UBS: Regulatory Mess Loser

NEW YORK ( TheStreet) -- UBS AG ( UBS) of Zurich was the bank stock loser on Tuesday, with shares dropping 8% to $19.66, in trading on the New York Stock Exchange.

UBS on Tuesday reported a small third-quarter net profit of 577 million Swiss francs, compared to 690 million the previous quarter and a net loss of 2.124 billion francs in the third quarter of 2012, which resulted from goodwill impairment charges. During the most recent quarter, net trading income was down 69% sequentially and 33% year-over-year, to 543 million francs, while net fee and commission income was down 10% sequentially and 2% year-over-year, to $3.831 billion francs.

The company reported a third-quarter return on tangible equity of 5.9%.

UBS reported $586 million in third-quarter provisions for litigation, regulatory and similar matters, compared to $658 million in the second quarter and $239 million in the third quarter of 2012.

The company also hinted at major trouble ahead, announcing that after "an initial media report in June 2013 of widespread irregularities in the foreign exchange markets" it had started a review of its foreign exchange business and that it was cooperating in regulatory investigations. UBS also announced it had "taken and will take appropriate action with respect to certain personnel as a result of our review, which is ongoing."

UBS's actions against employees were first reported by the Wall Street Journal.

UBS has said that among its major goals is to reduce its risk-weighted assets (RWA). A bank's RWA is the denominator for key regulatory capital ratios. The company reported that over the past four quarters it has reduced its RWA by 80 billion francs, or 27%, while reducing its total balance sheet by 300 billion francs. But there was bad news as well. The Swiss Financial Market Supervisory Authority (FINMA) in October ordered "a temporary 50% add-on" to the company's operational risk RWA "in relation to unknown litigation," according to USB. This has the effect of temporarily increasing RWA by 28 billion francs.

Along with the continued elevation of litigation and regulatory expenses, the RWA hiccup and the foreign exchange investigation, UBS said that "without the complete removal of the temporary add-on if RWA, its goal of achieving a 15% return on equity (ROE) in 2015 "will be delayed by at least one year."

Canaccord Genuity analyst Arun Melmane in a note to clients on Tuesday struck a brighter tone, writing that "The capital story for UBS is coming along strongly," as the company's fully-implemented Basel III Tier 1 common equity ratio was 11.9% as of Sept. 30.

Melmane rates UBS a "buy."

"The ROE target being potentially postponed by 1 year, we view as less of a worry for the investment case. We see the capital level within UBS as still excessive for a restructured bank with a focus on wealth management with constrained investment bank RWAs. Management has shown good progress on de-leveraging and RWA reduction and we expect them to be able to offset the FINMA charge via management actions," Melmane wrote.

Market Upbeat on Fed Policy

Back home, the broad indices all ended higher on Tuesday, as the Federal Open Market Committee began its two-day meeting. The FOMC will release its statement on Federal Reserve policy Wednesday afternoon. The committee surprised many economists and investors by deciding to make no change in the central bank's "QE3" stimulus policy, which includes net month purchases of $85 billion in long-term bonds.

The bond purchases have continued since last September. In light of the partial shutdown of the federal government during the first half of October and some negative economic reports, most economists this time around believe the FOMC will stand pat again, since there's no compelling sign of accelerating economic growth in the United States.

Still, most economic reports on Tuesday were positive. The Commerce Department said retail sales increased by 0.4% in September, excluding auto sales. That figure matched the consensus forecast among economists surveyed by Thomson Reuters. Then again, retail sales including autos were down 0.1% in September, against expected growth of 0.4% among economists.

The S&P Case-Shiller home price index beat expectations, climbing 0.9% in August from July, ahead of an expected increase of 0.7%. Home prices were up 12.8% from a year earlier, which was the largest increase since 2006.

The Conference Board on Tuesday said the Consumer Confidence index had dropped to 71.2 in October from 80.2 in September, below economists expectation of a reading of roughly 74.3. "Consumer confidence deteriorated considerably as the federal government shutdown and debt-ceiling crisis took a particularly large toll on consumers' expectations," said Conference Board Director of Economic Indicators Lynn Franco, in a statement. While similar declines have been seen following other disruptive federal government events, Franco expects continued volatility for the index, "given the temporary nature of the current resolution."

That's fine with investors, since it adds to the likelihood of the FOMC not tapering QE3 until next year.

Turning to U.S. bank stocks, the KBW Bank Index ( I:BKX) rose slightly to close at 65.04, with winners and losers roughly split.

The Wall Street Journal on Tuesday reported that the expected agreement on multiple settlements of criminal and civil investigations of JPMorgan Chase's mortgage lending and sales activities was "at risk of collapse." The Department of Justice is leading the settlement negotiations. As part of the broad bundle of settlements, JPMorgan on Friday announced an agreement with the Federal Housing Finance Agency (FHFA) to pay Fannie Mae ( FNMA) and Freddie Mac ( FMCC) $5.1 billion to settle loss claims on mortgage-backed securities from JPM, as well as from Bear Stearns and Washington Mutual, which JPMorgan acquired during 2008 through government-sponsored deals.

JPMorgan admitted no wrongdoing in the FHFA settlement. The broad settlement with the Justice Department springs from a dispute between the bank and the Federal Deposit Insurance Corp. Following the failure of Washington Mutual in September 2008, the FDIC sold the nation's largest S&L to JPMorgan. The DoJ and JPMorgan continue to dispute how liable JPMorgan should be for actions taken by Washington Mutual leading up to its failure.

JPMorgan's shares rose slightly to close at $52.59.

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-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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