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Executives

John Cryan - Group CFO

Caroline Stewart - Head, IR

Analysts

Kian Abouhossein - JPMorgan

Huw van Steenis - Morgan Stanley

Jon Peace - Nomura

Derek De Vries - Bank of America

Jernej Omahen - Goldman Sachs

Matthew Clark - KBW

Kinner Lakhani - Citi

Fiona Swaffield - Execution

Georg Kanders - WestLB

UBS (UBS) Q1 2010 Earnings Call May 4, 2010 7:45 AM ET

Caroline Stewart

Good morning and welcome to our first quarter results presentation. My name is Caroline Stewart and I’m the head of investor relations here at UBS. This morning John Cryan, our chief financial officer will present the first quarter results.

After the presentation we will be happy to take any of your questions. Before we get started today I’d like to draw your attention to this slide. It contains our cautionary statement with regard to forward-looking statements. I recommend that you take a few moments to read it in detail. With that, I’d like to hand over to John.

John Cryan

Good morning, everyone. It’s my pleasure to take you through the results for the first quarter of 2010. This morning we reported a pre-tax profit of CHF 2.8 billion for the first quarter, in line with the announcement we made just prior to our AGM last month.

The net profit attributable to shareholders was CHF 2.2 billion equivalent to diluted earnings per share of CHF 0.58 and representing an annualized 21% return on average equity. The improvement in our revenues on the fourth quarter was attributable mostly to a significantly better result in our fixed income current season commodities unit. This was achieved with no significant increase in risk taking. In fact, we continued to reduce our exposure to legacy risks during the quarter.

Risk-weighted assets at quarter end where only marginally higher than they had been at the start of the quarter and the average market value at risk was flat on recent quarters. We continue to build our financial strength, increasing our capital primarily through profit retention. Our tier 1 capital ratio at the end of the quarter was 16% and our core tier 1 ratio was 21.5%.

Making money remains a key focus of management. Although each of our asset gathering divisions will continue to outflows in the quarter, the level of outflows did fall substantially.

This chart shows the first quarter performance by division. I’ll go through detailed results for each division as usual but at this point let me make some general remarks on the overall results. Our revenues in the quarter totaled CHF 9.3 billion before own credit effects. This brings us close to our medium-term revenue target of over CHF 10 billion for the quarter. Revenues were positively impacted by the strong trading environment in the fixed income markets, especially in January.

Personnel expenses across the group do show an uptick on the level we reported in Q4. You may recall that for the 2009 performance year we increased the proportion of variable compensation awarded in the form of deferred share grants. This changes books in the fourth quarter with a cumulative adjustment for prior quarters and had the effect of deferring into future periods, a recognition of a greater proportion of the overall cost of variable compensation in our accounts.

The personnel expense charge in this quarter reflects a return to a more normal level of compensation accrual. However, variable compensation is determined annually, so you should bear in mind that the rate of bonus accrual could change through the remainder of the year.

The own credit charge for the quarter was just under CHF 250 million, so that at quarter end we held a net life-to-date gain from own credit of just over CHF 650 million. The tax charge of CHF 603 million represents an implied tax rate of 21.5% in line with what we currently expect our long-term normalized tax rate to be.

The vast majority of the charge, some CHF 565 million, was a deferred tax expense as Swiss tax losses, for which we previously recognized deferred tax assets, were applied against profits for the quarter. We also incurred tax expenses of CHF 125 million, mainly on profits in APAC. Finally we were able to re-measure our US deferred tax assets and increase them by CHF 87 million.

This slide shows the group net profit progression quarter-on-quarter. The improvement in the bottom line result was just short of CHF 1 billion but the top line improvement was nearer to CHF 3 billion. This was offset by an increase in personnel expense of CHF 1.2 billion and a net increase in tax expense of almost CHF 1.1 billion, given that we took a significant tax credit in Q4, after we re-measured our deferred tax assets at year end.

There was relatively little allocation of profit to minorities in Q1. The vast majority of our minorities are represented by the holders of our hybrid tier 1 capital. Net profit is attributed to minorities when events occur that trigger mandatory payments of dividends on our trust preferred securities. We expect dividend payments in an amount of up to CHF 300 million to be triggered in the second quarter.

On this slide we’ve sought to analyze the drivers of the revenue improvement in the first quarter by business division. The top graphic is a straight comparison with Q4s numbers. You’ll see that the main driver of the 48% increase in revenues is the improvement in fixed income. The bottom chart shows the same analysis but this time against the average quarterly performance for 2009 and the turnaround in FICC is again the principal driver, this time with a 59% improvement.

Total operating expenses grew by 20% quarter on quarter to CHF 6.2 billion. This chart shows Q1 verses the average of the quarters in 2009. The principal component of the increase in expenses was the accrual we made for variable compensation which includes amortization of the deferred compensation we awarded to staff for 2009 and earlier years.

Our underlying expenses, excluding bonuses but including grid base compensation for financial advisors in the USA remained below out target run rate for 2010 of CHF 5 billion per quarter. While on the subject of expenses, I should mention that we expect that second quarter’s result will be impacted by the bank payroll tax introduced in the UK's Finance Act 2010 which was enacted in April.

We have a preliminary approximation of the cost of the levy which is CHF 300 million, though this amount is subject to further detail at assessment. The levy will be charged as a personnel expense and will mainly impact the investment bank.

