected only against a first loss of typically two to four per cent of the nominal amount. The third category consisted of unhedged positions retained in the expectation of hedges that were never executed.² The partial hedge rested on a statistical assumption: historical data suggested that losses on mortgage pools would never reach the super senior layer, so that protection against the first few per cent of losses appeared sufficient. When American house prices fell nationally for the first time in decades, that assumption failed. The Banking Commission noted that the bank had treated a super senior tranche rated AAA as equivalent to other AAA debt securities, although the two carried very different risks.³

The economic rationale of these positions was a carry trade. UBS funded the super senior holdings at its internal cost of funds and earned a spread that was small in percentage terms but attractive on a large notional amount. The Shareholder Report put this positive carry at roughly 20 basis points and observed that the funding framework made such positions appear profitable, since the internal transfer price did not reflect their liquidity risk.⁴ The Banking Commission reached the same conclusion from a regulatory perspective. It found that UBS had provided all business lines with funding on the same, relatively favourable terms, without regard to the risk and return profile of the assets financed. The neutral design of the internal pricing model reflected the belief of management that its risk management and control processes were sensitive enough to prevent abuse.⁵

Risk control, value at risk and stress tests

The positions grew so large because they were almost invisible in the bank’s risk reports. UBS measured market risk mainly with value-at-risk (VaR) models calibrated on recent market history, and supplemented them with stress tests. A super senior position combined with a hedge appeared in these systems as neutral, both for VaR and for the stress tests. The Banking Commission concluded that the positions had “disappeared from the radar screen” despite a nominal exposure of some USD 50 billion. Because more aggressive parameters had been discarded as unrealistic, the stress scenarios used by the bank proved far too optimistic. When the market dislocation of 2007 came, its scale surprised those responsible for risk.⁶

The Shareholder Report added several findings from inside the bank. Until the third quarter of 2007 there were no aggregate notional limits on the CDO warehouse or on super senior positions. Risk reports showed positions net of hedges, which hid the gross inventory. Risk control did not have granular data on the collateral underlying the structures, such as the vintage of the mortgages, the credit scores of the borrowers or the ranking of the liens. Nor did any “look-through” analysis of the underlying loans take place.⁷ The approval of new business was fragmented. For the AMPS strategy, the report found that no formal new business initiative approval had been obtained, although eleven trades had been executed under it. The Banking Commission added that approvals were sometimes granted after positions had already been acquired or retained on the trading books, which could turn the approval into a fait accompli.⁸

The supervisory side of the story is equally instructive. FINMA’s report of 2009 records that in March 2007, at a meeting in London, the bank’s chief risk officer told the Banking Commission that UBS held a net short position in subprime, which suggested that the bank was protected against a fall in the market. The supervisors accepted this statement without detailed verification. Only later did it become clear that, once DRCM was included, the bank held a large net long position. According to the same report, the senior management of UBS and the Banking Commission learned about the full extent of the super senior positions at the same moment, in August 2007. FINMA also found that UBS, unlike Credit Suisse, which had begun reducing its subprime exposure in the fourth quarter of 2006, had been taken by surprise, entirely unprepared, by the crisis on the American property market.⁹

The regulatory framework itself had encouraged the model-based approach. The Banking Commission had approved the bank’s market risk model, including a granular modelling of credit spreads, in July 2004. It had also accepted the bank’s arguments against an unweighted leverage ratio, pointing to the distortions that differences between IFRS and US GAAP created in the size of balance sheets. FINMA later regretted that decision.¹⁰ In the years before the crisis, Swiss capital requirements exceeded the international minimum in what became known as the “Swiss finish”. FINMA’s report observed that the Swiss requirements were meant to lie above the international minimum standards, yet “not in a disproportionate and competition-distorting manner”, a formula that captured the political constraint under which the supervisors had worked.¹¹

The write-downs of 2007 and 2008

The losses emerged in waves. In the autumn of 2007 UBS announced its first quarterly loss in years, driven by write-downs on American mortgage positions. On 10 December 2007 the bank disclosed further write-downs of about USD 10 billion on its subprime holdings, mainly on CDOs and super senior tranches, and announced at the same time a package of measures to strengthen its capital, described below.¹² The final figures for 2007 showed a net loss of about CHF 4.4 billion, the first annual loss in the history of the merged bank.¹³

