UBS Profit Falls as Hedge Fund Losses Hurt Bond Fees (Update9)

Date: Thursday, May 3, 2007
Author: Jacob Greber, Bloomberg

May 3 (Bloomberg) -- UBS AG, the world's biggest money manager, reported a third straight decline in quarterly profit and said it plans to scrap the hedge fund run by John Costas after losses in the U.S. mortgage market.

First-quarter net income fell 7 percent to 3.28 billion Swiss francs ($2.7 billion), or 1.62 francs a share, from 3.5 billion francs, or 1.69 francs, a year ago, Zurich-based UBS said today. Profit a year earlier was boosted by 290 million francs from the sale of Motor Columbus AG, a power company.

UBS shares dropped after Chief Executive Officer Peter Wuffli said in a statement that the hedge fund, Dillon Read Capital Management, ``did not meet our expectations.'' The bank, which gave Costas control of the fund to keep him from leaving, will now pay $300 million to shut it down after Dillon Read's 150 million francs of losses led to lower fixed-income revenue.

Dillon Read was ``an unbelievable misstep,'' said Florian Esterer, who helps manage $49 billion at Swisscanto Asset Management, including UBS shares. ``Once UBS agrees on a strategy they normally stick to it. There must have been huge problems.''

The stock fell 2.05 francs, or 2.6 percent, to 76.5 francs in Zurich. The shares are up 3.3 percent this year, less than the 10 percent gain in Credit Suisse Group, its largest Swiss rival.

`Subprime Space'

UBS started the Dillon Read hedge fund less than two years ago, partly to hang onto Costas, the former investment banking chief. Costas, 50, will help shut down the hedge fund and stay at the bank in an advisory role, Chief Financial Officer Clive Standish said on a conference call with reporters today.

``The vast majority of the business lines performed fine,'' Costas said in an interview. ``The area that gave us some trouble was the one that's been highlighted here in the reports by the bank and that was the subprime space.''

U.S. subprime borrowers, those with poor or limited credit histories, fell behind on their mortgages at the highest rate in four years in the fourth quarter, according to the Mortgage Bankers Association, pushing more than 40 lenders to shut operations or seek buyers in the past 12 months.

Dillon Read President Michael Hutchins will leave the bank, Standish said in an interview. Hutchins, along with about 120 members of UBS's fixed-income division, joined Dillon Read in 2005. The unit currently has about 250 employees, most of whom will move back to the investment bank, Standish said.

``There is considerable staff departure risk,'' from Dillon Read, said London-based Morgan Stanley analysts David Williams and Solveig Babinet in a note to investors. They cut their rating on UBS to ``underweight'' from ``equal-weight.'' ``Until now, they were part of an elite hedge fund unit.''

Long-Term Capital

It marks at least the second time that UBS has been hurt by hedge funds, which are mostly private and unregulated pools of capital where managers can buy or sell any assets, participating substantially in the profits of the money invested. The bank ran up about $700 million of losses in 1998 related to the collapse of Long-Term Capital Management LP, a $4 billion U.S. fund.

Earnings at UBS lagged behind Zurich-based Credit Suisse for a fifth straight quarter, and trailed the five largest U.S. securities firms, which reported record combined first-quarter earnings of $9.7 billion.

JPMorgan Chase & Co., the third-largest U.S. bank, on April 18 said first-quarter profit rose 55 percent to a record $4.79 billion. Merrill Lynch & Co., the world's biggest brokerage, a day later reported a 31 percent gain in net income, led by the fastest trading gains on Wall Street and higher fees from underwriting stocks and arranging takeovers.

`Revenue Gap'

Wuffli, 49, has been trying to plug what UBS calls a $4.6 billion ``revenue gap'' with its three largest U.S. rivals by hiring investment bankers and expanding in commodities, energy trading and fixed income.

UBS agreed last year to pay as much as $2.6 billion for Banco Pactual SA, a Brazilian investment bank specializing in fixed income, and $386 million for the U.S. futures brokerage of Amsterdam-based ABN Amro Holding NV.

Pretax profit at UBS's securities unit, run by Huw Jenkins, 49, rose 3 percent to 1.8 billion francs. The division accounted for 42 percent of first-quarter earnings from the bank's financial businesses. Income from equities rose 10 percent to a record 3.13 billion francs, and advisory fees gained 30 percent to 865 million francs.

Wealth Management

The unit spent 71.3 francs of every 100 francs of revenue in the first quarter, up from 70.8 francs a year earlier. The bank's return on equity, a measure of how effectively companies reinvest earnings, slipped to 28.8 percent in the quarter from 33.9 percent in 2005.

UBS said revenue from financial businesses rose 8 percent to 13.3 billion francs in the first quarter.

At the main wealth management unit, which doesn't include the U.S., profit gained 18 percent to 1.5 billion francs. The Swiss consumer banking unit reported profit of 572 million francs, up 2 percent, and earnings at the global asset management business gained 8 percent to 404 million francs.

The U.S. wealth management operation, which includes the former Paine Webber Group Inc., said pretax profit dropped 8 percent to 171 million francs.

UBS last year bought Minneapolis-based Piper Jaffray Cos.'s brokerage and KeyCorp's McDonald Investments unit in the U.S. to add affluent American customers.

The bank attracted a record 52.8 billion francs of new client money in the quarter.

Standish reiterated UBS's plans to sell a ``roughly 20 percent'' stake in Julius Baer Holding AG, a Swiss private bank, after an agreement not to sell the shares ends at the end of May.

To contact the reporter of this story: Jacob Greber in Zurich at jgreber@bloomberg.net