Introduction
The report covers fundamental analysis of the Swiss banking industry and the UBS bank with reference to key variables and performance during 2007/2008. The research in the report is based on data from last three years using ratio analysis, risk analysis, trend analysis and other tools for research. The relation of the Swiss banking industry with Swiss economy and the future aspect of investment in the industry are discussed. The ratio, risk, trend and industry analysis of UBS with respect to the banking industry and economic conditions of Switzerland are also discussed.
The Swiss Banking Sector
The Swiss Banking Sector is different from other banking sectors of the world in that the sector provides secrecy to clients’ information to a high extent and is fairly stable. The banking sector is the leader in asset management of foreign entities and contributes to 9 percent of the Swiss GDP. The Swiss economy showed positive growth during 2004-2007 but in the last quarter of 2008 it showed a decline of 0.6 percent due to the global economic crisis and this was especially due to the decline in the banking sector. The sector has been facing challenges in recent times due to the global economic crisis and the largest bank UBS posted heavy losses and faced pressure of revealing account information from USA.
The banking sector has shown phenomenal growth in the past five to six years but hit a crisis at the end of 2008 as it was also affected by the global financial crisis which had a hard impact on a large number of banks including UBS. The Swiss banks were managing $206 trillion in 2001 and this amount decreased by $400 billion in 2002. The key ratios or indicators that help evaluate the Swiss banking sector are the Return on Equity, Earnings per Share, Cost / Income ratio and Net New Money. As of 2007 there were 330 banks in Switzerland with the leaders of the industry being UBS and Credit Suisse. One third of the direct investment abroad comes from banks which were CHF 89 billion in 2006.
Overview of UBS
UBS was formed in 1998 with the merger of Union Bank of Switzerland and Swiss Bank Corporation. It is the largest bank of the sector in Switzerland with Credit Suisse in second place. The major operations of UBS include wealth management, investment banking, asset management and other commercial and corporate banking services. With a rating of AA+ the bank stands as one of the largest in corporate services and wealth management. Until 2006 UBS displayed stable growth but due to investments in subprime loans the bank faced heavy losses in the last quarter of 2007 and 2008.
The net profit for the bank in 2005 was CHF 13,532; in 2006 it was CHF 11,527; in 2007 CHF (5,247) and in 2008 it declined to a staggering CHF (21,292). This indicates the heavy decline in the profits for UBS during the last two years. The Swiss Government is also taking measures to improve the overall profitability and economic condition of UBS through a bailout package which would strengthen the financial position of UBS.
Ratio Analysis
The ratio analysis includes an overview of the key ratios for UBS during 2006-2008 which clarifies the financial position of the bank during this period. The ratios included in this analysis are Current ratio, Debt to Assets ratio, Earnings per Share, Return on Equity, Return on Assets, Cost / Income ratio and Net New Money.
Source: UBS Annual Reports 2005-2008
As can be seen from the table the key performance indicators and ratios have been on a decline since 2005 till 2008 except for the current ratio and debt to assets ratio although the bank faced liquidity problems in 2008 the current ratio remained constant as a balance was kept between the current assets and current liabilities of the firm. The debt to assets ratio also remains constant due to the fact that the gain or loss on the assets which were revalued impacted mainly the income statement rather than the balance sheet.
The Earning per share was CHF 5.98 which declined slightly to CHF 5.19 per share in 2006. The dividend payout ratio was 26.8 in 2005 which increased to 42.40 in 2006 which means a higher percentage of dividends out of net income were paid in 2006. The Return on equity decreased from 36.7 percent to 25.7 percent and the return on assets also decreased from 0.7 percent to 0.5 percent in 2006. The cost / income ratio in 2006 which describes the cost and relative income dropped to 70.5 percent from 71.2 percent in 2005. The net new money saw a record increase to 151.7 billion in 2006 from the previous level of 148 billion.
The Earning per share was CHF 4.99 in 2006 which declined to a negative 2.43 in 2007 and plummeted to a negative 7.69 in 2008 which shook the shareholders confidence greatly. The return on equity percentage shows the same pattern of decline but the significance of the decline in 2008 is to be noted as it has declined from a negative 10.90 percent in 2007 to a negative 58.70 percent in 2008. This was due to the huge losses registered in 2008 by the investment bank.
The cost / income ratio has risen from 111 percent to 753 percent in 2008 which also shows a significant loss for the bank as the cost is quite high as compared to the income generated from this cost. The Net New Money indicator shows the outflows or inflows of the bank in different periods. In 2008 the Net New Money indicates a negative amount which means the bank had major outflows in 2008 reaching to CHF 226 billion from the inflow of 140.6 in 2007.
The main reasons which contributed to this negative amount were the outflows of global wealth management and business banking division which amount to CHF 123 billion with large outflows in the South America, Middle East and African regions. There was no dividend payout ratio in the last two years under analysis as no dividends were paid due to losses reported by the bank. The return on assets registered a reduction and posted negative figure of 0.2 and 0.9 in 2007 and 2008 respectively.
