Morgan Stanley Downgrades UBS, Sees Lower Profit Hurting Dividends

Morgan Stanley has downgraded Swiss banking giant UBS Group AG (USA) UBS to Equal-Weight from Overweight saying that dismal quarterly results may hurt dividend prospects.

UBS's first quarter profit plunged 64 percent to CHF 707 million, as lower trading income, fee income and CHF 39 million litigation charges weighed on the results. The company's fully-applied common equity tier (CET) 1 capital ratio was 14.0 percent, and a fully applied Swiss SRB leverage ratio was 5.4 percent.

"The best Q for private banking inflows ever was more than offset by soggy revenues, lack of operational leverage & miss in capital ratios," analyst Huw Van Steenis wrote in a note.

As of March 2016, UBS achieved cost savings of CHF 1.2 billion, and the bank is on track to achieve CHF 2.1 billion in net cost reductions by the end of 2017. Steenis expressed surprise as the bank did not signal more aggressive cost control to respond to the "paralyzing volatility" of 2016.

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UBS's board proposed to shareholders to pay an ordinary dividend of CHF 0.60 per share, as well as a special dividend of CHF 0.25 per share, for the year 2015. The analyst expects a dividend of CHF 0.65 per share (4.3 percent yield) for 2016, down from CHF 0.85 per share last year.

Looking Forward

"We think UBS has the potential for an appealing yield as it works through its issues-however the environment & capital misses mean the odds for specials in the next three years is remote," Steenis highlighted.

In addition, the analyst expects $2.5 billion for DoJ settlement, but the shadow of litigation to impact near-term dividends.

Further, the analyst expects UBS's Equities trading results to be 1.5 times worse than for U.S. peers given European and Asian skew.

"Whilst UBS leading franchise remains intriguing L-T, given headwinds, relative valuation no longer stands out at ~9.5x 18e (vs 9x for peers) & 5 percent 17e yield," Steenis continued.

"To outperform from here UBS would require a big increase in cost efficiency, client risk appetite improving and sight-raising divis," Steenis added.

The analyst also cut the price target to CHF 18.30 from CHF 20.80, saying that the key upside risks to the price target include a sharp and continued recovery in investment banking revenues across the industry and far stronger private banking profits.

On the other hand, the main downside risks are "higher book value erosion from risky assets and material client money outflows, as well as greater ongoing marks from de-leveraging, an inability to improve the profitability of the i-bank, and higher litigation charges."

At time of writing, UBS was down 0.5 percent on the NYSE, trading at $15.83.