UBS's Investment Banking and Wealth Management Arms Drive Q1 Profit, Watch $20 Resistance (Activist Wants To Spin-Off Investment Bank)

I saw that UBS, "the second-largest private bank in the world after Bank of America," uploaded a Youtube video summarizing its Q1 2013 financial results, so I embedded it below for all the UBS fans, investors and employees out there. I also took a closer look at the stock.

UBS reported a net profit of CHF 988 million in Q1 2013 compared with a loss of CHF 1.9 billion in Q4 2012 and a profit of CHF 1.04 billion in Q1 2012. Pretty big swings there. According to Bloomberg News, CHF 988 million "surpassed the 412.3 million- franc mean estimate of nine analysts surveyed by Bloomberg." It also beat a Reuters analyst poll which expected UBS to earn CHF 601 million. On October 30, 2012, UBS announced it was cutting 10,000 jobs and winding down its fixed income business.

Here's a look at UBS's quarterly revenue, quarterly profit margin, and trailing twelve month price/sales ratio since 2008 via Ycharts.

UBS Revenue Quarterly Chart

I'm not going to attempt to deeply analyze UBS's TBTF-ish type numbers, but I thought it was interesting that UBS's Wealth Management division was booming again after it saw massive outflows during the financial crisis and tax/legal scandals. (Articles: UBS outflows accelerate in Q3 - Reuters, 10/16/2008; UBS Said to Cut Jobs At U.S. Wealth Arm - NYT/DealBook, 9/24/2009; UBS client outflows increase - Reuters, 2/9/2010; UBS Nears Wealth Management Turnaround as Outflows Taper Off - Bloomberg, 10/25/2010; Tax could cost UBS up to 10 percent of Europe assets - Reuters, 5/26/2012; Swiss banks to suffer big withdrawals over tax - UBS - Reuters, 9/17/2012.)

Here's more info from UBS's Q1 2013 release:

Wealth Management delivered the highest levels of quarterly net new money since 2007, and the highest quarterly profit since 2009. Wealth Management Americas achieved another record profit and strong net new money inflows. Combined inflows into UBS’s wealth management businesses increased to almost CHF 24 billion.

Wealth Management’s profit before tax in the first quarter was CHF 664 million compared with CHF 398 million. Adjusted profit before tax was CHF 690 million compared with CHF 415 million in the prior quarter. The gross margin on invested assets increased 6 basis points to 91 basis points, mainly reflecting an upturn in transaction-based income. Operating expenses decreased to CHF 1,250 million from CHF 1,350 million, mainly due to seasonally lower general and administrative expenses. Net new money inflows of CHF 15.0 billion represented the highest quarterly net inflows since 2007. The cost/income ratio decreased to 64.9% from 77.3%. On an adjusted basis excluding restructuring charges of CHF 26 million compared with CHF 17 million in the previous quarter, the cost/income ratio improved 12.7 percentage points to 63.6% from 76.3%, and was within our target range of 60% to 70%.

Wealth Management Americas profit before tax was USD 251 million compared with a profit before tax of USD 216 million in the prior quarter. It reported a record adjusted quarterly profit before tax of USD 262 million in the first quarter of 2013 compared with an adjusted profit before tax of USD 219 million in the prior quarter. The improvement reflected a 3% decrease in operating expenses, mainly due to lower charges for provisions for litigation, regulatory and similar matters. Net new money continued to be strong and improved to USD 9.2 billion. In US dollar terms, the gross margin on invested assets decreased 4 basis points to 80 basis points and remained within the target range of 75 to 85 basis points. The gross margin from recurring income decreased 4 basis points due to lower mutual fund and annuity fee income, while the gross margin from non-recurring income remained unchanged from the prior quarter. The cost/income ratio decreased to 85.5% from 86.8% in the prior quarter. On an adjusted basis excluding restructuring charges, the cost/income ratio decreased to 84.9% from 86.6% and remained within the target range of 80% to 90%.

The Investment Bank recorded a profit before tax of CHF 977 million in the first quarter of 2013 compared with a loss before tax of CHF 243 million in the fourth quarter of 2012. Adjusted profit before tax was CHF 928 million compared with a loss before tax of CHF 70 million. Return on attributed equity was 49.5%. Both Corporate Client Solutions and Investor Client Services reported higher revenues. Total operating expenses decreased 2% to CHF 1,806 million from CHF 1,847 million. On an adjusted basis, operating expenses increased 8% to CHF 1,800 million from CHF 1,674 million, mainly due to higher variable compensation accruals. Fully applied BIS Basel III risk-weighted assets increased by CHF 5 billion to CHF 69 billion as of 31 March 2013, compared with pro-forma CHF 64 billion as of 31 December 2012, and were compliant with our target of CHF 70 billion or less. Funded assets were CHF 193 billion as of 31 March 2013, unchanged from 31 December 2012 and within our target range of less than CHF 200 billion. The cost/income ratio improved to 64.8% from 114.7%. On an adjusted basis, the cost/income ratio improved to 65.9% from 104.0%, within the target range of 65% to 85%.

$UBS has been trading in a sideways channel between 78 and $20 since 2008. It is currently trading at $18.18 after reaching a high of $18.50 a few days ago, so it could eventually test $20 resistance where traders would then decide the multi-year channel's fate (the stock would either break out or roll back in its jail cell). The stock is also riding the 50 and 200 week moving averages with some decent strength and momentum behind it (see below), so keep an eye on that resistance level.


