UBS: A Hedge-Fund Stumble

Shares fell Thursday after the fiancial services outfit reported a profit shortfall on losses at its Dillon Read Capital Management unit

UBS AG UBS on May 3 announced a weaker profit during recent months, thanks in part to a big loss at a hedge fund unit, and plans to fold that operation into its investment banking business. Although UBS grappled with challenges in fixed-income trading, analysts gave the financial services firm credit for delivering strong results in its businesses overall.

To be sure, UBS' profit sank 7% year over year to 3.275 billion Swiss francs during the quarter ended March 31, or roughly $2.7 billion dollars. In the first quarter 2006, the results had included items including an after-tax gain of 290 million Swiss francs related to UBS' sale of the energy company Motor-Columbus.

Many banks have felt pain in recent months from the recent subprime mortgage lending meltdown. The chaos in the mortgage securities industry also affected UBS' hedge funds, which are currently steered by Dillon Read Capital Management (DRCM) within UBS' global asset management unit.

"Operating a proprietary trading platform outside the Investment Bank and managing client money alongside became too complex and expensive," John Fraser, the CEO of Global Asset Management, in a press release May 3.

Now UBS plans to merge the funds instead into "relevant business lines" within its investment bank unit. In the meantime DRCM will continue operations until the transition period ends, most likely in the third quarter of 2007.

After the news investors sold UBS' stock 3.4% to $63.20 per share in early trading on the New York Stock Exchange. Analysts surveyed by Thomson Financial were expecting UBS to earn $1.40 per share during the March quarter. Instead the company reported having 1.62 Swiss francs per share from continuing operations, or around $1.33 per share.

"In our view, Q1 fixed-income trading revenues were hurt by a loss of 150 million [Swiss francs] at Dillon Read," Standard & Poor's Corp. analyst Derek Chambers said in a research note. "In other areas of the investment bank (equity trading and corporate finance) and wealth management divisions, the company continued to report good results, matching expectations." Chambers maintained a hold opinion on the stock. (S&P, like, is owned by The McGraw-Hill Companies.)

Indeed, most of UBS' business units reported growing operating income. For example, its global asset management business gained 23% year over year to 997 million Swiss francs during the March quarter. The investment bank improved 5% year over year to 6.26 billion. And the financial businesses, which account for the lion's share of UBS' overall operating income, brought in 13.3 billion Swiss francs, or 8% more than the same period last year.

"While the (Dillon Read Capital Management) u-turn is clearly an embarrassment, we believe the u-turn is to be welcomed while the solid results elsewhere are a relief given cost concerns," Keefe, Bruyette & Woods Ltd. analyst Matthew Clark said in a research note. (The investment bank does business with companies covered in its reports, but Clark certifies that he isn't receiving compensation in exchange for expressing specific recommendations.)

UBS thinks the U.S. economic expansion will likely slow down over the next few months, but still does not expect such difficulties to have a negative long-term effect on a global scale, as the rest of the world economy is in good shape. As customers from regions like Asia and the Americas put in more new money, UBS' wealth management unit recorded inflows of 44.8 billion Swiss francs in the March quarter, up from 33.6 billion in first quarter 2006.

"Over the course of 2007, we will concentrate on consolidating the investments we initiated last year. We will also continue to manage capital, risk and costs in disciplined fashion - and in line with market developments," UBS CFO Clive Standish said in the press release May 3. "In the past, we have repeatedly proven our strength in delivering strong returns throughout the business cycle, which makes us confident that 2007 will be another successful year of growth for UBS."

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