The bank has implemented a new key performance indicator framework from the first quarter of 2009 which would measure the performance in 2009 and in the future. Looking at the ratios from 2005 to 2008 we see a major decline in all the key indicators such as earnings per Share, dividend payout ratio, cost / income ratio, return on assets and equity with several ratios going into negative values. This is mainly because of the huge losses registered by the bank affected by the global economic crises and heavy investment in subprime loans. Going forward it would be quite hard to create value for the bank with respect to shareholders.
Risk Analysis
The risk for UBS can be classified into two main areas, primary risk and operational risk. Primary risk covers credit risk, market risk and liquidity risk. The most significant of the primary risks is the credit risk which entails the risk when clients fail to meet their obligations. The market risk is the risk of loss from changes in the market. The liquidity risk arises when UBS is unable to pay its liabilities when they become due or when UBS needs to borrow funds from the market in order to meet current commitments. The operational risk means the risk of loss from the failure of operations of the bank such as internal systems failure, people or processes of the bank such as fraud by an employee of UBS or the failure of IT systems or loss from external sources related to operations of the bank.
Credit Risk
Credit risk is the risk of potential loss resulting from the failure of the clients to meet their obligations. This can be due to matters directly linked to the clients such as business or management crisis or political unrest in the client’s country. Another factor affecting this risk is the failure in the settlement process which means that UBS meets the obligations in a foreign exchange transaction whereas the client fails to honor the commitment. There are many sources of credit risk for banks such as loans, contingent liabilities, derivatives such as forwards or options contracts and borrowing and lending transactions on securities.
Like other banks UBS also faces these types of credit risks and especially after the bank had financed many subprime loans. The credit risk on all such types of loans and commitments was quite high as the bubble of subprime burst in 2007 and 2008 many of UBS’s clients failed to meet their obligations on due time. The risk is further elevated when much of the clients are based in the same geographical and economical areas which would mean that if an economic crisis hits that area all these clients would be affected. Although UBS has implemented measures to control credit risk the amount of losses due to failure of the clients in meeting commitments is quite high.
Market Risk
Market risk is the risk of loss from variations in the market. This risk can be divided into two categories which are general market risk and idiosyncratic risk. General market risk is attached with macroeconomic, political, geographic and other areas affecting market mechanism. The general market risk includes risk due to changes in the interest rates, commodities such as metals and stock market indices. Idiosyncratic risk refers to the risk directly affecting a particular bank with respect to prices of debt and securities linked to that bank in some way or the other. UBS is exposed to both general market risk and idiosyncratic risk in various areas.
Much of the clientele of UBS is in the US which makes it more vulnerable to the changing market conditions of USA. The investment banking division is highly affected by the real estate crisis as much of the asset backed loans have proven to be a major loss for the bank. The bank is now trying to bail out of such commitments and clearing the remaining commitments in the real state and securitization areas. Another thing which affects the market risk for the bank is fixed income trading and the bank has also been trying to reduce the investment in this area to reduce the overall market risk of the bank.
UBS measures market risks through two basic tools which are Value at Risk -VaR and Stress Loss. VaR estimates the loss to the bank from severe movements in the market but VaR has limitations according to the management of UBS as the realized losses can be different from the potential losses identified by VaR. The bank did not anticipate the severe losses of 2008 as the Var failed to indicate significant losses from market risk. The bank is now turning the preference to stress testing which is more reliable in terms of market risk analysis and is based on future assumptions rather than tools like the VaR.
Liquidity Risk
The liquidity risk is the risk of being unable to pay liabilities when they become due or when the bank needs to borrow from new sources to settle previous commitments. There is a liquidity management mechanism already in place in UBS but the severe economic conditions of 2008 affected the liquidity of the bank quite heavily. UBS might be at high risk if it has to borrow to fund its ongoing operations including current and future commitments.
UBS knows that liquidity and funding are not same but they are linked to each other quite closely. The financial crisis that started in 2007 from the United States had a large affect on the liquidity of most banks of Europe and Asia. UBS also faced liquidity crunch as short term and long term funds were unavailable like they were available before and a majority of assets were not being taken as collateral.
Governments of different countries are still trying hard to alleviate the liquidity crisis facing these banks by injecting liquidity, buying majority shares and proposing bailout packages. The Swiss Government also proposed a bailout plan by injecting liquidity of CHF 6 billion into UBS which is the largest bank of Switzerland. This move allowed UBS to get rid of the risky assets which could affect the future operations and liquidity of the bank.
