NEW YORK (TheStreet) -- With 16 years passing since Nick Leeson's unauthorized trades brought down Barings Bank, it's time for banks to stop pointing the finger at "rogue traders" and clean up their trading operations.
When looking at the "latest media releases" on the company website by UBS AG (UBS), each press release going back over 10 years, has a specific headline, except for the release from Thursday, which is entitled simply, "Media Release."
Guess what event was covered by this media release?
Here's the entire release:
"UBS has discovered a loss due to unauthorized trading by a trader in its Investment Bank. The matter is still being investigated, but UBS's current estimate of the loss on the trades is in the range of USD 2 billion. It is possible that this could lead UBS to report a loss for the third quarter of 2011. No client positions were affected."
Translation: "We don't have any clue what our traders are doing on a day-to-day basis and none of our executives want to face the music, at least for the moment."
The losses have been widely reported as coming from equity trades.
Britain's Financial Services Authority previously fined UBS £8 million in November 2009, after unauthorized trading by four employees on at least 39 customer accounts cost the company $55 million, including compensation to the customers of over $42 million.
The good news for UBS and its investors, according to Bank of America Merrill Lynch analyst Derek De Vries, is that "UBS is one of the few banks in Europe that can announce a $2 bn trading loss and not face immediate questions about its capital position."
The analyst estimates that "a $2 bn trading loss in Q3 will push UBS' 2013 fully-phased in Basel III core tier 1 ratio just below 12%." And that is a very strong Basel III Tier 1 capital ratio.
De Vries has a neutral rating on UBS' shares, saying the loss will heighten investor concerns about the company's "ability to earn a sustainable return above its cost of equity in the investment bank." He's also concerned about "investment bank compensation, and therefore employee retention, as the loss is likely to impact the 2011 bonus pool and could trigger clawbacks for some employees whose bonus is tied to profitability of the IB."
In addition to their undoubted sympathy for traders potentially taking a hit on their bonuses and year-end Rolex purchases, investors may also be concerned about inadequate operational controls at USB.
There's more to risk management than checking ratings and ticking off things on a list. Robust technological and human systems need to be in place, to monitor trading positions on a day-to-day basis.
Deutsche Bank analyst Matt Spick also has a neutral rating for UBS, saying on Thursday that the UBS announcement "may undo some of the reputational improvement in the private bank." Spick thinks the trading loss could have a "silver lining," as "this event could accelerate the decision making progress at UBS on how to position and right-size the investment banking operations within the group, although we think that the complexity of unwinding an i-bank and disentangling it from the private bank means investors may still be disappointed with how quickly this happens."
Collins Stewart analyst Matthew Czepliewicz calls the $2 billion loss "a huge hit" to earnings, saying in a report Thursday that his Sept. 6 upgrade of UBS to a "Buy" rating from a neutral rating, "now looks memorable, to say the least," and that "As large and embarrassing as the loss is, it may in fact drive a positive strategic overhaul of the company." Czepliewicz hasn't yet taken further action on his rating, as he awaits "further detail on what went wrong and how management will respond."
In their initial reports, most analysts were assuming that the trading loss was tied to UBS' fixed-income trading business.
Czepliewicz told TheStreet that subsequent word that the $2 billion trading loss was from equity trading activity "makes the loss a bit more worrying and puzzling," adding that "it is hard to take that kind of loss in an equity business."
When asked it UBS' controls over its trading operations were inadequate, Czepliewicz said "It is safe to say that yes, clearly it is an indictment of their internal safeguards. "
JPMorgan Cazenove analyst Kian Abouhossein views Thursday's announcement as the "final straw in UBS' ambitious build-out to a [Tier 1 investment bank]," although the analyst retained his "Overweight" or "Buy" rating on the shares. Like the other analysts, Abouhossein says that "capital and funding are not a concern for UBS." Abouhossein sees "management changes within UBS IB" as likely, and also expects the company to come under "material pressure from shareholders and [Swiss regulators] to review its IB business," considering the unit's underperformance and the trading loss.
Following a radical restructuring of the company, Abouhossein sees "the new UBS as a private bank and asset gatherer with a smaller IB business," and concludes that the company "remains a top pick with its IB restructuring potential," as well as "limited sovereign risk exposure," strong capital and "excellent funding ability as a Swiss bank."
So the analysts uniformly agree that UBS has plenty of capital and liquidity to absorb the trading loss.
But this is a major event for UBS, as a $2 billion loss springing from senior management's lack of control over its trading operations is simply a waste of investors' money. Heads should roll.
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