Cost of Banking Clean-Up Once Again Hits UBS, Deutsche

UBS AG Bank Branches And Logos Ahead Of Earnings
Gianluca Colla/Bloomberg via Getty Images
By Katharina Bart
and Thomas Atkins

ZURICH and FRANKFURT -- Three of Europe's biggest banks suffered third quarter hits on Tuesday as the relentless rise in the cost of an industry clean up after a string of scandals shows no signs of abating.

Shares in Deutsche Bank (DB) and Lloyds Banking Group fell sharply after they set aside unexpectedly large sums to cover possible law suits and fines, overshadowing their day-to-day performance in the quarter.

UBS (UBS) stock also tumbled after the Swiss bank announced it has been ordered to hold extra capital in case it has to pay out more than expected in legal settlements.

European and U.S. banks are still struggling to cast off the shadow of the scandals revealed after the financial crisis that erupted in 2008.

"Just as we thought the regulation might be over, back it comes," said Andrea Williams, European equities fund manager at Royal London Asset Management, referring to the UBS hit.

Deutsche, Germany's largest bank, set aside an extra 1.2 billion euros ($1.7 billion) to deal with potential litigation costs, depressing its quarterly pretax profit to 18 million euros from an expected 642 million. Its shares were down 1.6 percent at 1115 GMT (7:45 a.m. Eastern time).

Net profit at its rival UBS was 577 million Swiss francs ($644 million), beating analyst consensus forecast of 537 million. However, UBS said the Swiss financial regulator was forcing it to hold extra capital to deal with possible legal costs, raising fears that it would end up paying billions to deal with claims and fines. This surprise sent UBS shares down 6.7 percent at 1115 GMT.

In Britain, Lloyds set aside another 750 million pounds ($1.21 billion) to compensate customers who were mis-sold payment protection insurance. Shares in Lloyds were down 1.9 percent at 1145 GMT, even though the bank almost doubled underlying profits in the third quarter.

Other banks have set aside billions of dollars for claims or already paid out billions in fines. Dutch mutual Rabobank could announce as early as Tuesday a settlement with U.S. and European regulators over claims it manipulated an interest rate.

"I'm sure there's a large amount of provisions still to come," said Rupert Baker, a European equity sales executive at Mirabaud Securities, speaking of the industry generally.

War Chest

Deutsche acknowledged it had sprung its shareholders an unpleasant surprise. "The timing and costs of legal charges is frustrating for investors and other stakeholders," said Stefan Krause, Deutsche's chief financial officer.

Deutsche's overall litigation reserves -- its war chest to deal with possible legal costs -- stands at 4.1 billion euros after the charges booked in the third quarter. "We expect the litigation environment to continue to be challenging," the bank said in a statement, signaling that the worst may not be over.

The latest charges amounted to 1.163 billion euros, with the lion's share set aside for cases involving residential mortgage-backed securities. Deutsche declined to give a more detailed breakdown.

Bonds backed by subprime and other risky residential mortgages lay at the heart of the financial crisis and are subject to a number of lawsuits in the United States.

More than a dozen banks and brokerages, including Deutsche, JPMorgan (JPM) and Citigroup (C), are under investigation by regulators over the possible manipulation of benchmark interest rates, including the London interbank offered rate, which are used to price trillions of dollars' worth of loans.

Unlike Barclays and UBS, Deutsche hasn't yet reached a legal settlement. %VIRTUAL-article-sponsoredlinks%"The investigations underway have the potential to result in the imposition of significant financial penalties and other consequences for the bank," Deutsche said in its third-quarter report.

In Zurich, UBS said its financial regulator Finma was forcing the bank to hold extra capital to deal with greater risk related to "known or unknown litigation, compliance and other operational risk matters".

The measure means the bank's target of achieving a 15 percent return on equity by 2015 will be pushed back by at least a year, UBS said.

Kian Abouhossein, a London-based banking analyst with JPMorgan who rates the stock "Overweight," said the market hadn't priced in this target. "That's less of a worry," he said. "The real worry is that there are more litigation charges."

Several regulators have recently launched investigations into the possible manipulation of foreign exchange markets, and UBS said it was also conducting an internal review.

"We have taken and will take appropriate action with respect to certain personnel as a result of our review, which is ongoing," it said, without elaborating.

Matt Spick, a London-based analyst at Deutsche Bank who rates UBS as a "Buy," said Finma's demand that UBS hold additional capital had "absolutely not" been expected. "Finma are effectively saying we think you need an extra 3 billion Swiss francs in capital against litigation issues," Spick said.

UBS repeated its commitment to paying out 50 percent of profits once it hits a common equity tier one ratio, under Basel III global banking rules, of 13 percent, which it expects next year.

Analysts remained wary. "A meaningful capital return won't be until 2015, a year later than most of us were hoping," Citi analysts said.

Turnarounds Hampered

In Britain, Lloyds has now set aside more than 8 billion pounds, far more than any other bank, to deal with the PPI scandal. This insurance is designed to protect borrowers who miss loan repayments due to illness or redundancy, but was often sold to people who were not eligible to claim.

Lloyds, which was bailed out by British taxpayers during the crisis and remains 33 percent state-owned, said volumes of PPI complaints were falling more slowly than expected. Responses to its letters to customers offering compensation had also been higher than forecast.

The additional hit took the shine off an otherwise strong performance by Lloyds, showing that this problem can hurt efforts to turn a bank around for years.

Both UBS and Deutsche highlighted difficulties in their day to day operations. Revenue from Deutsche's profit engine -- sales and trading of debt -- fell 48 percent to 1.2 billion euros, compared with the year-ago period.

