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Buy into UBS's capital strength

UBS has a chequered past in investment banking, but its underlying trading looks reasonable and the bank has lots of capital
January 26, 2012

With the eurozone sovereign debt crisis unresolved, investors could be forgiven for steering clear of banks' shares. After all, fear of banks' exposure to the debt of peripheral eurozone states continues to depress their shares, while a default somewhere in the single currency area could yet trigger economic meltdown. But Swiss banking giant UBS deserves to be judged differently.

IC TIP: Buy at 11.99CHF
Tip style
Value
Risk rating
Medium
Timescale
Long Term
Bull points
  • Exceptionally well capitalised
  • Reasonable underlying trading
  • Not overly exposed to eurozone debt
  • Returning to the dividend list
Bear points
  • Chequered investment banking past
  • Weak backdrop for banking sector

That's mainly because the bank has so much capital to absorb potential losses. In October, UBS revealed tier one capital equal to 18.4 per cent of assets weighted for risk, while its core tier-one ratio - comprising the more liquid elements of capital and retained profits - came in at 16.3 per cent. This largely reflects tough new rules that Swiss regulators are forcing on banks, the so-called Swiss finish, requiring Switzerland's biggest banks to hold tier one capital of at least 10 per cent, three percentage points more than required under the internationally-agreed Basel III rules. But, regardless of the reason, UBS is now one of the world's best-capitalised lenders. Even HSBC, the biggest and healthiest of the major UK banks, can't compete with that - its core tier-one ratio is 10.8 per cent.

The risk that UBS's capital cushion could be substantially eroded looks low, too. Crucially, UBS isn't overly exposed to the sovereign debt of weaker eurozone countries. In October, it reported a net exposure to Greece and Portugal of SFr130m (£90m) and SFr263m, respectively. True, its combined net exposure to Spain and Italy was SFr5.6bn, but that still looks thoroughly manageable for a bank with a loan book of SFr266bn. "Our net exposures to the sovereigns... have been further reduced during the third quarter of 2011 and remain limited," said its bosses.

UBS (UBSN:VX)

ORD PRICE:SFr11.99MARKET VALUE:SFr45.9bn
TOUCH:SFr11.98-11.9912-MONTH HIGH/LOW:SFr19.13SFr9.34
DIVIDEND YIELD:0.8%PE RATIO:9
NET ASSET VALUE:SFr13.52  

Year to 31 DecPre-tax profit (SFrbn)Earnings per share (SFr)Dividend per share (SFr)
2008-27.76-7.68nil
2009-2.56-0.74nil
20107.461.99nil
2011*5.871.260.1
2012*6.251.340.1
% change+6+6Nil

*Citigroup estimates

Beta: 1.6 £1=SFr1.45

Credit quality looks reasonable, too. At the third-quarter stage, its ratio of impaired loans to total loans stood at a modest 1.1 per cent, down from 1.3 per cent at end-June. Moreover, helped by the sale of a chunk of US and UK government bonds, UBS is making progress. The retail and corporate arm saw profits reach SFr1.51bn for the nine months to end-September, up 9 per cent on a year earlier. While the wealth management unit reported a profit of SFR2.1bn for the first nine months of 2011 - up 19 per cent year on year - and, in the third quarter, the division saw fund inflows of SFr3.8bn net.

However, the investment banking arm is under the cosh. In September it suffered a painful SFr1.85bn hit following rogue trader Kweku Adoboli's alleged unauthorised speculative trading spree, involving various index futures. That meant a SFr650m third-quarter divisional loss. Indeed, UBS's investment banking side has a chequered past. The effects of the financial crisis, for instance, resulted in writedowns on asset-backed securities that forced UBS, in 2009, to report the biggest single-year loss in Swiss corporate history. Since the Kweku Adoboli incident, management plans to cut its involvement in investment banking, shifting the focus back to its core business of managing the assets of the rich.

Still, the ravages of the financial crisis are looking increasingly distant, while the bank's capital strength leaves it more than able to absorb the fallout from incidents such as the Kweku Adoboli affair. UBS also plans to return to the dividend list with an end-2011 pay-out of SFr0.10 per share and implement a "progressive capital return programme thereafter". Admittedly, that only generates a nominal yield of under 1 per cent, but it's in stark contrast to many other big lenders that don't pay dividends or may yet have to axe them to conserve capital. "We believe it [the proposed dividend] is a signal of management's confidence in UBS's starting position of capital strength," says Kinner Lakhani, an analyst at Citigroup.