Headcount fell by 940 in the quarter overall. Starting from this quarter, all headcount in the shared services and control functions of corporate center together with their related cost base is allocated to the business divisions. The chart of the left-hand side shows the headcount development including the effect of an additional allocation of around 1250 corporate center staff to the respective divisions. On the right we show the underlying change in each division.

Now, we've made a number of changes to our financial disclosures this quarter. These are aimed at providing you with a more comprehensive understanding of the component drivers of our reported revenues. We provide you once again with a full P&L for the wealth management business separate from the retail and corporate banking business whilst we retain the revenue split between Swiss and non-Swiss clients of wealth management.

I'll also show you a new cut of the overall divisions’ revenues, supplementary to the recurring verses nonrecurring split we continue to provide in the quarterly pack.

In global asset management we’ve replaced the wholesale verses intermediary -- I’m sorry, wholesale intermediary verses institutional split with income and selected value drivers shown by business line. This better reflects the way that John Fraser and his team manage the division. We also show separately new additional information on the firm services businesses that sit within that division.

Finally, in the investment bank, we’ve provided a much more detailed breakdown of the revenues generated by our sales and trading operations, setting a new standard of disclosure.

So turning to Wealth Management and Swiss bank, here’s the new cut of revenues generated by the overall division in the first quarter and bi-quarter over the past two years. As I just mentioned, we’ve retained the old disclosure of recurring verses non-recurring income but I thought this view would be helpful in explaining some of the drivers of the overall revenues of the division.

So starting with the blue bars, you can see what effect the flattening of the old curve has had over the past couple of years. In particular, declining returns on the re-investment on our deposits have been a major driver of the overall decline in net interest income. Revenues in Q1 were down almost CHF 200 million from the corresponding period last year, almost entirely because of this effect.

The gold bars by and large measure the portfolio management fees we charge clients on the balance of their invested assets. These fees are predominately driven by the volume of invested assets as can be seen by the effect on these revenues as a steep fall in the markets in the second half of 2008 and early 2009. This is an area of management focus that I will touch on in a bit more detail soon.

The green bars give an indication of client activity levels from the brokerage fees we charge on non-discretionary accounts and trading revenues we make by crossing bid offer spreads. Here we saw early signs of a pick-up in revenues.

You’ll note that credit loss expense has not been a major feature in our experience of the crisis. Retail and corporate saw a steady improvement in performance quarter-on-quarter with an increase in revenues and a significant reduction in G&A expenses. The cost income ratio is held at around 52.5%.

Wealth Management reported a 6 % improvement in revenues in the first quarter on the higher gross margins. Non-recurring revenues were particularly strong, impacted by low evaluation adjustment on a property fund.

Expenses increased 7% but this largely reflected in more normalized level of accruals for variable compensation. Cost-cutting measures taken last year continue to have a positive impact on non-personnel expenses. As with all other divisions, disclosed expenses are impacted by the incremental allocation of the costs from corporate center. If you’d applied this allocation in 2009, Q4's operating expenses would’ve been CHF 32 million higher in the pre-tax profit correspondingly lower.

This slide shows the gross margins across wealth management for Q1 and each quarter for the past two years. In the quarterly report we also show the margins for Swiss and International clients separately. At our investor day in November last year we set out some of the measures we intended to take to grow our gross margin back to over 100 basis points. Key amongst these were the full measures shown on the slide and I can report that we already see some signs of these actions having an effect on our results.

We’ve seen an increase in the penetration of discretionary wealth management mandates on the back of the reconfigured product suite. Better and more proactive engagement with clients and increased client confidence have boosted activity levels. We’ve seen a pickup in Lombard lending balances in the past two quarters. Finally, we’ve shown greater discipline in pricing and have re-priced selected services, especially in off-shore markets.

Overall, these measures have underpinned a pleasing improvement in the annualized return on the invested assets to 93 basis points, although two of the five basis points of improvement in the quarter related to non-recurring income.

The first quarter saw some improvement in net new money flows but they were still negative. The overall division recorded net outflows of CHF 8.2 billion while CHF 8.0 billion in wealth management.

We continue to see net inflows in the Asian Pacific and this quarter saw some of the important European markets turn net positive. We saw net inflows from the ultra high net worth client base. We're tacking the drivers of outflows and inflows. With outflows, consumption levels are still running at relatively high rates, especially in certain markets.

Client advisor attrition is clearly a continuing factor for us. In Q1 we saw increasing price competition. We're determined to focus on attracting profitable new money and to shun opportunities to buy market share on attractive terms.

In the first quarter we saw continued attrition in client advisor numbers with a net reduction of 148 or 3%. This partly reflected the late stages of the adjustments we made in 2009, the client facing staff numbers, to right size the business.

We’re now actively seeking to hire advisors on a selective basis but we do still expect net client facing staff numbers to continue to decline slightly in the second quarter. Thereafter, we would expect to grow the number gradually towards our medium-term target of around 4700.

Invested asset balances at the end of March stood at CHF 827 billion, up marginally in the quarter, as strong investment performance outweighed negative net new money. The average volume of invested assets per client advisor reached CHF 200 million, marginally short of our effective medium term productivity target.

At Wealth Management Americas, Bob McCann and his new team and making discernable progress, although the first quarter pre-tax results went to CHF 15 million to CHF 178 million in Q4. The result was impacted by an increase in deferred compensation awards to financial advisors and by the introduction of Growth Plus, a new FA loyalty program.