The first quarter of 2008 brought the worst results of all. On 1 April 2008 UBS announced write-downs of some USD 19 billion on positions linked to the American real estate market, and on the same day Marcel Ospel announced that he would not stand for re-election as chairman.¹⁴ When the bank published its full quarterly accounts in May, it reported a loss of CHF 11.5 billion for the quarter and cumulative write-downs of USD 37.4 billion since the summer of 2007. It announced the reduction of about 5,500 positions by mid-2009, some 2,600 of them in the investment bank, and the sale of USD 15 billion of subprime and mortgage-backed securities to a fund managed by BlackRock. The same report recorded net outflows of CHF 12.8 billion from wealth management clients during the quarter, a large part of them in Switzerland.¹⁵ Those outflows mattered more to Zurich than the trading losses themselves, because they showed that the crisis in the investment bank had begun to damage the franchise on which the whole group rested.

Measured by the Banking Commission, the write-downs up to the middle of 2008 amounted to about USD 42.8 billion. Almost half of that sum related to carry trades in AAA-rated asset-backed securities and to super senior CDO positions.¹⁶ By the end of the crisis, the losses of UBS on these positions were commonly put at around USD 50 billion.¹⁷ For the full year 2008 the group reported a pre-tax loss of CHF 34.3 billion and a net loss attributable to shareholders of about CHF 19.7 billion.¹⁸ The share price reflected the change of fortune. Within two years it fell from about CHF 75 to about CHF 8, destroying a large part of the savings of Swiss retail shareholders and pension funds, for whom UBS had long been regarded as a core holding.¹⁹

Notes

1. UBS AG, Shareholder Report on UBS’s Write-Downs, 18 April 2008 (as above), section on super senior positions. ↩
2. UBS AG, Shareholder Report on UBS’s Write-Downs, 18 April 2008 (as above), definitions of negative basis, AMPS and unhedged super senior positions. ↩
3. SFBC, Subprime Crisis (as above), section on the assessment of risk exposure. ↩
4. UBS AG, Shareholder Report on UBS’s Write-Downs, 18 April 2008 (as above), section on the funding framework. ↩
5. SFBC, Subprime Crisis (as above), section on internal funding and transfer pricing. ↩
6. SFBC, Subprime Crisis (as above), section on stress testing. ↩
7. UBS AG, Shareholder Report on UBS’s Write-Downs, 18 April 2008 (as above), findings on risk control and on data and analytics. ↩
8. SFBC, Subprime Crisis (as above), section on process and approval weaknesses. ↩
9. FINMA, Finanzmarktkrise und Finanzmarktaufsicht (as above), comparison of UBS and Credit Suisse and findings on crisis scenarios. ↩
10. FINMA, Finanzmarktkrise und Finanzmarktaufsicht (as above), sections on the market risk model and on the leverage ratio. ↩
11. FINMA, Finanzmarktkrise und Finanzmarktaufsicht (as above), section 2.2.3, p. 20: “die schweizerischen Eigenmittelanforderungen dürfen auch für die Grossbanken über den internationalen Mindeststandards liegen, jedoch nicht in unverhältnismässiger und wettbewerbsverzerrender Weise.” The quotation in the text is translated from the German. ↩
12. UBS AG, Form 6-K, press release of 10 December 2007 (as above). ↩
13. Swiss National Bank, Financial Stability Report 2008 (as above), section on the big banks. ↩
14. Investment & Pensions Europe (IPE), “Ospel quits UBS amid further write-downs”, 1 April 2008, https://www.ipe.com/ospel-quits-ubs-amid-further-write-downs/27580.article. ↩
15. NBC News (Associated Press), “UBS reports quarterly loss of $10.97 billion”, May 2008, https://www.nbcnews.com/news/amp/wbna24480735. ↩
16. SFBC, Subprime Crisis (as above), overview of the write-downs. ↩
17. Matthew Allen, “Swiss bank bailout turned poison into profit”, swissinfo.ch, 31 October 2013, https://swissinfo.ch/eng/business/bye-bye-bad-bank_swiss-bank-bailout-turned-poison-into-profit/37218080. ↩
18. UBS, “2008–2015” (company history), https://www.ubs.com/global/de/our-firm/our-history/ubs-in-the-world/2008-2015.html. ↩
19. swissinfo.ch, “Ex-UBS chiefs dodge legal action – for now”, 14 October 2010, https://www.swissinfo.ch/eng/banking-fintech/ex-ubs-chiefs-dodge-legal-action-for-now/28544626. ↩

For general information only. This article does not constitute legal or tax advice, does not replace advice on an individual case and creates no lawyer-client relationship. It reflects the legal position as of September 2025.