UBS Heeding Wake-Up Call

UBS AG (UBS), which at USD 12.90 is down 68% year to date, faced its accusers at its EGM yesterday. The main topics were to inform shareholders about the changes to its compensation system and allow them to vote on measures related to the government bailout. It seems that everyone hates the stock, but this could well be the time to speculatively buy. Despite the noise from angry shareholders, upset that the bank has faced two bailouts, the management appears to now be focused on the long-term and more closely aligned with the value creation of the firm. In short, the compensation package was in investor interests.

Anyway, it is not pay that is the big issue as far as the stock price goes, it is the risk systems. They proved to be totally inadequate. In this respect, the bank has quietly made changes. It no longer reports internal management Value at Risk, but instead regulatory Value at Risk. At the same time, it has increased the scope of its internal management Value at Risk to more accurately represent risk exposures and related hedges: important changes that should benefit transparency and control. On the same vein, UBS AG recently increased hedging activity against credit exposures in its over-the-counter derivatives portfolio.

The good news is that recent losses have now reversed. UBS AG posted a net profit of $252 million for the third quarter. The bank benefited from a $776 million tax credit and a revaluation of its credit positions that led to a $1.88 billion gain on its books. That said, next quarter might not look so bright. The credit gains reflect an increase in the difference between the market value of its outstanding debt and the amount it would cost UBS to issue this debt under current conditions. Some or all of the gain could be erased if credit conditions change. The potential impact on credit reversals is $2billion (if spreads on UBS debt remain unchanged from current levels. The bank could also be hit by a loss on the equity it is transferring to a fund controlled by Switzerland's central bank).

The jewel in the crown is the wealth management division. In the third quarter, the bank suffered a net outflow from this and its asset-management division of $72.0 billion. This sounds bad, and it is, but it is not all loss of confidence. Part of it can be attributed to clients seeking diversification and the trend to deleverage. That said, customers are continuing to withdraw funds and that remains a big uncertainty.

The bank now appears determined to continue to cut operating expenses and efficiency and personnel reduction programs look more promising than they have in the past.

The bank is not out of trouble yet. Its management has been delivered a severe wake up call which they appear to be heeding.

Disclosure: No stock owned by Daniel Broby or Danfonds.