We also took restructuring charges of around CHF 20 million as we continue to right size the division's infrastructure and staff [inaudible]. The division's results were also impacted by the allocation of around CHF 25 million of additional charges from corporate center.

The number of financial advisors fell by 3% or so to just under 6900. The business had been configured to support 10,000 advisors, so we still have some way to go to achieve the right level of operational gearing.

I expect to have to take additional restructuring provisions, primarily in relation to real estate rationalization, of potentially up to CHF 150 million and this is likely to be charged against the division's results for the second quarter.

Net new money outflows this quarter was CHF 7.2 billion down from CHF 12 billion in the fourth quarter in line with the slow rate of financial advisor departures. We’re now back in the market hiring financial advisors on a selected basis. We're pleased to report that we had positive same-store sales, i.e. positive net new money from financial advisors who have been with us for more than 12 months. This is the first time this has been the case since 2007.

We’re holding our annual financial institutions investor conference in New York City next week. Bob McCann will be presenting on behalf of UBS and he will unveil in some detail his strategy and plans for the division.

Global Asset Management's revenues fell slightly quarter-on-quarter mainly due to lower transaction fees in global real estate. Other management and performance fees were largely unchanged. Personnel expenses doubled from their unusually low level in Q4 to CHF 279 million as we increased variable compensation accruals and the division was impacted by additional costs allocated from corporate center.

We extended our run of strong investment performance. We saw net new money inflows from third parties of CHF 2.1 billion. These were, however, offset by net outflows of CHF 4.7 billion through our Wealth Management channels.

In traditional investments, net new money was flat for the quarter excluding money market flows. Fixed income saw strong net inflows of CHF 4.4 billion mainly into Swiss passive bonds and emerging markets debt. The overall picture on net new money showed a significant improvement over the fourth quarter.

The Investment Bank reported a profit for the first quarter of CHF 1.2 billion compared with just under CHF 0.3 billion in the prior quarter. The biggest factor driving the increase was the huge improvement in fixed income which more than quadrupled the revenues to almost CHF 2.2 billion. Revenues for the division as a whole almost doubled those in Q4 reaching CHF 3.9 billion after credit write-backs of over CHF 100 million and an own credit charge of almost CHF 250 million.

Expenses for the quarter were CHF 2.7 billion compared to the average quarterly run rates in 2009 of CHF 2.3 billion. The increase was again many attributable to higher variable compensation accruals. The cost income ratio improved to 71.5% close to our medium term target of 70%.

The improvement in performance was achieved with no significant increase in risk utilization. Risk-weighted assets increased only marginally and average [inaudible] was flat quarter-on-quarter. As a consequence the annualized return on risk-weighted assets improved significantly to over 12%.

Revenues and equities increased by 32% to CHF 1.3 billion. Cash revenues benefited from high commissioning income and better trading income. In derivatives we saw good recovery to almost CHF 0

5 billion with stronger performances in structured product issuance and in equity linked trading.

Prime services was flat on the fourth quarter notwithstanding the higher ETD revenues. PB revenues saw some decline as continued spread compression offset higher client balances. In comparing our results from equities with those of our principal competitors, you might bear in mind that unlike US GAAP preparers, we show retrocessions and the like as contra revenues and not as business expenses. On a comparable basis our revenues would’ve been approximately CHF 0.25 billion higher.

FICC had its best quarter since early 2007. All of the segments improved after a lackluster fourth quarter. Revenues were well diversified. The credit business performed well. It recorded over CHF 750 million of revenues. Client flows were strong in Europe. In the US we traded well in the investment grade and distressed asset classes. Structured credit also contributed strongly, partly driven by a number of restructuring trades.

Macro performed well despite difficult market conditions. We built volumes in FX and money markets but the benefit was largely masked by continued spread compression in the short-term highly liquid markets.

Rates have improved client flows, though its performance over all was dampened by slow markets. Emerging markets revenues recovered to just under CHF 0.25 billion with good performances in Latin America and in emerging Europe. We continue to work on our residual risk positions in the quarter. We sold or redeemed student loan option rate certificates for proceeds of over CHF 2.3 billion and a net gain of over CHF 100 million.

The return of some liquidity to the structured credit markets helped to raise the prices of many CLOs and CDOs. This positively impacted our legacy negative basis trades where we were able to release around CHF 300 million a CVA held against the underline insurers as replacement values fell in the insurance credits rates were generally tightened.

Investment banking revenues fell 19% on a seasonally strong fourth quarter. Advisory revenues were down 11% in a quiet period for M&A activity. Capital markets revenues fell 19% but DCM was up 15%. ECM fell by 35% in very quiet markets enough for a strong fourth quarter.

Risk management charges on or franchise lending book remain stable. Overall, we improved our market share in M&A and ECM, although in very low volumes. We did slip a little in equity capital market.

Turning finally to the group's global capital position, our core tier one capital improved by 60 basis points, 12.5%, as did our overall BIS tier ratio to 16%. On the FINMA calculation basis, our leverage ratio is now over 4%.

From the 30th of June 2010, we come under a new set of liquidity regulations imposed by the FINMA and the Swiss National Bank. These will require us to maintain excess liquidity to cope with the model set of prescribed seven-day and 30-day severe stress scenarios akin to the liquidity coverage ratio proposed by the Basil Committee on Banking supervision. We’ve met this test at the end of March and would expect to do so at the end of June and into future periods.

With that, Caroline and I would be happy to take your questions.

Question-and-Answer Session

Operator

The first question comes from the line of Mr. Kian Abouhossein - JPMorgan.

