$2B loss from unauthorized trading could be ‘critical tipping point’ for UBS

UBS AG, Switzerland’s biggest bank, said it may be unprofitable in the third quarter after a $2 billion loss from unauthorized trading at its investment bank.

London police arrested Kweku Adoboli, a UBS employee, in connection with the loss, according to a person with knowledge of the situation who requested anonymity. City of London police and UBS declined to identify the man.

UBS management aims to “get to the bottom of the matter as quickly as possible, and will spare no effort to establish exactly what has happened,” the bank’s group executive board, led by Chief Executive Officer Oswald Gruebel, said in a memo to staff today.

[More: UBS CEO Gruebel resigns following $2.3B trading scandal]

The bank tumbled the most since March 2009 in Swiss trading following the announcement, which deals a blow to Gruebel’s attempts to rebuild the investment bank after the division recorded 57.1 billion Swiss francs ($65 billion) in cumulative pretax losses in three years through 2009. The trading loss may revive calls for Gruebel to shrink or shut the unit.

“How many times do we have to see huge UBS losses?” said Simon Maughan, head of sales and distribution at MF Global Ltd. in London. “It looks unreformed, unwieldy and ultimately unsustainable. This could be a critical tipping point for UBS’s strategy.”

‘Suspicion of Fraud’

UBS fell 11 percent to 9.75 francs, bringing the drop this year to 36 percent, compared with a 33 percent decline in the 46-company Bloomberg Europe Banks and Financial Services Index.

A 31-year-old man was arrested at business premises in central London at 3:30 a.m. on “suspicion of fraud by abuse of position,” City of London Police Commander Ian Dyson said in a statement today. The man remains in custody while the police investigate, the police said.

Adoboli’s LinkedIn page lists him as a director in ETF and Delta1 Trading at UBS investment bank in London. He previously held the position of trade support analyst at the investment bank, according to the LinkedIn profile. A University of Nottingham spokeswoman confirmed that Adoboli graduated from the school in July 2003, earning a degree in Computer Science.

Risk Management

The matter is still under investigation and the “current estimate of the loss on the trades is in the range of $2 billion,” UBS said in a statement today, the third anniversary of the collapse of Lehman Brothers Holdings Inc. No client positions were affected, the company said, declining further comment.

UBS had to raise more than $46 billion in capital from investors, including the Swiss state, to make up for the record losses during the credit crisis. The investment-banking unit had pretax earnings of 1.21 billion francs in the first half of 2011, while UBS as a whole had net income of 2.82 billion francs in the period.

The bank’s tier 1 capital at the end of the second quarter was 37.39 billion francs, giving it a tier 1 capital ratio of 18.1 percent, compared with 14 percent at Deutsche Bank AG, Germany’s biggest bank.

While the loss is “manageable” for UBS, it’s “obviously not helpful for sentiment and confidence in the bank’s risk management following the near-death experience of 2008-2009,” said Andrew Lim, a London-based analyst at Espirito Santo Investment Bank, in a note. Lim had estimated third-quarter net income of 1.1 billion francs for UBS.

Gruebel, Kengeter

UBS last month said it will eliminate about 3,500 jobs, with about 45 percent of the reductions coming from the investment bank, as stricter capital requirements and market turmoil hurt the earnings outlook. The bank in July scrapped the target of doubling pretax profit from last year’s level to 15 billion francs by 2014.

Gruebel, 67, and Carsten Kengeter, 44, who runs the investment bank, have been trying to revive earnings at the division for two years. They hired more than 1,700 people across the investment bank and brought in new business heads to replace those that left or were fired. They’ve also increased risk- taking to improve earnings opportunities.

The investment bank last had a pretax loss in the third quarter of 2010 when what Gruebel called “very low levels of client activity” and a charge related to the bank’s own debt hurt revenue at the division.

Kerviel, Leeson

UBS’s trading loss doesn’t rank as the largest. Societe Generale SA of Paris said in January 2008 that the bank lost 4.9 billion euros ($6.7 billion) after trader Jerome Kerviel took unauthorized positions on European stock index futures.

At Amaranth Advisors LLC, trader Brian Hunter’s bad bets on natural gas triggered $6.6 billion of losses in 2006, while Long-Term Capital Management LP lost $4 billion after a debt default by Russia. Nick Leeson piled up $1.4 billion of losses that brought down Barings Plc in 1995.

Credit Suisse Group AG, Switzerland’s second-biggest bank, had a loss in the first quarter of 2008 in part because of writedowns on debt securities that were intentionally mispriced by a group of traders.

Costas, Wuffli

UBS, created through a merger of Swiss Bank Corporation and Union Bank of Switzerland in 1998, was shaken in its first year of existence as the new entity by losses related to Union Bank’s $1 billion investment in Greenwich, Connecticut-based hedge-fund firm Long-Term Capital Management, which was rescued by a consortium of banks.

This century the bank was among the first stung by the subprime contagion when its Dillon Read Capital Management LP hedge fund, run by former investment banking chief John Costas, lost 150 million francs in the first quarter of 2007. By May that year, UBS decided to close it, and in July CEO Peter Wuffli stepped down.

Subprime-related losses that followed at UBS’s securities unit also led to the departures of executives including finance chief Clive Standish and Huw Jenkins, the head of the investment bank. Chairman Marcel Ospel resigned in April 2008 after shareholders demanded he take responsibility for the bank’s woes.

Gruebel, who formerly ran Credit Suisse, was brought out of retirement by UBS in February 2009 to take over from CEO Marcel Rohner after the company posted the biggest annual loss in Swiss corporate history. A former bond trader, Gruebel doubled profit at Credit Suisse between 2004 and 2006.

–Bloomberg News–

Related Topics: UBS AG, UBS Wealth Management