OREANDA-NEWS. Fitch Ratings says that UBS Group AG's (UBS; A/Positive/a) 1Q16 results highlight the bank's sensitivity to client-driven transactions, whose lower volumes during the quarter resulted in a decline in revenue. As a result, all business divisions reported yoy declines in adjusted pre-tax profit.

UBS's 1Q16 adjusted pre-tax profit declined 40% yoy to CHF1.4bn, excluding CHF265m restructuring costs and CHF123m foreign currency translation losses, compared with a 1Q15 figure of CHF2.3bn adjusted for CHF305m restructuring costs and CHF745m gains on own credit and sale on real estate and businesses. Low client transactions reflected general market risk aversion in response to prevailing uncertainty and negative sentiment around global growth prospects.

UBS generated an 8.5% adjusted annualised return on tangible equity, excluding the adjusting items in 1Q16 (tax-affected), which was well below the 14.4% it generated in a particularly strong 1Q15. Weak results in a first quarter - historically the strongest seasonal quarter in the year - in our opinion will make it difficult for UBS, as with most of its peers, to generate strong earnings for the full year.

UBS is committed to reducing operating costs by a further net CHF900m by end-2017 after having achieved a net reduction of CHF1.2bn between 2013 and end-1Q16. We expect UBS to continue to benefit from its strong global wealth management franchise, which should allow it to generate sound returns. However, prolonged periods of low client activity, together with continued pressure on net interest income from negative or low interest rates, will make it challenging for the bank to reach its targeted adjusted return on tangible equity of above 15% in 2018.

UBS's capitalisation remains strong despite a 50bp decline in the bank's fully-applied CET1 ratio in 1Q16 to 14%. This CET1 ratio remains at the upper end of its peer group, and the decline was primarily caused by an increase in risk-weighted assets (RWA), which at CHF214bn remain below the group's CHF250bn short- to medium-term expectation. The expected higher RWA level is based on both the impact of regulatory increases in RWA and projected business growth in less challenging market conditions. The RWA increase in 1Q16 was driven by regulatory add-ons for credit risk and market risk following four back-testing exceptions in 1Q16, as well as increased credit exposure. The bank's Basel III fully-loaded tier 1 leverage ratio stood at 4.1%, and we expect the ratio to further gradually improve to meet the expected new Swiss leverage ratio requirements. Once finalised, these should come into effect on 1 July 2016, and will phase in between then and end-2019.

UBS reported an increase in its liquidity coverage ratio (LCR) to an average of 134% in 1Q16, driven by increased levels of liquid assets, which were partly the result of the group's preparation for liquidity requirements in its US intermediate holding company, but also included some wealth management inflows onto the balance sheet prior to investment. We believe that UBS's funding remains a key strength given the bank's diversified funding base and a large stock of wealth management and retail deposits, complemented by well-diversified wholesale funding.

UBS's Wealth Management division's (WM) 1Q16 adjusted pre-tax profit declined 26% yoy to CHF636m, primarily driven by a 10% drop in adjusted net revenue as invested assets (AuM) declined and weak client activity. Assets under management (AuM) in WM fell 5% to CHF925bn, primarily driven by negative market performance. Net new money (NNM) showed a strong CHF15.5bn inflow, which reflected a seasonally strong quarter, but in our opinion also demonstrates the bank's strong franchise in several geographic segments, especially in Asia Pacific. Some CHF13.3bn of NNM inflows came from ultra-high-net-worth clients, which are a key target of the bank's strategy.

The Wealth Management Americas (WMA) business division reported 12% lower adjusted pre-tax profit at CHF244m, mainly as a result of higher operating expenses. Operating income continued to improve, in Swiss franc terms, as net interest income benefited from higher loan and deposit bases. NNM was strong at CHF13.6bn in the quarter, benefiting from assets managed by newly recruited advisors. AuM declined slightly to CHF1,009bn.

The Asset Management business division reported a 41% drop in adjusted pre-tax profit to CHF110m, mainly as a result of lower performance fees in the hedge fund businesses. AuM stood at CHF628bn at end-1Q16, down 5% yoy, which was partly the result of CHF2.9bn NNM outflows (CHF5.9bn excluding money market flows). Outflows included a CHF7.2bn price-driven withdrawal from a single client as well as CHF3.8bn relating to investors' reduced available liquidity.

The Personal & Corporate Banking (P&C) division reported CHF422m 1Q16 adjusted pre-tax profit, 5% lower than in 1Q15 as transaction-based fees declined. The division reported zero net loan impairment charges for the quarter, but the ongoing challenges faced by Switzerland's export-oriented corporates given the strength of the Swiss franc suggests that loan impairment could increase in the future. We believe that any increase should be easily manageable for the bank given the sound quality of its domestic mortgage portfolio and the resilience shown to date by the Swiss corporate sector.

Similarly to peers, the difficult market conditions in the quarter had a material effect on results in the Investment Bank (IB) division, where net revenue declined 29% yoy to CHF1.9bn. Operating expenses adjusted for restructuring expenses were reduced by 17% yoy as performance-related variable compensation was lower. Adjusted pre-tax profit fell 56% to CHF370m in 1Q16, but the division still generated an adjusted 19% return on attributed equity in the quarter.

UBS's capital markets, advisory and financing solutions businesses reported a 25% drop in revenue, reflecting lower deal volumes in the industry, with debt capital markets managing to report flat revenue yoy. The bank's revenue from equities, foreign exchange, rates and credit fell 25% from a strong 1Q15, which had benefited from high foreign exchange revenue due to the Swiss franc's exit from its floor against the euro. Income from equity derivatives suffered in 1Q16, but the bank's rates and foreign exchange businesses showed resilient performance.