Kian Abouhossein - JPMorgan

The first questions is relating to compensation ratio. I mean you have a target medium term over cost income of 17% for the investment bank and I just wanted to see how we should sync with the current revenue environment about the cost income ratio for the year?

John Cryan

Well, at the moment our cost income ratio on a reported basis is running around 53%.

Kian Abouhossein - JPMorgan

That’s right but then I strip out all the one-off items. I get cost income ratio which is significantly higher and then clearly I make some adjustment for seasonality of revenues, especially in fixed income which I assume will come through the year.

John Cryan

Well, I mean, you’re obviously free to strip out whatever cost you think. The one point I would make on compensation if you’re comparing us with some of our US competitors is that they obviously show their revenues and expenses in a different split. So I would encourage you to add back the contra revenues. I think on that basis we come down to a level that’s comparable with the US investment banks around the mid-40s or so.

Kian Abouhossein - JPMorgan

Well, if I ask the question differently -- because I get to 73 for the [IB clean] -- but if I ask the question differently, if I take the CHF 20 billion that you're indicating in terms of cost run rate, if I clearly annualize it now I get to about CHF 25 billion. How should I think about the compensation impact or the bonus impact basically which is not included in the CHF 20 billion?

John Cryan

Well, the CHF 20 billion includes personnel expense. It includes the fixed element plus the broker comp in THE us. So the difference between your CHF 20 billion and your CHF 25 billion would be the bonus accrual fee.

Kian Abouhossein - JPMorgan

The second question is related to your pickup value and the equity value of the SMB fund value. I mean, the value of the fund is going up which you record but how should I think about that in terms of realization? I mean your value is continuously going up but in realization terms is that realistic to -- because I’m a bit questioning the value that is created on paper.

John Cryan

Well the way we calculate the value of the option is to use cash flows that we receive from the staff fund. It’s not based on market values because of the underlying assets, nor is it based on the carrying value in the SMB's books. So it’s a separate exercise that we perform and it takes into account that the cost of the option, the strike price of the option and the present value of the cash flows that we model, that we receive from the funds of administrators.

Kian Abouhossein - JPMorgan

You are expecting the ongoing increases in default or you take a current default levels?

John Cryan

Well, we model it on a whole range of scenarios. We model it in a fashion that is somewhat akin to the way that we calculate the value of the BlackRock loan that we have. So we build in a whole range of factors. It’s a complex model and we come up with a range of outcomes and then select a value on the basis of that. It’s predicated obviously on exercise of the option at some stage.

Kian Abouhossein - JPMorgan

Last question on regulation and especially [that Lincoln] reform bill, how do you see that impacting the investment banking business and your medium-term targets?

John Cryan

Well, at the moment what we set out on the investor day was predicated on the set of regulations that was in force on that date. That could clearly be a whole range of changes in regulation and it’s difficult to speculate on which direction they may move in and what impact it would have on our business. So at the moment we’re almost in a holding pattern waiting to see what regulations are actually introduced and then it’s easier for us to then comment on actual rather than muted changes.

Operator

Your next question comes from the line of Mr. Huw van Steenis - Morgan Stanley.

Huw van Steenis - Morgan Stanley

I was just following up on Kian's question on the SMB record. Is there any updates on when you’d like to buy back in and what financial consequences would be if you did it this year versus next year?

John Cryan

Well, it is something obviously we have to look at from time to time. The option has value and as it has value there’s no point in exercising it right now. At the moment we look at the fund in a number of ways. It would clearly add a number of risk-weighted assets. It would increase our stress loss and it would be a drain on some of our cash capital because a lot of the content of the funds obviously highly are liquid. So I think at the moment we're waiting to see. We're in no rush to exercise the option.

The markets underpinning the assets in the fund seem to be improving. They seem to be continuing to improve. The SMB I think is reporting on the staff fund in a couple of weeks' time, so you’ll see the March numbers there and they underpin the increase and the value of the option that we took in the quarter.

But it is something we monitor but we are in no rush to do it and at the moment I think we’ve taken the view that it’s still larger than we want to take on as a form of risk concentration.

Huw van Steenis - Morgan Stanley

It doesn’t have an impact net operation on your ability to compensate people appropriately this year though?

John Cryan

It doesn’t at all, no and it’s a clean sale to the SMB. It’s an option that we have to acquire the fund at some stage. We don’t have to exercise the option obviously. We’d have to write off the carrying value of the option in our account, so we didn’t. But for that reason I do think at some stage we will exercise the option. We intend wherever possible to repay the loan in its entirety.

It's an international bank. We don’t want to leave risk with an international bank if we can possibly avoid it. But the timing of the exercise of the option I think we probably leave for some time now.

Operator

Your next question comes from the line of Jon Peace - Nomura.

Jon Peace - Nomura

Two few questions please; the first is on the FICC trading revenues, obviously ahead of the CHF 2 billion medium-term target. Now I know seasonality obviously helps at the start of the year but I wondered to what extent have you been able to generate some kind of prompt revenues and if you could give us any idea of kind of what you think a sustainable run rate might be for 2010.

Do we think by the end of this year we could still be ahead of your CHF 2 billion target or do we still need some more quarters of investment to get up to that goal and a sustainable client basis?

The second question is just on your outlook statements about net new money outflows expected to be at relatively moderate levels in the near term but the steps you’ve taken should be effective. What’s your current thinking in terms of when we might see those outflows turn positive?

