DBRS: UBS Results Show Continued Momentum; Legacy Headwinds Receding, Capital Strong

Summary:
• 1Q14 net profit of CHF 1.1 billion, up 15% quarter-on-quarter (QoQ), with positive operating leverage driven by revenue growth and expense stability.
• Legacy issues continue be reduced as the Non-core and Legacy (NC&L) portfolio is run down; 1Q14 expense reductions driven by lower charges for provisions for litigation, regulatory and similar matters, as well as lower restructuring charges.
• Capitalization further improved with a common equity Tier 1 ratio of 13.2%, based on Basel III fully-applied, exceeding UBS’s target ratio of 13% by the end of 2014.
• DBRS rates UBS AG Senior Unsecured Long-Term Debt at A (high) with a Stable trend.

DBRS, Inc. (DBRS) views the 1Q14 results of UBS AG (UBS or the Bank) as continuing to demonstrate the momentum of the Bank’s franchise, with strength across core businesses. Net revenues improved 15% QoQ to CHF 7.3 billion, while expenses remained largely flat, resulting in positive operating leverage. The Bank is committed to a further CHF 2.1 billion in annualized expense saves out of its Corporate Center, with a large portion to be completed by 2015.

Of particular note is the Bank’s continued momentum in its wealth management franchises, which include its Wealth Management (WM) businesses globally, excluding the Americas, and Wealth Management Americas (WMA). WM performance indicators demonstrated improving trends, including sizable net new money inflows of CHF 11 billion in the quarter, or a 4.9% growth rate annualized and at the high end of UBS’s new target range of 3-5% annually. The Bank is also focusing on improving its gross margin, at 87 basis points (bps) in 1Q14, up 2 bps sequentially, (target: 95-105 bps) and cost/income ratio, which was down to 68% in 1Q14 (target: 55-65% from 2015, lowered from 60-70%).

In WMA, the Bank reported record pre-tax operating profits of USD 284 million, flat QoQ and up 29% YoY. Record revenues were driven by record levels of invested assets of USD 987 million, driving higher levels of recurring fee income. WMA reported net new money inflows of CHF 2 billion in the quarter, or a 0.9% growth rate annualized (new target: 2-4%). With a gross margin of 76 bps, WMA is within its new target range of 75-85 bps, albeit at the low end of this range.

While legacy issues remain, DBRS views this hindrance as receding given the Banks’s success in reducing its NC&L Portfolio, with assets in this portfolio declining to CHF 190 billion at 1Q14 from CHF 215 billion at year-end 2013 and down 56% from year-end 2012. That being said, the NC&L Portfolio remains notable at 19% of total assets. The continued rundown of this portfolio could reduce the associated staffing and overhead costs, as well as credit costs. In 1Q14, expenses also declined with lower charges for provisions for litigation, regulatory and similar matters, as well as lower restructuring charges. UBS reported a pre-tax operating loss in its NC&L Portfolio of CHF -225 million in 1Q14, much reduced as compared to net losses CHF -2.3 billion in 2013 and CHF -3.8 billion in 2012.

DBRS views capitalization as strong and improving. Earnings retention contributed to a common equity Tier 1 ratio of 13.2%, based on Basel III fully-applied, as risk-weighted assets increased slightly in the quarter. This ratio exceeds UBS’s target ratio of 13% by the end of 2014. Furthermore, the Bank’s Swiss SRB (systemically relevant banks) Basel III leverage ratio was boosted to 3.8%, fully-applied, in 1Q14 by the issuance of EUR 2.0 billion of low-trigger, loss-absorbing Basel III-compliant Tier 2 subordinated notes.

UBS also announced a reorganization of its group structure and its intention to establish a holding company to improve its resolvability. The holding company will be formed through a share-for-share exchange offer, to be launched later in 2014, subject to regulatory approval. The Bank anticipates a lowering of its overall capital requirements as a result of this modification of its legal structure.

DBRS rates UBS AG Senior Unsecured Long-Term Debt at A (high) with a Stable trend.

Note:
All figures are in Swiss francs (CHF) unless otherwise noted.