Leading Swiss Banks Navigate Scandals and Shrinking Business

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UBS AG (NYSE: UBS), the largest Swiss lender and one of the world’s leading financial institutions was badly hit by the global financial crisis and its ongoing sequel the European Debt Crisis. In October of this year, the bank had announced plans to eliminate 10,000 jobs and implement aggressive cost cutting measures that will reduce expenses $3.6 billion by 2015. Almost half of the layoffs will happen in London alone which is the hub of its investment banking division. It is also getting rid of its riskier assets from its fixed-income unit trimming it to $85 billion from $117 billion in assets under management. UBS would now prefer to focus on wealth management operations rather than essentially running a hedge fund.

Along with the crisis, the twin scandals of LIBOR manipulation allegations and the sketchy trading activities of Kweku M. Adoboli – the former trader who cost the bank potential losses of $12 billion – have UBS’s once excellent reputation in tatters. It’s now on the table that UBS could face fines of $72 million in connection with Adoboli who was recently sentenced to seven years in prison.  Of course, this is par for the course for the major banks; fire and jail a few patsies and keep the reputation in tact just enough to prevent any upheaval or loss of confidence as that is what modern banking is, a confidence game.

UBS has itself paid $31 million to KPMG for an internal investigation. All the while, the bank’s quarterly income has fallen from $1.08 billion (CHF 1.017 billion) to a loss of $2.3 billion (CHF 2.17 billion)

Adoboli’s activities though have not caused any losses to clients but rather only to the bank itself which opens them up to shareholder retribution, especially if they intentionally under-reported the potential loss. UBS is now looking to focus on wealth management, but this unit’s track is also not the cleanest with a $12.75 million fine for unauthorized trading in the past.

UBS’s massive restructuring, which comes with a price tag of $3.5 billion, may take up to five years which means that earnings will remain low during this period. Besides UBS, the overall financial sector has shed about 28,000 jobs in the first nine months of 2012, which is almost 50% less than last year’s count of 54,000 in the same period. No more cuts related are expected from UBS but market conditions, particularly the slowdown of the European economy, may necessitate further layoffs. For the future, the bank is looking at emerging markets and is aiming for a spot among the top-3 investment banks in that region.  Southeast Asia, in particular, is important with UBS’s investment banking chief Andrea Orcel calling it a ‘second home market’ in a recent interview. 

Meanwhile, UBS’s biggest rival and Switzerland’s second biggest lender Credit Suisse (NYSE: CS) has also been facing dwindling income due to similar issues albeit with smaller-scale scandals. It is currently being sued by New York’s Attorney General for misleading investors that cost them $11.2 billion in losses. The bank’s quarterly income has dropped by 62% YoY to $271.8 million.

Credit Suisse is also implementing a cost cutting and restructuring program that involves the merger of asset management with its private banking division and the departure of three of its top executives. At the end of this month, CS will have effectively two divisions, wealth management and investment banking. Like UBS, CS will also significantly revamp its fixed income unit. However, it has shied away from revealing the total number of job cuts the revamp is going to cause.

<table> <tbody> <tr> <td> </td> <td> <p><strong>UBS</strong></p> </td> <td> <p><strong>CS</strong></p> </td> <td> <p><strong>KBE</strong></p> </td> <td> <p><strong>PJB</strong></p> </td> </tr> <tr> <td> <p><strong>YTD</strong></p> </td> <td> <p><strong>30%</strong></p> </td> <td> <p><strong>-3.52%</strong></p> </td> <td> <p><strong>16.1%</strong></p> </td> <td> <p><strong>10.35%</strong></p> </td> </tr> <tr> <td> <p><strong>P/E</strong></p> </td> <td> <p>N/A</p> </td> <td> <p>133.24</p> </td> <td> <p>12</p> </td> <td> <p>9</p> </td> </tr> <tr> <td> <p><strong>EPS</strong></p> </td> <td> <p>-0.17</p> </td> <td> <p>0.17</p> </td> <td> <p>-2.98</p> </td> <td> <p>-2.01</p> </td> </tr> <tr> <td> <p><strong>Yield</strong></p> </td> <td> <p>0.50%</p> </td> <td> <p>3.50%</p> </td> <td> <p>1.84%</p> </td> <td> <p>1.41%</p> </td> </tr> <tr> <td> <p><strong>ROA</strong></p> </td> <td> <p>-0.02%</p> </td> <td> <p>0.07%</p> </td> <td> <p>N/A</p> </td> <td> <p>10.53%</p> </td> </tr> <tr> <td> <p><strong>ROE</strong></p> </td> <td> <p>-0.57%</p> </td> <td> <p>1.78%</p> </td> <td> <p>N/A</p> </td> <td> <p>10.59%</p> </td> </tr> </tbody> </table>

Nonetheless, there are not going to be any short term recoveries for both the Swiss lenders and its profits will remain volatile in the coming quarters.  Since January, UBS has been up 30% while Credit Suisse, on the back of the massive quarterly loss, is down 3.52%. UBS has been ahead of SPDR S&P Bank ETF (NYSEMKT: KBE) and PowerShares Dynamic Banking ETF (UNKNOWN: PJB.DL) that reflect the performance of U.S. bank’s stocks.

We are in the part of the credit cycle where the banks collectively have over-stepped their mandates, lent too much with too much risk at too long a carry arbitrage and there is no way out of it other than becoming smaller and less interesting.  While this happens the banks will, and are, squaring off with their national central banks backing them up as artillery to go into battle and retain as much of the post-crisis business they can get. 

For banks like UBS and Credit Suisse I would say at this point that one shouldn’t think they can fight the Fed and win.  The Fed and U.S. politicians and officials are on an obvious mission to protect their own and attack foreign banking interests.  As an investor I would stay out of the cross-fire and wait to see who is left standing.  There may be trading opportunities that pop up from time to time but as investments the worst of their excesses have yet to be bled off and with an enemy as powerful as the Fed on the other side, it is prudent to put your investment capital in other places.


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