John Cryan

Well on the FICC trading revenues, the reason we feel more confident that the CHF 2 billion or so is a reasonable run rate, obviously these are larger trading revenues so you can never predict them with any great certainty but the revenues in the first quarter were really very diversified across the different units within fixed income and the boss has a view that CHF 2 billion is now not very ambitious.

So we’re under a lot of pressure from him to increase the amount but I think CHF 2 billion to be realistic is in context of where the business sits at the moment is an okay run rate. It will move around because it’s predicated largely on trading revenues so far.

We are still building up the business. We’re still building out the sales and distribution element of fixed income in particular and we are also bringing fixed income closer together with some of the better practices that we’d had in equities. You may have read that we’ve essentially brought together our research functions, for example, now between the two elements of the securities and trading operations.

So I’d have thought CHF 2 billion is a reasonable base from now on. It’s not a short-term profit's warning but we feel fairly comfortable given the diversity of sources of revenues that on average over the next few quarters that should be well coming out. There’ll be some plusses and minuses but that’s a reasonable medium.

On net new money, a lot of management effort is going into addressing this. As I said we’re looking at the gross outflows and the gross inflows and trying to tackle both because they have separate drivers. There’s also I think a bit of a seat change in the perception of UBS now that we’re back reporting some profits. I think clients can have more confidence in us and there are definite signs of that being the case.

That has the positive effect of boosting the morale of the client advisors because their lot becomes all the more easy and, therefore, I think there's just more impetus behind that business. A number of the external factors that were impacting us, the obvious one is the Italian tax amnesty, have now essentially run their course for us and so they’re not weighing on us to the extent they were in first quarter in particular.

So we’re in a better place. We still are not satisfied. We still have net outflows. We are seeing gradually market-by-market some improvement. It’s not that solid yet clearly and there’s still a lot of work to be done. On the timing of when the inflection point comes and we become beneficiaries of net inflows, it’s very, very difficult to say because it’s driven by factors that are somewhat outside of our control.

But where -- we'd like to think it was sometime by the end of the year. We hold that we would like to see the inflection point still sometime this year.

Operator

Your next question comes from the line of Mr. Derek De Vries - Bank of America.

Derek De Vries - Bank of America

A few questions if I may; I’d like to return to Kian’s question on OTC derivatives and I understand your unwillingness to kind of quantify the number but maybe to help us make some stabs at it, could you just give us a sense of what percent of your sales and trading revenues in the normalized world or in your targeted world or whatever you want, would come from OTC derivatives?

So just ballpark what percent of your sales and trading revenues come from OTC derivatives would be very helpful for us as we try to understand the impact. Then switching over to the Wealth Management business, you gave some very clear guidance in terms of the headcount of the international client advisors and you said it’ll be down again in Q2 and then you hope Q3 will show an increase in client advisors.

I was wondering if you could give a little more color. What’s the delta there? Is it suddenly more hiring or is it less departures that’s going to drive that delta Q3 and Q2?

Then in terms of the people you are hiring, maybe you can give some color, either by geography or perhaps more interestingly where these people are coming from institution wise, maybe not specific institutions but just what type? Are these ex-UBS people that are coming back, are these people coming from the sort of global competitors you have, or are they coming from smaller shops, etcetera?

John Cryan

Well, on derivatives I think we have to go almost business by business. In equities we’ve essentially shown you the revenues that were attributable to the derivatives business, CHF 0.5 billion, and a proportion of those would be OTC. It’s difficult to gauge how much. In equities we don’t write as big a proportion as OTC. The big area of OTC derivatives is in rates where this option business is essentially an OTC business.

In credit, as you’ll see from our disclosures, you know we’re not a huge credit derivative writer. We do have [notionals] of over CHF 1 trillion but we're not anywhere near the top ranks of the market. But we do write credit default swaps as we buy them and we trade them actively. But the big pool of OTC derivatives is clearly in rates where we write a fairly large volume of interest rate swaps. That amounts to roughly half of our replacement values on both sides of the balance sheet.

Derek De Vries - Bank of America

I guess I’ve been able to work that much out myself. I was hoping maybe you could kind of say 40%, 50%, 30% or something like that.

John Cryan

Well, in rates it’s the -- .

Derek De Vries - Bank of America

It’s vast majority.

John Cryan

-- vast majority, yes.

Derek De Vries - Bank of America

Yes, but in terms of equity derivatives -- .

John Cryan

A big source of equity derivative issuance would be derivatives but embedded in our structured products business. That’s a sizable business. You can see the [MTM] balances on the balance sheet are the ones held at fair value liabilities on the balance sheet.

So that’s a sizable business and we would -- that’s a core business for us and it’s a business which deals with two of our core client bases, the Hedge Fund clients and the High Net Worth individuals. So that would very much be an area of growth for us.

Derek De Vries - Bank of America

On the Wealth Management side?

John Cryan

On the Wealth Management side, I think you mentioned international Wealth Management client advisors. I’m not sure that we’ve necessarily be growing those particularly. I think our focus is as much been in onshore markets. In Asia, for example, there’s very little scope for us to hire senior client advisors.

We already employ quite a significant proportion of the whole population of client advisors in APAC. Our next competitor has a fraction of the number that we have. So the opportunities there for hiring are relatively low.

In Asia, we cope to that by establishing a university where we train, essentially create our own advisors. I think generally speaking, the delta in the number of client advisors would be some hiring in the European markets.

