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Fitch: UBS's Results Solid; Legal Structure Plans to Improve Resolvability
May 7, 2014 / 3:10 PM / in 3 years

Fitch: UBS's Results Solid; Legal Structure Plans to Improve Resolvability

(The following statement was released by the rating agency) PARIS, May 07 (Fitch) Fitch Ratings says that UBS AG's (UBS; A/Stable/a) 1Q14 results were solid and highlighted the benefits of the bank's diversified franchise, but net profitability was also helped by a diminishing drag from the bank's shrinking non-core and legacy portfolios. UBS also announced plans to significantly change its legal structure, including the establishment of a group holding company, which should over time improve the bank's resolvability. The results have no immediate impact on UBS's ratings. We had stated in March (see 'Fitch Takes Rating Action on Global Trading and Universal Banks Following Peer Review', published 26 March 2014) that as a result of regulatory developments - which include improving bank resolvability - Fitch is considering revising downwards Support Rating Floors over the next one to two years. As UBS's Issuer Default Ratings (IDRs) do not benefit from sovereign support, the bank's IDRs will remain unaffected by this development assuming its 'a' Viability Rating remains unchanged. For 1Q14 UBS reported EUR1.5bn pre-tax profit adjusted for fair value of own debt changes (EUR88m gain in 1Q14), net restructuring charges (CHF204m), and gains on sale of real estate (CHF23m). This was up 97% qoq but 22% lower yoy, although 1Q13 had benefited from particularly favourable market conditions for its investment bank (IB). We believe that UBS's profitability should remain solid for the remainder of 2014 although net profitability is likely to remain affected by still high litigation charges, restructuring costs and costs relating to exiting its remaining non-core and legacy portfolios. The bank announced that it intends to run down its non-core and legacy portfolios faster than previously announced (end-2015 risk-weighted assets (RWA) target of CHF40bn versus CHF55bn previously), which could increase 2014 exit costs. UBS's business strategy remains broadly unchanged. We believe that the bank's wealth management-oriented business mix provides it with a strong recurring earnings base. Earnings volatility has declined in line with the smaller size and successful repositioning of its IB. UBS continues to target a return on equity greater than 15% by 2015 or 2016 (depending on the development of FINMA-imposed incremental operational risk RWA). Its 1Q14 adjusted return on equity of 8.7% (8.3% for 2013) was still some way below its 15% target, which we believe UBS would not be able to meet without a decline in litigation and restructuring charges (and of operational RWA, accordingly) towards the end of 2014. As part of its investor day strategy update, UBS also announced plans to modify part of its legal group structure. In line with FINMA's preferences for a single-point of entry approach when resolving complex groups, UBS intends to establish a group holding company through a share-for-share exchange offer, which will begin later in 2014, subject to regulatory approvals. The holding company will complement its previously announced changes to UBS's legal group structure, by establishing both an intermediate holding company to hold all its US subsidiaries by July 2016 and a Swiss banking subsidiary which would be expected to house its domestic retail banking and Swiss-booked wealth management businesses by mid-2015. Once set up, the holding company will be the main bail-in debt-issuing entity. While UBS is one of the first European banks to announce an alteration of its legal group structure following regulatory preferences, we believe that it is likely that other European banks will follow once the regulatory framework and preferences in other countries have been finalised. In 1Q14, both of UBS's wealth management businesses continued to perform well. In wealth management (WM), the bank's adjusted pre-tax profit grew 29% qoq and was only 4% lower yoy. Net new money (NNM) inflows were solid at CHF11bn, largely in Asia and Switzerland, more than offsetting the continued outflows from its European offshore businesses (CHF2.5bn). Gross margin rose 2bp qoq to 87bp, and we consider that UBS is well-positioned to benefit from any improvement in market conditions, although meeting its 95bp-105bp target range might prove challenging absent further market improvements. To improve its gross margin UBS intends to move more clients to a mandate relationship. This should help recurring fees at the expense of more volatile transactional