There is of course downside risk for the stock if the U.S. enters a recession, there's a market or credit shock, central banks pull liquidity, the eurozone crisis flares up again, or if other advanced and emerging economies contract significantly. (Or if a rogue UBS trader loses billions on unauthorized trades!) But central banks around the world are trying to prevent deflation, financial crises and lost economic decades at all costs (almost). We'll see what happens.

In other UBS news, I noticed that activist investor Eric Knight, founder of Knight Vinke Asset Management, is trying to get UBS to separate its Investment Bank (and legacy assets) from its Wealth Management and Swiss Banking divisions to unlock shareholder value. He wrote an open letter to UBS on May 2, 2013 (source: Reuters).

Ladies and Gentlemen,

Knight Vinke is an institutional shareholder of UBS. We are publishing this letter now, on the date of the Annual Shareholders' Meeting, so as to initiate a transparent debate about UBS' group structure. In particular, we question the merits of keeping the Investment Bank under the same roof as the Wealth Management and Swiss Banking businesses.

The Investment Bank has delivered a good set of results for the first quarter of 2013 but nearly destroyed UBS in 2007-09. Investment banking is a very risky business and these risks pose a serious threat to UBS' Wealth Management and Swiss Banking franchises. They may also be preventing them from achieving their true potential. This is a discussion that is best had when all the businesses are doing well - as is the case today - and the Board needs to be encouraged to act quickly and decisively so as not to lose the opportunity.

As we all know, in 2007-09 the Investment Bank lost SFr 57 billion and UBS had to be rescued by its shareholders and by the Swiss National Bank. In 2011, we were again reminded of the risky nature of investment banking when UBS lost SFr 1.8 billion as a result of an "unauthorized trading incident" and in 2012 it was fined SFr 1.4 billion for its part in the LIBOR rigging scandal. Of course, this record of losses is not unique to UBS - many other banks have also suffered catastrophic losses in the last few years. In the case of UBS, however, the damage has gone further because the losses have weakened the reputation of its prized Wealth Management division and the all-important trust of its clients.

UBS appears to believe that the Investment Bank can now be re-engineered to generate reasonable returns for shareholders by eliminating some of its most capital intensive units. This has been achieved by parking these "non-core" businesses, together with the Investment Bank's toxic "legacy" assets, in other parts of UBS. It is no surprise, therefore, that the Investment Bank is now producing very good results - but one should remember that the Group as a whole remains exposed to these risks.

In the case of UBS, the risks that are inherent to investment banking are compounded by organizational complexity and territorial behaviour that result from the way in which the Group was created through a series of major cross-border acquisitions. These risks are unrelated to capital intensity or size and are not adequately addressed by the down-sizing of the Investment Bank and internal transfer of some of its activities.

It is argued that the Investment Bank brings cross-selling opportunities to the Wealth Management business - and to a limited extent this may be true. However, whatever benefits there may be need to be viewed in the wider context of the risks that the Investment Bank brings to the Group as a whole - and the damage that it potentially does to the brand and client trust that are so vital to the Wealth Management and Swiss Banking businesses.

What is missing, in all of this, is a far more ambitious vision of what UBS' Wealth Management and Swiss Banking businesses might aspire to if they had none of the risks associated with the Investment Bank or its related portfolio of legacy assets.

What is also missing is the recognition that the best owners of the Investment Bank could well be its management and employees - who in any case receive the largest part of any profits. Since 1998, the Investment Bank has paid SFr 115 billion in salaries and bonuses to its employees. By contrast, over the same period it has contributed a negative SFr 25 billion to its parent and shareholders. Transferring full or partial ownership of the Investment Bank to insiders would almost certainly lead to more prudent behaviour.

To its credit, the Board under the direction of Dr. Axel Weber has taken a welcome first step in the restructuring of UBS by repositioning the Investment Bank. The Board now has the opportunity to go further so as to unlock the full value potential of UBS - by separating the Investment Bank from Wealth Management and Swiss Banking, by possibly contracting out the liquidation of the legacy portfolio, and by simplifying the Group structure so as to reduce risk overall.

We now urge the Board to pursue these strategic options as a priority and to ensure that the interests of shareholders are kept distinct from those who have vested interests of their own.

Yours sincerely,

Eric Knight

Knight Vinke Asset Management

Here's an analyst's view on UBS's wealth management arm via Bloomberg News.

Wealth management is “the business that will drive the share price because that’s the one that attracts the highest valuation,” Christopher Wheeler, a London-based analyst at Mediobanca SpA, said before today’s release.

Also, Reuters Breakingviews columnist Dominic Elliott thinks a "UBS split would not be the best move" (via DealBook).

The argument for doing the split is that it is the only sure way to protect wealth management from potential losses in the investment bank. The snag is that separation would remove the synergies between wealth management and investment banking — the first is a big customer of the second, for example. Above all, it would carry big one-off costs. As a standalone entity, the investment bank would almost certainly require an additional capital injection to be able to finance itself. It’s not clear where that capital would come from. Meanwhile, UBS is lumbered with 382 billion Swiss francs of noncore assets that look like a huge obstacle to corporate change.

And Quartz columnist Gina Chon believes "smaller is better for UBS's investment banking" (via Quartz).

Investment banking at UBS has already taken the biggest hit as part of the overhaul. That’s why as part of its revamp, UBS should no longer try to be a major investment bank in the US and turn that unit, including its mergers & acquisitions business, into a boutique. UBS could abandon the pretense of having comprehensive investment banking services and pick and choose just the parts of the business that are especially lucrative or otherwise useful for the rest of the bank.

Interesting. Well, in conclusion, I just think that after 5 years of chopping around between $7 and $20, UBS could attempt to breakout at some point.
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