There’d be appointed -- creating new ones essentially through our universities and through our training programs and a reduction in departures. We’re expecting a significant fall off in the number of departures that were non-voluntary because the measures we took in 2009 have pretty much now expired. There will be some residual effect in Q2 as I mentioned but then after that we’d be flat on redundancies.

Caroline, did you want to add anything?

Caroline Stewart

No, I just wanted to point back to the information that we provided to you on investor day. It’s slide 21 on the Wealth Management presentation. It gives you the breakdown of how we expect the client advisor numbers across Wealth Management to increase over the next couple of years.

Operator

Your next question comes from the line of Mr. Jernej Omahen - Goldman Sachs.

Jernej Omahen - Goldman Sachs

Just a few very brief questions; the first question is on the net new money into your Wealth Management businesses. You mentioned Lombard loans for the first time in a long time and I was just wondering if you can update us as to what the contribution to net new money was in Q1 '10 from these Lombard loans and maybe also remind us what the total outstanding is currently.

The second question, again, just a numbers question, the CVA release was CHF 300 million on the model, so I think that’s CHF 2.5 billion left. As things stand now, I guess, would you be willing to I guess give us a focus of how much of that you think is realistic to be released into the P&L over the course of this year.

Finally, just on FICC revenues, again, a huge number and I was just wondering if you can maybe just shed some light on how much of the improvement in FICC -- and I believe that the previous commentary was that the underlying run rates were around CHF 1 billion a quarter or so. We are now at above CHF 2 billion.

We're just below CHF 2 billion [inaudible] and I was wondering how much of that result or improvement do you actually think is down to operating actions taken by the UBS management and how much of it is down to the better operating environment?

John Cryan

The first one on Lombard loans, the balance we disclose is CHF 40.6 billion and the net new money contribution from Lombard loans in the first quarter would’ve been CHF 1 billion to CHF 1.5 billion or so. That’s the net volume increase.

On the [model lines], there are two stories on the [model lines] just to remind you. The [model line] exposures are largely in relation to these negative basis trades where the long end of the trade is generally a series now of CLOs. The CDOs have, as you can see from our disclosures, have by and large been, been either written off or restructured.

Those long assets are by and large held in our books as loans and receivables. So when the market value of those increases, which is what’s happened over the past few quarters, we have not been able to take a write off in our trading account because they’re not held in the trading account. There is over time an improvement in the effective interest rate attaching to those positions but there’s no immediate write-up.

However, from the perspective of the CDS from the [model line], that’s a derivative and we have to mark that to market and that takes into account the market value of the long limb of the negative basis trade. So the replacement values have been shrinking. As the replacement value shrinks that’s a market-to-market hit to our P&L.

Now against that, we had credit valuation adjustments and as the CDS loses its replacement value, so our receivable the PRV reduces, we can reduce the credit valuation adjustment all other things being equal. So there’s a bigger hit because the credit evaluation adjustment is not 100% of the receivable so actually a net hit to our P&L from an improvement in the underlyings.

Now, in addition to that, there’s been a market perception of an improvement in the financial health of the [model lines]. So the spreads on [model lines] have come in and they are the principal driver of the credit valuation adjustment. So we’ve reduced the credit valuation adjustment by more than the proportion by which the CDS value has come in because the [model lines] are healthier, so there has been a release of CVA to the P&L for that reason too.

But the big change is the change in the value of the underlyings and that doesn’t come through as an increase in the carrying value of the CLO because they’re held in long-term receivables. So you have this slightly asymmetric and ironic accounting impact that as the value those things that we hold as assets go up, we actually have a hit to our P&L.

Now whether that comes through in time would depend on your view of the long term value of the CLOs. My view would be more positive than the carrying values. I think they will accrete back towards par. The CDOs we hold, which are relatively small, I’d be much less confident about.

We haven’t had great experience with those. We are still proactively looking to work out those positions and we are looking back where we can to restructure those trades and then sell the contents of the CDOs once they get into default.

So I think the answer -- it was a long answer -- but it’s some of the amount will come back into the P&L but I wouldn’t be confident that absolutely all of it did, but some will. On the FICC revenues, I think you question was whether they had essentially improved because the market had improved or whether they had improved because of actions we’d taken.

I fairly strongly feel it’s the latter because I do feel actually that first quarter last year, for example, was stronger than the first quarter of this year and we were on the sidelines and we missed four relatively strong quarters or three quarters, the first three quarters of last year which was strong generally in the fixed income markets and we essentially just watched them happen from the sidelines.

It wasn’t until third and fourth quarter when we’d installed new trading capabilities, new people and started to build out ourselves a distribution capability, that we became participants in those markets, so very much a late reentrant.

The credit market's essentially an entrant. We weren’t really there before. I think therefore it’s more of the fact that we have a presence versus not having one before than the fact that the markets were strong. Having said that, January was particularly strong and was, in my view, almost as strong as two other months. So there’s a degree to which potentially we had four months of revenues and three of expenses in the first quarter.

But as I said to Huw or Jon or whoever it was earlier, I do think that there will be some stability in the FICC trading revenues. It will continue to be trading and, therefore, it will move up in time but I think the CHF 2 billion mark, as we said at the investor day, is where we feel fairly confident we can generate revenues. It’s not particularly market leading in any way. A lot of our competitors are doing twice that much, so not entirely ambitious as our boss keeps reminding us.

Jernej Omahen - Goldman Sachs

Excuse me, can I just ask a follow-on?

John Cryan

Yes.