fees. In US wealth management (WMA), adjusted pre-tax profit was flat at USD284m qoq. NNM inflows were lower than in previous quarters, although they remained satisfactory (USD7.6bn including dividends and interest versus USD11.1bn quarterly average for 2013). UBS has ambitious performance targets for its asset management, where it plans to generate CHF1bn annual pre-tax profit within the next three to five years. We believe that the group's strong distribution network and cross-selling opportunities to wealth management clients should help improve the division's performance. However, increasing earnings will be contingent on the success in expanding higher-margin alternative products. UBS's IB continued to generate a high adjusted return on allocated equity in 1Q14 (28%). This is above its 15% target, and we believe that UBS should be able to continue meeting this target through the cycle. IB's adjusted pre-tax profit was down 41% yoy but up 42% qoq. The yoy decline affected both the bank's corporate client solutions division (-23% yoy; +9% qoq), which is dominated by the bank's solid equities trading franchise, and its investor client services unit (-18% yoy; +23% qoq), although 1Q13 was a particularly favourable quarter. UBS's retail banking business (R&C) continued to generate satisfactory and recurring profitability, in our view (CHF401m adjusted pre-tax profit). The division's adjusted cost/income ratio was down to 58% on cost reduction, and pre-tax profit also benefited from net credit loss recovery in 1Q14 (CHF12m). Adjusted pre-tax losses from both UBS's corporate centre - core functions (CC-CF) and corporate centre - non-core and legacy portfolio functions narrowed qoq to CHF285m and CHF216m respectively. The former is mainly composed of unallocated funding costs from long-term funding of UBS's legacy IB assets (reported in non-core), and is expected to fall progressively in line with any further debt-buy back exercises and maturities. We expect the performance of UBS's non-core and legacy portfolio to remain unpredictable with losses booked largely depending on market conditions and the speed of asset disposals and wind-downs. RWA associated with UBS's non-core portfolio declined CHF4bn qoq to CHF29bn, and were largely related to over-the-counter products (63% of the non-core portfolio; versus 5% cash assets) and operational risks (32%). RWA relating to UBS's legacy portfolio were flat qoq. UBS's capital is a key rating strength. The bank continued to strengthen its balance sheet and reported a 13.2% fully-loaded Basel III common equity Tier 1 (CET1), the highest within its peer group. This ratio improved 40bp since end-2013, mainly on earnings retention, exceeding for the first time the internal target set for 2014. In addition, the bank was close to meeting its secondary capital ratio target, a post stress test CET1 ratio above 10% (9.9% at end-1Q14). RWAs increased slightly (by 1% qoq), mainly driven by the revision of model assumptions and/or requirements. UBS's unweighted leverage, according to the Swiss interpretation of Basel III regulations (Swiss SRB ratios), improved to 3.8% on a 'fully loaded' basis at end-1Q14 from 3.4% at end-2013 (3% and 2.8% respectively if loss-absorbing capital notes are excluded) and compares adequately with European peers. Fitch expects leverage to improve further as the bank progressively reduces its non-core and legacy portfolios. UBS is on track to meet its new Swiss SRB leverage ratio denominator target of CHF900bn by 2016 (CHF988bn at end-1Q14) We believe that UBS remains significantly exposed to operational, litigation and regulatory risks. This is partly reflected in the incremental operational risk RWA add-on imposed by the FINMA on the bank in 4Q13 (supplemental operational risk capital analysis since 4Q13), although we expect supplemental operational risk RWA (around a quarter of operational risk RWA at end-1Q14) to gradually fall as UBS provides for or resolves outstanding litigation or regulatory matters. While Fitch considers UBS's solid capital would be able to absorb significant non-recurring items, such as litigation costs, its VR and IDRs remain sensitive to any large litigation or regulatory expense that would significantly alter its capital ratios. Contact: Alain Branchey Senior Director +33 1 44 29 91 41 Fitch Ratings S.A.S. 60 rue de Monceau 75008 Paris Francois-Xavier Marchand Associate Director +33 1 44 29 91 46 Media Relations: Hannah Huntly, London, Tel: +44 20 3530 1153, Email: hannah.huntly@fitchratings.com. Additional information is available on www.fitchratings.com. ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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