UBS profits hit by wrong-way bet on US rates

Profits at UBS plunged in the third quarter after the "bulge-bracket" investment bank bet the wrong way on US interest rates and racked up higher costs.

Revenue from stock trading also slumped 25 per cent, due to the "quiet" equity markets. Income from bond trading fell 15 per cent, "reflecting a fall in derivatives trading in the US and Europe".

Costs, including staff costs, rose steeply, with the cost/income ratio coming in at 73.8 per cent, from 68.9 per cent in the same quarter last year. This included the expense of setting up Dillon Read Capital Management, a new hedge fund operation within UBS, under John Costas, which involved unexpectedly high legal expenses.

Group net profits fell 21 per cent to Sfr2.2bn (£927m), compared with the period the previous year, well below expectations.

Jon Peace, an analyst at Fox-Pitt, Kelton said: "UBS is seen as a safe, predictable bank, so to miss forecasts by some 15 per cent is quite an eye-opener."

Clive Standish, UBS's chief financial officer, said: "We felt the effects of the May and June market correction in the first part of this quarter as sentiment did not really improve until September - which is why we were not able to match the very strong performance in the first half."

UBS indicated the fourth quarter would show a recovery as the market recovery continues and there would be fewer one-off costs. "At this point, it looks as though we will remember 2006 as another record year for UBS - in terms of both financial results and strategic progress," Mr Standish said.

UBS's investment bank saw third-quarter profits decline 22 per cent from last year, or 38 per cent from the previous quarter, to Sfr1.1bn, as lower revenues in equities, fixed income, rates and currency were partly offset by a 35 per cent rise in investment banking revenues.

Equities revenues were down 24 per cent on the previous quarter as most of its equities businesses, except for proprietary trading, showed declines. Fixed income, rates and currency revenues were off 25 per cent from the second quarter.

Revenues in the rates business were down significantly for this quarter after the bank was "positioned for a rise in market interest rates over the quarter, but in fact the reverse took place".

It is thought the bank misread the direction of yields on long-dated US Treasuries, though UBS would provide no details or quantify the losses.

Christopher Wheeler, an analyst at Bear Stearns said: "These results will undoubtedly disappoint. While wealth management has continued to make excellent progress, the investment banking business seems to be struggling... [But] The long-term story at UBS remains very much in tact."

Two other major European investment banks, Deutsche and Credit Suisse, report figures this week, with analysts expecting the latter to disclose significant losses in its equity trading operations.