Jernej Omahen - Goldman Sachs

Just very quickly, I mean you would understand why this is just somewhat confusing for, I guess, the followers of UBS stock. If we just go back to your medium-term target and the investor day in November of last year I think you laid out very clearly here’s the operational plan and I think the time spans were anywhere from 12 months up to 24 months and more.

So when your explanation is this is due to essentially management decisions, successful management implementation that’s fine but then is the answer also we have by far exceeded the implementation of the program we’ve presented to you just four months ago, or is the answer something else?

John Cryan

No, I think the answer is something else. I think I was -- I’ve been relatively clear that in fixed income in particular where you have a trading operation, once the traders are installed and they’re at their desk and they have their risk limits and their funding, then they’re up and running and you are the -- it’s almost binary. You're either in business or you’re not in business. So I think we said in relation to the trading areas, we would expect to see pretty pronto some serious improvement, which so far we’ve seen.

In some areas, for example in Wealth Management, in the turnaround in the net asset position, the net new money position, we said that that was a much more intractable problem. It's a more difficult for us because to some extent to the reputation of the bank and it would inevitably take much, much longer to achieve.

So, you’re right. Our medium term was never a particular specified period but there were always going to be some of our businesses that would immediately come on stream because if you have a trading operation it works or it doesn’t work. In our case it appears now to work. But with Wealth Management it will take much longer and it may take -- to get it back to where we want to get it, it may take a number of years.

Operator

Your next question comes from the line of Mr. Matthew Clark - KBW.

Matthew Clark - KBW

Two questions please; firstly, on slide 17, just wondering if you could maybe talk us through how you see the delta between the first quarter 2010 equities trading revenues and the target level. What’s going to drive that improvement and is this management leave as you go or just the broader market?

Then secondly, I think the same-store charts for the Wealth Management US, I was wondering if you could give us some guidance on what same-store would look like for the traditional Wealth Management divisions.

John Cryan

On equities, I think in terms of cash there’s a little bit of room for improvement. I think we’ve essentially regained the market share we had pre-crisis. There may be a percentage point or so to go. But in terms of cash revenues I think we are somewhat beholden to the market.

We saw slightly stronger trading revenues in the first quarter than we’d seen in the fourth and we saw higher commission incomes. But in cash I don’t think there’s much room for a sort of doubling. I think that’s a gradual improvement but not much else.

In derivatives is where I would expect to see quite a lot of improvement. As you may know, our derivatives business pre-crisis was very heavily focused on our Wealth Management client base and although it’s a bit rude to say that it was mono client, it was really skewed towards servicing the High Net Worth individuals Wealth Management business.

I think in derivatives, we will continue to build out ourselves a distribution capability including in equities and there will be a lot of scope for us to work between equities and the fixed income businesses to build out derivatives capabilities. Our structured products businesses, there's plenty of room to grow.

Then in prime services I think there is room to grow there. Client balances continue to increase but we are seeing a little price competition and a bit of [straight] compression, but generally speaking I think the outlook is okay for equities.

On same-store sales, I’m not sure that concept works necessarily in our core Wealth Management business, particularly the Swiss business. The difference being that in the US the financial advisor is to some extent also a client of ours and he in turn would have his client base. So essentially there we’re looking at branches and or client advisory operations, the financial advisor network, and looking at their performance period-on-period.

In the Wealth Management business elsewhere, in Asia and in Europe, our clients as much bank with UBS as they do with an individual advisor and so the concept of tracking advisors' performance in terms of net new money is not a straightforward. So I think it’s less meaningful, which is why we tend to look at it in the US but not anywhere else.

It’s actually not a number we particularly track internally as a management team. If it were, we’d be more inclined to share but I don’t think it has the meaning that it has in the US.

Operator

Your next question comes from the line of Mr. Kinner Lakhani - Citi.

Kinner Lakhani - Citi

Three questions actually; firstly on the Wealth Management revenue margin, if we strip out the two basis points of one-offs, the kind of remaining three basis points improvement that you're seeing, just wanted to understand what part of that is kind of UBS efforts and what part of that is clients actually regaining confidence to do business?

Second question on capital, I’ve noticed there’s a 60 basis point hits from what I believe is securitization, just wanted to get some more flavor on that, whether this could continue going forward. Also, if you could add a quick word on dividend policy in the context of the 60 basis point improvement that you’ve seen in the core tier one ratio in this latest quarter.

Finally, on kind of the usual kind of litigation issue post Goldmann Sachs actually, on the softer credit side what your sense is as to how UBS is positioned now?

John Cryan

On wealth margin, the two basis points I described as nonrecurring, so I wouldn’t dismiss them entirely as one-offs, although that fact that they were nonrecurring suggest that they may be less dependable than the three which come from the portfolio management fees. I would -- you may say I’d like to do this but I would like to suggest that the improvement does come from the UBS' efforts.

There has been something of an uptick in the amount of brokerage commission as you saw, which is reflective of increased confidence in clients and attacking the markets but I think the portfolio management fee improvement really was driven by the three or four factors that we identified. In particularly, the increase mandate penetration because the margins on mandates are higher than the combined margin from a advisory and brokerage type arrangement.

The lending does help. That’s double leverage generally. Then improved pricing and I think it’s the pricing discipline that was at the heart of the improvement. Clearly that is within our control to a large degree. And we have re-priced as I said in selective markets now. I imagine you can guess which markets are the selected markets.

