Fitch: UBS Reports Resilient 3Q15 Operating Performance in Difficult Markets
OREANDA-NEWS. Fitch Ratings says that UBS Group AG's (UBS; A/Stable/a) operating profitability was resilient in 3Q15 despite difficult market conditions. Net profit was affected by higher provisions for litigation and regulatory matters in 3Q15. In addition, UBS announced that it expected the new Swiss capital requirements, announced in October 2015, to have a 3pp negative impact on its return on tangible equity target, before mitigation action taken by the bank.
UBS reported CHF979m 3Q15 pre-tax profit adjusted for changes in the fair value of own debt (CHF32m gain in 3Q15), net restructuring charges (CHF298m), gains on a financial stake (CHF81m), foreign exchange losses from a subsidiary sale (CHF27m) and a gain from changes to UBS's retiree plan in the US (CHF21m). Adjusted 3Q15 pre-tax profit included CHF592m provisions for litigation, regulatory and similar matters. Excluding these provisions, adjusted pre-tax profit was up 11% yoy and stable qoq excluding similar items in respective quarters.
UBS's CHF2,068m 3Q15 net income benefited from a CHF1,513m net upward revision of deferred tax assets (DTA) in 3Q15, which mainly related to its US business. UBS announced that it expects a further net upward revaluation of approximately CHF500m in 4Q15 and CHF500m in 2016. Excluding the impact from DTA revaluation, UBS generated a good 10% annualised adjusted return on tangible equity in 9M15. Including the DTA revaluation, the annualised 9M15 adjusted return on tangible equity was 14.5%.
UBS's performance in its Wealth Management (WM) and Wealth Management Americas (WMA) businesses were both affected by negative market performance in 3Q15, which translated into CHF26bn and USD53bn qoq declines net of currency effects in invested assets, respectively. While the 3Q15 decrease in invested assets will weigh on fee generation in the coming quarters, we believe that UBS should continue to report sound profitability in both businesses.
In WM, adjusted net new money (NNM) inflows slowed to CHF3.5bn in 3Q15 (equal to a 1.5% annualised growth of assets under management) mainly due to client deleveraging in Asia and Europe following high equity market volatility during the summer. UBS reported CHF698m adjusted pre-tax profit in 3Q15, down 9% both yoy and qoq. Net interest income increased on higher lending volumes, but this was offset by low transaction-based income. WM reported a satisfactory 64% cost-income ratio in 3Q15. WMA reported an 8% yoy increase in 3Q15 adjusted pre-tax profit to USD287m. Similar to WM, transaction-based income was lower but earnings benefited from continued lending growth, which is in line with the bank's strategy. NNM inflows declined to a low 0.2% annualised growth rate in 3Q15 after sound growth since 3Q14.
UBS's Asset Management division, a smaller contributor to UBS's earnings, reported a CHF137m adjusted pre-tax profit in 3Q15, up 2% qoq. Gross margin on invested assets rose 2bp qoq to 31bp, as management fees increased and earnings also benefited from positive currency effects.
UBS's Retail & Corporate division reported 3Q15 adjusted pre-tax profit of CHF428m, 3% higher than in the previous quarter as operating income benefited from continued lending growth - new lending business was up 2.5% yoy. UBS's net interest margin held up despite the low interest rate environment (167bp of average loan exposure, up 2bp qoq). Loan impairment charges were immaterial in 3Q15. While asset quality is likely to deteriorate in the future following the economic slowdown in Switzerland, we expect any deterioration to be easily absorbable given the sound quality of UBS's domestic loan book. Costs remain under control with a 56% adjusted cost-income ratio in 3Q15.
UBS posted resilient results in its investment bank (IB) despite difficult market conditions in 3Q15 and saw a 6% revenue increase yoy unlike most of its global trading and universal bank (GTUB) peers. UBS's equities sales and trading franchise reported a 4% yoy increase in revenue, as cash equities and the US business performed well. Unlike most of its GTUB peers, IB's FX, rates and credit business reported a resilient performance (up 37% yoy and 11% qoq), notably in macro products. UBS maintained good cost control in IB with a 70% cost-income ratio and the bank generated a solid 34% return on attributed equity on an annualised basis in 3Q15.
UBS's corporate centre reported a CHF1,174m adjusted pre-tax loss in 3Q15, CHF803m of which related to the Non-Core and Legacy Portfolio. We expect that litigation and conduct costs will continue to affect UBS's performance, as was illustrated by the CHF534m provision for such matters booked in the Non-Core and Legacy Portfolio in 3Q15. UBS's Non-Core and Legacy Portfolio contributed CHF59bn to the group's leverage ratio denominator in 3Q15, down CHF12bn qoq. Around two-thirds of the leverage exposure was to rates products, and most of the associated risk-weighted assets (RWA) related to operational risk (CHF20bn out of CHF32bn total RWA).
We believe that UBS is well positioned to meet the increased regulatory capital requirements announced by the Swiss government in late October. UBS continues to report the highest risk-weighted capital ratios among its GTUB peer group, with a 14.3% fully-applied CET1 ratio at end-3Q15. UBS announced that it expects RWA to increase as a result of regulatory initiatives, including operational risk add-ons and multipliers on some asset classes, and revised its RWA expectations to CHF250bn from CHF216bn at end-3Q15.
Under the revised capital requirements, UBS will have to comply with a 5% leverage ratio by end-2019, of which at least 3.5% will have to be in common equity Tier 1 (CET1) capital and up to 1.5% in high-trigger additional Tier 1 (AT1) instruments. At end-3Q15, UBS's fully-applied Basel III leverage ratio stood at 3.9%, of which 3.3% was in the form of CET1 capital. The Swiss regulations allow for existing low-trigger AT1 instruments and low- and high-trigger Tier 2 instruments to be grandfathered for inclusion as going concern capital. Using these grandfathering rules, UBS's fully-applied leverage ratio under Swiss regulations stood at 5%.
The Swiss authorities also announced minimum total loss-absorbing capacity (TLAC) requirements, and the two big Swiss banks have to hold a TLAC equivalent of up to 28.6% of risk-weighted assets (RWA) and 10% of total leverage exposure by end-2019. UBS announced that it intends to replace existing Tier 2 instruments at their call dates with high-trigger AT1 instruments issued by the holding company and to continue issuing TLAC-eligible senior unsecured debt by the holding company. The bank also intends to replace on maturity existing senior unsecured bonds and covered bonds issued by the operating bank (UBS AG) with TLAC-eligible bonds issued by the holding company. At end-3Q15, about CHF33bn, equal to 3.5% of leverage exposure, of senior unsecured bonds and covered bonds were outstanding, and the replacement of these instruments with TLAC-eligible bonds would bring the bank close to meeting maximum TLAC requirements of 10% of leverage exposure.