UBS Says It Didn t Recognize Subprime Risk Until July

UBS AG, Switzerland's biggest bank, said senior management of its investment bank only recognized the severity of its subprime problem in late July.

``It appears that the investment bank management did at no stage conduct a robust independent assessment of its overall subprime exposures,'' the Zurich-based company said in a report on its Web site today. ``Consequently, group senior management relied on assurances of others rather than obtaining all of the facts and analytically reviewing the situation.''

The report is a summary of the review submitted to Switzerland's federal banking commission EBK, which is looking at the causes of the bank's subprime holdings and resulting writedowns. UBS's losses from mortgage-related holdings have swelled to about $38 billion over the past three quarters.

The Dillon Read Capital Management LLC hedge fund that was shut down in May 2007 following losses from mortgage-related securities accounted for about 16 percent of the bank's subprime markdowns last year, UBS said. About two-thirds of almost $19 billion in losses came from the investment bank's business with collateralized debt obligations.

John Costas, a former investment banking chief, stepped down in 2005 to help create and then run DRCM, which took 120 employees from the bank's fixed-income division and $3.5 billion in assets. The hedge fund was among the first burned by the collapse of the U.S. subprime market, losing 150 million francs in the first quarter of 2007. When the business was transferred to the investment bank in the second quarter, its subprime holdings were about $20 billion.

`Reactive' Appointments

Following the creation of the hedge fund, UBS identified successors to key management positions ``on a reactive basis,'' it said in the report. The bank named Huw Jenkins as head of the investment bank, succeeding Costas, and Simon Bunce as head of fixed-income, replacing Michael Hutchins who also went to DRCM.

``The successors of the departing top managers in the investment bank appointed in July 2005 had strong sales and client attributes, but it appears that neither had strong risk management backgrounds,'' the bank said.

Jenkins commissioned external consultants to evaluate growth areas for the investment bank after his appointment, who found the biggest gap was in fixed income. Subsequently, the investment bank began accumulating mortgage-related assets as part of its CDO business, which repackaged residential mortgage-backed securities for sale to other investors.

Additional Returns

While CDO desk initially sold so-called ``super senior'' tranches of securities to third-party investors, it later decided to keep these assets on UBS books to earn additional returns. By September 2007, the desk accumulated $50 billion in super-senior bonds, of which $20.8 billion were bought from third parties.

Bunce left the bank in August, and Jenkins's departure was announced in October. David Martin, who as head of global rates was in charge of building UBS's mortgage-backed and asset-backed securities businesses, and James Stehli, who ran the CDO desk, also left in October.

The bank today also blamed its compensation structure, which didn't differentiate between ``return generated by skill'' and ``returns made from exploiting UBS's comparatively low cost of funding,'' for the buildup of mortgage-related assets.

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UBS Says It Didn t Recognize Subprime Risk Until July