TEXT-Fitch UBS Makes Good Progress Despite Earnings Set-Backs
Feb 06 - Fitch Ratings says that UBS AG (UBS; 'A'/Stable; 'a-'/Rating Watch Positive) made significant progress in Q412 in further improving its capitalisation and leverage, repositioning its investment bank (IB) and implementing its cost-savings strategy. The bank benefited from a favourable quarter for non-core asset disposals, which allowed for aggressive balance sheet and RWA reduction at minimal exit costs.
UBS reported a CHF1.8bn pre-tax loss in Q412, which included CHF2.1bn litigation and regulatory provisions (booked in the corporate centre), a CHF414m own credit loss and CHF258m net restructuring charges. Adjusting for these items, UBS would have reported a pre-tax profit of around CHF1bn with a disappointing performance in IB somewhat compensated by resilient results in its wealth management and Swiss businesses.
Underlying profitability remained sound in its Wealth Management Americas (WMA) and Global Asset Management (GAM) segments while the performance of its key global Wealth Management (WM) division suffered from a squeezed gross margin (85bps, below the bank's 95-105bps target range) and lower net new money (NNM) inflows (around 1% of assets under management; annualised; 3%-5% target).
While UBS's Q412 results do not have immediate rating implications, trends in RWA reduction and underlying performance are supportive of UBS's Viability Rating (VR; a-), which Fitch placed on Rating Watch Positive (RWP) on 1 November 2012. The agency expects to resolve the RWP in the short term. Key considerations for resolving the RWP will be an assessment of UBS's underlying profitability under the revised structure, notably in its core IB, risk controls especially in its non-core IB portfolio and Fitch's view about the bank's potential litigation exposure relating to certain legacy transactions.
Quarterly NNM inflows in UBS's WM division, which is at the centre of the bank's revised strategy, were at the lowest level in Q412 since end-2010 largely due to accelerated net outflows from Western European clients. NNM inflows in UBS's APAC, emerging markets and ultra-high net worth individual segments remained strong. The WM gross margin (85bps, down 4 bps qoq) continued to be suppressed by low interest rates, subdued client transaction activity and a significant cash bias in average client accounts. Fitch expects the WM gross margin to remain subdued as long as interest rates remain low but UBS's net margin should improve in 2013 as cost-containment measures initiated in late 2012 start to feed through.
IB reported a pre-tax loss of CHF557m for the quarter (CHF333m loss adjusted for own credit, restructuring and certain other one-off charges). While UBS's advisory-related IB businesses performed well (up 19% qoq to CHF479m), its equities business suffered from losses on structured products-related derivatives in Japan and its FICC business among other factors from lower RWA utilisation. Management has indicated that operating revenue from non-core IB and treasury activities, which will be shown in the corporate centre from Q113, accounted for around 15% of operating IB revenue in 2012 although according to management, this is not necessarily a representative split between future core and non-core revenue in IB.
Following the CHF1.5bn Libor settlement in Q412, outstanding reserves for litigation and regulatory matters amounted to CHF1.4bn at end-2012, up from CHF0.5bn at end-2011, with around CHF600m earmarked for US RMBS matters and the remainder relating to various litigation including retrocessions relating to discretionary WM mandates. Management has indicated that it expects litigation and regulatory provisions to remain elevated until at least end-2013. Should litigation expenses relating to UBS's legacy businesses be higher than currently anticipated by Fitch, this could ultimately be negative for UBS's VR, but Fitch currently expects that the increased regulatory and legal costs at UBS and its peers will remain manageable for the banks.
Fitch considers UBS's capitalisation to be a key credit strength relative to peers. UBS's "fully-loaded" Basel III common equity Tier 1 ratio improved by 50bps to 9.8%, largely as a result of significant RWA reduction in its IB (CHF31bn or 19% of end-Q312 RWA) and legacy portfolio (CHF11bn, 22%) and despite the CHF1.9bn net loss for the quarter. UBS's ratio compares well with peers (eg Deutsche Bank 8.0%, JPMorgan 8.7%), and approaches the 10% minimum requirement set by the regulator for 2019. UBS's loss-absorbing capacity will further benefit from the issuance of up to 1% of RWA in five-year high-trigger loss-absorbing capital notes to senior employees over the next five years as part of the bank's revised compensation scheme (deferred contingent capital plan) announced yesterday.
UBS funding and liquidity position improved in Q412, largely as a result of a further 7% reduction of its funded balance sheet (to CHF841bn at end-Q412) and the bank reported sound Basel III liquidity and funding ratios (LCR of 113%, NSFR of 108%). Its FINMA Basel III leverage ratio improved to 3.6% (from 3.4%) and is approaching its 2019 minimum requirement of currently 4.2%. Reflecting its lower funding requirements and to reduce funding costs, UBS will buy-back up to around CHF5bn of senior unsecured debt and will call a EUR1bn hybrid instrument on its first call date in April 2013.