UBS Recovery in Trading Could Spell Upside

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UBS ( UBS ) is a financial services firm that offers a strong combination of wealth management, asset management and investment banking services on a global and regional basis. Its trading division accounts for about 40% of the $19.30 Trefis price estimate for UBS's stock , which is about 8% ahead of the current market price. UBS competes Morgan Stanley ( MS ), JP Morgan ( JPM ), Credit Suisse ( CS ), and Goldman Sachs ( GS ) in trading, investment banking and asset management services.

We have a $19.80 price estimate for UBS , which is about 8% ahead of the current market price.

Trading Assets Increasing

The relative increase of Bonds, Currencies & Commodities (BCC) trading assets in 3Q FY10 from 2009 can potentially provide some insight on the outlook for these banks in terms of their sales & trading activities. The trading assets for these businesses increase has varied from as high as nearly 20% by UBS and 17% by Deutsche Bank to only 3% by Citigroup. Goldman Sachs and Morgan Stanley and Credit Suisse have been on the conservative side with their BCC trading assets increase from 2009  being 8% and 12% and 11% respectively.

We consider the trading assets for banks as the fair value of their financial instruments, which they use for trading purposes. It reflects the proprietary capital they can leverage for generating returns. For most of the investment banks we cover we have separated their sales & trading division into Bonds, Currencies  & Commodities Trading and Equities Trading. Then we calculated their relative contribution to each of the banks' stock price and discovered that the trading division is one of the largest drivers to value for these banks when compared to other segments like M&A, Equity Underwriting and Debt Origination.


Assets for Bonds, Currencies & Commodities

Trading Asset Bases Among Banks

The above chart shows the change in trading asset bases for BCC from 2007 to 3Q 2010.  For most of the banks, the trading assets declined between 2007 and 2009, but recovered slightly in 2010. Though 2010 has been a better year, trading has been weighed down by sovereign debt risk and interest rate volatility in Europe. This has limited the increase in trading asset bases for many asset classes and impacted trading activities for the banks in the 4Q.

In 2006, among the above banks, UBS had the largest amount of BCC trading assets, totaling around $760 billion. However, this decreased to around $220 billion by 2009 , reflecting the poor performance of UBS, with it being among the banks requiring significant amount of sovereign bailout funds.

However, the global economic environment is slowly improving and has led to an increase in volumes and liquidity across most assets classes. As a result, we have seen an increase in the BCC trading assets for the above banks.

Upside to UBS Trading Recovery

UBS has the heaviest exposure to trading and so its stock price can be more vulnerable to the profits from its trading actiivities. The yield on trading assets for BCC for UBS decreased from 1.4% in 2005 to -8% in 2008, with the bank incurring heavy losses on its trading portfolio during the economic downturn, when returns across most major asset classes were sharply declining.

However, with the global economic environment slightly improving in 2009, the Yield on Trading Assets for Bonds, Currencies & Commodities increased to -0.25%. We expect the Yield on Trading Assets for Bonds, Currencies & Commodities to increase to nearly 5.2% towards the end of the Trefis forecast period, with the improving economic environment increasing liquidity and improving returns across asset classes.

If this however trended by 100 basis points higher to around 6.25% by the end of our forecast period, this would add around 10% to our price estimate.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: CS , GS , JPM , MS , UBS

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