Kinner Lakhani - Citi

Could you just elaborate on the two basis points if it’s not completely one off?

John Cryan

The two basis points is a whole miss mash of tiny things. None of them is particularly noteworthy or otherwise we would have mentioned them, but it’s mixed in the overall trading account, this property fund we’ve been taking provisions on now for four or five quarters.

There was a big improvement there, CHF 60 million quarter-on-quarter improvement. We took an CHF 88 million charge in Q4 and it's done CHF 28 million in Q1. But there’s nothing other than just a whole array of small things that are going to the mix and the revenue line.

On your securitization point you’re right. This was a range of assets we held in the securitization framework for regular true capital purposes. The rule is that if the credit rating assigned by internationally renowned credit rating agencies falls below BB level then they are no longer allowed to be held as risk assets in that frame work and instead they become deductions from total capital.

The way that it works is that half of the deduction comes from tier one and the other half is actually from tier two and in the quarter that amounts to CHF 1.2 billion, which fell where the credit rating migration was so negative as to take them below that BB level. So CHF 600 million came from the tier one and then another CHF 600 million came from the total capital line from tier two and it can continue to happen unfortunately. It’s driven unfortunately by rating agencies and, therefore, it’s outside of our control.

It can happen and it is a phenomenon across the industry. It has actually been happening just more noteworthy in the first quarter than it has been in some of the previous quarters. Just so you know, in managing the investment bank's risk-weighted assets, we managed them on a effective risk-weighted asset number which grosses up that deduction for capital on the national tier one ratio so that we do take it into account when we’re managing the business. That deduction from capital we add back as a effective risk asset.

Dividend policy, there’s not much to say I’m afraid. Given where capital regulation is moving and where the FINMA in particular, which has already issued its capital degree to us, is we’re going to have to retain earnings as I said at the investor day for quite some time to come and below 16% tier one ratio keeps us a very strong capital ratio compared with some of our competitors. There’s still quite some way to go before we meet the medium-term capital requirements.

So it’s unlikely that we will be declaring a dividend in relation to this year’s profits and if we do it would be extremely modest. I think I used the word symbolic, I think on the investor day.

Then on the litigation issues in relation to credits, I think that all I can say there -- I obviously can’t comment on Goldmann Sachs issue because we’re not a party to it. We were in that business. We’re not particularly in that business anymore and we were included in what I think is being called The Street Sweep by the SEC when they contacted most of the nature investment banks whenever it was, 18 or 20 months or so ago.

We would obviously been cooperating there with any inquiries they make. But so far we have no further information we can give you on it.

Operator

Your next question comes from the line of Mrs. Fiona Swaffield - Execution.

Fiona Swaffield - Execution

Just two things, firstly on the personnel expenses; at the end of the year you talked to us about deferred compensation costs coming in more in 2010. I just wondered how much is coming in Q1 and whether we should see a ramp up in Q2. I think that seems like a CHF 1.5 billion delta.

Then the second area is on the outflows of the CHF 1.8 billion, so slide 12. I was surprised. That number’s a little bit higher and I wondered if you could talk a bit more about that but also about Germany and whether there were net outflows in Germany and what’s happening there in terms of clients presenting themselves. I think that was something you were relatively concerned about.

John Cryan

On personnel expenses, we did change the structure of the compensation plans in Q4 and as a consequence you’re right, we deferred CHF 1.5 billion into future periods and I think I said at the time, the majority of that hits the 2010 accounts and we would sort of accrue that relatively evenly across the quarters.

On Germany, I don’t think we said anything specifically about individual countries but Germany is one of those contiguous countries we highlighted at the investor day. It’s the one that has the biggest volume of cross-border business for us and so it is a market that, we have special focus on and it’s obviously an element of our outflows. I don’t know what proportion it is.

Fiona Swaffield - Execution

But it’s not in the CHF 1.8 billion?

John Cryan

No, it’s not. No, it’s not. It’s not.

Operator

Your last question comes from the line of Mr. Georg Kanders - WestLB.

Georg Kanders - WestLB

I have a question on the corporate center on this -- I mean, revenue is one that says the staff fund option but I wonder what -- there also was this gain from the property save in New York and what are the other elements for the revenue center?

John Cryan

Well, corporate center has within it the treasury operations, so the treasury profits that we make, which are profits on an accruals basis, are credited to corporate center still. The core book in the Swiss bank and Wealth Management stays there and the investment bank has its own secured funding operations and obviously its own treasury operations but the group treasury operations remain in corporate center.

I don’t think there are any other items of particular note in corporate center. The two big items were the staff fund option and then the sale of our stake in the company that had an interest in [299 Park]. Corporate center will continue to take, for example, foreign currency translation, account wash charges or credits from time to time but there’s nothing particularly additional that’s material.

Georg Kanders - WestLB

But overall in normal times this would be a negative revenue contribution.

John Cryan

No, it shouldn’t be because the expense base is now very, very low. Expense base is now truly corporate center. It’s the expense of the external board, the group audit for example that sort of thing, that is not justifiably attributed to the businesses. There ought to be some revenues on a normal basis from our treasury operations at center but both numbers should be very, very small and not particularly meaningful in the context of the group and that’s the way we’ve designed it.

Essentially all the cost base of the group is attributed back to the divisions which generate the revenues to cover those costs.

John Cryan

I think that looks as though that’s all the questions, so from Caroline and from me here in Zurich, thank you very much for watching.

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Source: UBS AG Q1 2010 Earnings Call Transcript
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