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UBS AG (UBS - Analyst Report) reported third-quarter 2013 net income attributable to shareholders of CHF 577 million ($619.1 million), which substantially lagged the prior-quarter’s income of CHF 690 million ($731.8 million). The quarterly results were impacted by net charges for provisions for litigation, regulatory and similar matters worth CHF 586 million ($628.7 million), partially offset by a net tax benefit of CHF 222 million ($238.2 million).

Based on the current regulatory and political climate affecting financial institutions and involvement in a number of claims and regulatory matters, UBS AG expects charges associated with litigation, regulatory and similar matters to remain at elevated levels through 2014.

UBS AG’s adjusted pre-tax income came in at CHF 484 million ($519.3 million) in the reported quarter compared with CHF 1.0 billion ($1.1 billion) in the prior quarter.

The company experienced lower net interest and trading revenues and reduced net fee and commission income. However, decreased operating expenses acted as a tailwind for the quarter.

Notably, the company experienced own credit loss on financial liabilities of CHF 147 million ($157.7 million) as against a gain of CHF 138 million ($146.4 million) in the prior quarter and net restructuring charges of CHF 188 million ($201.7 million) in the reported quarter versus CHF 140 million ($148.5 million) in the prior quarter.

Performance in Detail

UBS AG’s operating income declined 14.9% from the prior quarter to CHF 6.3 billion ($6.8 billion) while operating expenses decreased 7.8% sequentially to CHF 5.9 billion ($6.3 billion).

On a sequential basis, adjusted operating profit before tax increased 1.6% at its Wealth Management division and 6.9% at Retail & Corporate. However, operating profit moved down 11.2% at the Wealth Management Americas division, 14.5% for Global Asset Management and 58.4% for Investment Bank. However, Corporate Center reported a loss.

Moreover, at UBS AG’s Investment Bank unit, the company experienced a pre-tax profit of around CHF 251 million ($269.3 million) compared with CHF 775 million ($822 million) in the prior quarter.

UBS AG's invested assets were CHF 2,339 billion ($2,509.5 billion) as of Sep 30, 2013, down from CHF 2,348 billion ($2,490.3 billion) as of Jun 30, 2013.

The company witnessed a rise in its regulatory capital. The BIS Basel III framework came into effect in Switzerland on Jan 1, 2013. The company’s phase-in BIS Basel III common equity tier 1 ratio stood at 17.5% as of Sep 30, 2013, compared with 16.2% in the prior quarter.

Further, phase-in BIS Basel III common equity tier 1 capital decreased slightly by CHF 0.4 billion to CHF 39.0 billion ($43 billion) as of Sep 30, 2013. Phase-in Basel III risk -weighted assets (RWA) declined CHF 20.3 billion to CHF 222.3 billion ($245.2 billion).

On a fully applied basis, UBS AG’s BIS Basel III common equity tier 1 ratio increased 70 basis points to 11.9% and fully applied RWA declined to CHF 218.9 billion ($241.5 billion) from CHF 239.2 billion ($253 billion) in the prior quarter. As of Sep 30, 2013, total assets stood at CHF 1,049 billion ($1,157 billion), dropping CHF 80 billion from Jun 30, 2013.

Outlook

According to UBS AG, failure to attain persistent progress on material improvements amid the ongoing Eurozone sovereign debt concerns, US fiscal and monetary issues and the ongoing global concerns, as well as the uncertainty at large, could impact the client activity levels in the fourth quarter of 2013. However, it expects wealth management businesses to continue to attract net new money.

Further, UBS AG expects the application of SNB StabFund option in the fourth quarter of 2013 will increase its fully applied and phase-in BIS Basel III common equity tier 1 capital ratios by about 100 basis points. Further, it anticipates a 25 basis points surge in Swiss (Systemically Relevant Banks) SRB leverage ratio.

At the end of the reported quarter, FINMA imposed a temporary 50% add-on to UBS AG’s advanced measurement approach-based operational risk-related RWA associated with expected or unexpected litigation, compliance and other operational risk matters.

Therefore, beginning in the fourth quarter of 2013, this temporary FINMA add-on is anticipated to record additional operational risk-related RWA of about CHF 28 billion on both a fully applied and a phase-in basis. Currently, UBS AG expects the effect of such an imposition to lower its fully applied Basel III common equity tier 1 ratios by 130 basis points.

In Conclusion

In the stressed operating environment, UBS AG recorded a sequential decline in its earnings owing to legal issues. The lawsuit settlements by the company manifest its aim to resolve all mortgage related issues, and thereby reduce costs over the upcoming period. Further, the move is expected to provide relief to the investors who were duped by such risky investments.

Amid the overall economic volatility and the Eurozone debt crisis, UBS AG will focus on building its capital level. Restructuring initiatives taken during 2012 are encouraging and we believe that such efforts would help improve the company’s operating competence in the future. Moreover, prudent business model changes can further improve its efficiency and bolster its competitive edge.

UBS AG currently carries a Zacks Rank #2 (Buy). Some foreign banks that are worth considering include Deutsche Bank AG (DB - Analyst Report), Banco Bilbao Vizcaya Argentaria, S.A. (BBVA - Snapshot Report) and Credit Suisse Group AG (CS - Snapshot Report), all carrying a Zacks Rank #1 (Strong Buy).

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