UBS Reports Q3 Loss As Legal Provisions Offset Strong Operating Performance

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UBS (NYSE:UBS) reported a loss for the third quarter of the year on Tuesday, October 28 due to a CHF 1.8 billion ($1.9 billion) increase in legal reserves. ((Third Quarter 2014 Full Report, UBS Earnings Releases, Oct 28 2014)) The largest Swiss bank is currently involved in several high-profile lawsuits and investigations, and the higher provisions this time around are most likely related to the forex manipulation charges against it. Looking beyond the swelling legal expenses – something that remains a nagging issue for all global banking giants – UBS’s results show a notable improvement in operating performance. The bank reported increased revenues across its operating divisions year-on-year, with its cornerstone wealth management operations churning out one of its best performances since the economic downturn of 2008 and the subsequent large-scale reorganization. In fact, adjusted pre-tax incomes for the bank’s wealth management, asset management and retail and corporate clients operations were at multi-year highs.

In addition to the strong showing by its operating arms, UBS continued to strengthen its balance sheet in Q3 2014 with its common equity Tier 1 (CET1) ratio reaching 13.7% on a fully-applied basis. This strengthens the Swiss banking giant’s standing as the best capitalized global systematically important financial institution. The bank also retained a leverage ratio of 4.2% (fully phased-in) – surpassing the Swiss banking regulators target of 4.1% expected by 2019.

We have revised our price estimate for UBS’s stock downwards from $22 to $20 to factor in the marked appreciation of the Swiss Franc with respect to the U.S. Dollar over the last three months. The new price estimate is still about 25% ahead of the current market price – something we believe is primarily due to the sell-off in the shares of European banks over recent weeks due to the weak economic outlook for the region as well as due to the poor results of the ECB’s stress tests for banks.

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See our complete analysis of UBS here

Wealth Management Operations Show Their Importance

UBS’s revamped business model hinges substantially on its global wealth management business. This is evident from the chart above, which attributes almost 50% of its total value to its wealth management operations. Adjusted for one-time and other restructuring-related expenses, UBS’s combined wealth management operations topped CHF 1 billion ($1.05 billion) in pre-tax income for the third quarter. The American operations were responsible for a quarter of this figure, with the Swiss and international operations churning out the rest.

Strong inflows from the Asia-Pacific region and favorable exchange rate movements helped the total asset base for the wealth management operations reach CHF 966 billion ($1 trillion) by the end of the quarter. Notably, the recurring fee component for the wealth management unit was the highest since the economic downturn of 2008 – indicating strong revenue potential for the refocused business in the future. Coupled with UBS’s organization-wide cost cutting initiative, the higher revenues helped adjusted operating margins swell to 37.8% for the quarter compared to 33.6% for the year-ago period.

Mixed Quarter For Investment Banking Division

UBS made drastic changes to its investment banking operations in recent years, announcing plans to reduce its fixed-income trading business to a fraction of its former size by slashing roughly 10,000 jobs. The bank also sought to refocus its efforts away from trading activities in a bid to shrink its balance sheet by freeing capital tied up in the capital-intensive business. The impact of this on UBS’s business model can be seen from the chart above, which shows that trading contributes less than 20% of the bank’s share value – around 15% for equities trading and less than 4% for the fixed income trading desk.

The third quarter of the year is normally the slowest period for investment banks, as trading as well as underwriting activity remains largely depressed over the period. This shows through in the bank’s results for Q3 2014, as revenues for both its fixed income and equities trading desks were lower than what was seen in the previous quarter and were almost identical to the figures reported a year ago. While the equities trading desk generated CHF 884 million ($930 million) in Q3 2014, the much smaller fixed income trading desk made CHF 315 million ($330 million) in revenues – bringing the total trading revenues for the period to just under CHF 1.2 billion ($1.26 billion).

The bank’s advisory and underwriting services units fared better this time around than they did last year. These services, which form a part of UBS’s Corporate Client Solutions sub-division, roped in CHF 738 million ($780 million) in revenues in Q3 2014 – a 46% jump compared to Q3 2013 but 25% below that for Q2 2014. The year-on-year improvement came from a better performance across the board as M&A advisory, debt origination as well as equity underwriting services making more money this quarter.

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