Operational Risk
Operational risk is the risk of loss from the operations of the bank whether internal or external. This could be due to improper internal practices, failure in the overall operations of the bank or due to external factors related to the overall operations of the bank. Operational risks are usually controllable to some extent and can be removed to a certain extent. UBS determines and controls operational risk to the highest extent possible as each division of UBS has an operational risk control unit along with a unit head who reports to the group head of operational risk. These units have been designed to manage the tangible and intangible assets of UBS and to solve and control issues like reconciliation of daily reserves, failure of IT systems and fraud control.
Industry Analysis
The banking sector of Switzerland is one of the largest private banking sectors in the world and has over 330 banks. The sector has been growing at a stable rate for the past 6 years and was the leader in investment and commercial banking till 2008 when the global economic crisis also affected the major banks of Switzerland. The banking sector contributes highly to the GDP of the country. An estimated 35 percent of all the global private wealth is managed by Swiss banks and these banks have restructured to cater to large corporate and professional clientele as well managing around CHF 4,900 billion in portfolios.
The banks in Switzerland are regulated and licensed through the Federal Banking Commission and foreign banks and their branches are governed by the Banking Law enacted in 1934. The major attraction for foreign private account holders is the secrecy and confidentiality of the Swiss banking sector. The Swiss banks are now facing great difficulty as many countries including the USA force these banks to reveal the identities of the account holders and abolish the popular anonymous money transfers through account codes from one country to another to limit money laundering cases.
The leaders of the banking sector are UBS and Credit Suisse who account for two-thirds of the total value of banks in the country. The sector includes savings, regional and cooperative banks including institutions specializing in asset management and securities and derivatives trading and contributes approximately between CHF 10 and 15 billion to the Swiss economy. The sector also accommodates foreign banks and their branches which make up about 40 percent of the entire sector. The presence of a large number of foreign banks exhibits the benefits of the Swiss banking industry. The sector is a major part of Switzerland’s economy as it constitutes about 9% of the GDP. The banking sector also employs a great deal of human resources of the country and about 3 percent of the total population of Switzerland worked in banks till 2008. The banking sector of the country was growing at a stable rate till 2008 when the global economic crisis also hit this sector and the largest banks of the industry now face a liquidity crunch and operational slowdown.
As a result of the crisis the Government had to inject CHF 6 billion into UBS which is the sector leader. UBS reported a loss of $12 billion for the first quarter of 2008 and a decision to cut down the workforce by 11 percent by 2010 was made. UBS currently employs 76,200 employees in 50 countries and after the lay off the employees remaining would be 67,500 by 2010. This slowdown has not only affected UBS but also other banks of the country as they go on to merge with other banks and try to figure out a way out of the liquidity crunch. Many foreign banks had to close down their branches and operations in the country as the cost nearly doubled with no new business to be found.
Trend Analysis
The trend analysis of the stock of UBS will be done according to the pattern of share prices from 2005 to the current price as of May 22, 2009. UBS bank started gaining value in 2005 with respect to share prices and went on to increase in 2006.
Looking at the share price pattern it can be seen that the share prices closed at 55.38 and during 2006 they went up to 65.86 and registered an increase of about 19 percent which is phenomenal for any share. The share of UBS started shedding its weight in 2007 when it declined to 46.6 in 2007. The last quarter of 2008 saw the share price plummet to record low levels of 8 per share meaning an extraordinary decline of 83 percent. This caused shareholders to lose millions in the share on UBS.
The share price was at 14.84 at the close of business on December 30, 2008 and the share price further declined to 10.7 after the bank reported heavy losses in the first quarter of 2009. The share price was 15.74 at the close of business on May 22, 2009 which means the share price has slightly moved upward during the second quarter of 2009. The bank reported heavy losses in 2008 which coupled with macroeconomic conditions caused the share price to plummet during that year.
The share prices during the early years under analysis were fairly stable but starting from early 2008 we see a continuous decline in the share prices and touch record low levels and the recovery from these levels is quite hard as the investor confidence is already shaken up and the global economy is not yet out of crisis. The share prices are expected to trade between the levels of 14 and 16 during the next two quarters of this year and in early 2010 as the effects of the bailout package by the Swiss Government would take at least a year to boost the operations of the bank.
Conclusion
From the research and analysis carried out it can be concluded that the overall financial condition of the banking sector is not quite healthy at the time being for investors specially seeking to earn a stable and long term profit from UBS or the banking industry. The ratio analysis has shown a decline in all the key indicators of the bank with special consideration of earnings per share which has declined sharply and due to heavy losses the bank has not paid any dividends during the last two years. The risk analysis has shown that the bank and the industry are quite risky given the present circumstances in terms of liquidity and overall market conditions.
There is a chance of profit taking from speculative trading but not on a long term basis as the share prices are trading in a range bound pattern since the last quarter of 2008. Buying on the lower side of 11 and selling at an upper side for 15.5 can result in a profit of 4.5 but only in speculative terms not for capital gains or long term investment. The banking sector and major banks of the world like UBS have yet to prove to the public of the overall profitability and strength of their institutions in order to achieve the former glory and value.
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