Weaker trading income has already hit rivals such as Credit Suisse (CS) and Goldman Sachs (GS) after the Federal Reserve surprised markets by deciding to keep up the rate at which it buys bonds to stimulate the U.S. economy, instead of starting to wind it down.

Analysts at Switzerland's J. Safra Sarasin said litigation costs and a weaker fixed income result had been widely discussed in the market, but the impact was still more severe than expected.

At UBS, the bank beat expectations for overall earnings. Analysts said this was largely because of one off gains including the release of deferred tax earnings, but UBS's turnaround story remained on track.

"The UBS story is still intact in terms of becoming a private bank and equities investment bank," said Spick. "All the targets are now pushed back by about twelve months because of the scale of litigation and perhaps slower rises in interest rates, but the end-point is still the same."

-Additional reporting by Edward Taylor and Arno Schuetze in Frankfurt and Sinead Cruise, Steve Slater, Matt Scuffham and Sudip Kar-Gupta in London; writing by Laura Noonan.

Fortune 500 Companies That Secretly Run Your Life
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Cost of Banking Clean-Up Once Again Hits UBS, Deutsche

The Big 3 carmakers get plenty of press, but what about the carmaker makers? Enter Johnson Controls, a deceptively under-recognized name for its contribution to one of the most consumer-focused industries.

Johnson Controls (JCI) makes much of that cushy seat-foam that lets you ride in cars in comfort. The company is the world's largest supplier of "seating solutions," a segment that pulled in $15.5 billion in sales for the company in 2012. Johnson Controls also makes products tagged to the construction industry such as heating, air-conditioning, ventilating and security systems.

The company has broadened its reach well beyond its roots. In 1885, Warren Johnson, developer of the first electric room thermostat, founded Johnson Controls to sell his invention. Johnson Controls was also first to market with lithium ion batteries for hybrid cars, and is currently the biggest supplier for battery technology for vehicles. It also makes driver information display panels, floor consoles and those garage-door clickers that are integrated to the interior of the car.

You can't tell by the company's name what it does, exactly. CHS Inc., however, has its hands in a wide range of lucrative industries: petroleum products, chemicals, food and financial services. The company is owned by United States agricultural cooperatives and has been ever since it was founded in 1929 as the North Pacific Grain Growers. In 2003, it changed its name from Cenex Harvest States Cooperatives to CHS Inc., keeping Cenex as the name for its energy business, and offering preferred stock and non-voting ownership to investors.

Today, the company is not necessarily the No. 1 player in any of the categories it's involved in, but sweeps in at second or third place in a variety of categories. CHS is the nation's third largest U.S. grain exporter, and the third largest U.S. propane retailer. It has a joint venture with Ventura foods, a major manufacturer of bulk margarine. And while it is by no means up there with the Exxons of the world, CHS sells more than 3 billion gallons of refined fuels such as gasoline and diesel.

(Pictured is CHS's propane innovation from weed control to irrigation.)

It's got a pretty hands-off name, but United Technologies (UTX) is a manufacturer with many arms, and it oversees some of the U.S.'s most prominent brands. Sure, Boeing (BA) and Airbus make the news when they win or lose bids, but United Technologies owns Pratt & Whitney, the company that powers many of the planes those companies produce. And, of course, we all know Otis, the iconic elevator brand, which is a United Technologies company too. Manufacturer Sikorsky is another part of United Technologies' profile. And while Sikorsky may not ring a bell, it made the famous Black Hawk helicopters for the U.S. military.

Even less sexy but more pervasive, perhaps, is United Technologies bread and butter -- its climate, controls and security unit. The division made up the largest portion of the company's net sales in 2012 -- $17.1 billion out of $57.7 billion total.

Behind the drugs you buy is an entire industry built on supplying, pricing, and subsidizing those meds, which is where AmerisourceBergen (ABC) lives. The megapharma company was formed in 2001, when Amerisource Health Corporation merged with Bergen Brunswig Corporation. Today, the resulting hybrid handles 20% of all of the pharmaceuticals sold and distributed throughout the United States, and employs 13,400 people full-time.

The pharma industry has undergone consolidation, with companies forming even larger units to prepare for health care reform, when the government will become an even more powerful drug-purchasing competitor. So AmerisourceBergen signed a three-year contract with Express Scripts, which had just bought Medco Health. Both Express Scripts and Medco are pharma suppliers and consultants. In 2013, AmeriSourceBergen penned a deal with Walgreen (WAG) and Alliance Boots. The deal could give the triad the purchasing power to buy more generics than any other purchaser in the industry.

Archer Daniels Midland Company has been around since the turn of the century, when George Archer and John Daniels went in together on a business based on crushing linseeds. ADM (ADM) has flown under the radar aside from a press spike when it got caught up in a price-fixing scandal during the 1990s, which was featured in the 2009 movie "The Informant."

By that time, the company had somewhat righted its reputation -- it was ranked the Most Admired company in the food Industry on Fortune's 2009, 2010, and 2011 lists.

ADM is known primarily for its involvement in the corn industry, but its reach extends far beyond that. ADM still crushes linseeds and other oilseeds, for example. In fact, strong global demand for those products protected the company this past year from drought problems in the U.S. that hurt harvests and lowered levels on the Mississippi River, a major ADM shipping channel.

ADM is also one of the largest milling companies anywhere, processing 20 acres of wheat per-minute, all over the world. If you've got a sweet tooth, ADM is one of the largest cocoa product producers and owns roughly 16% of the ground cocoa market. If you raise pig, horse, fish or any of several other animals, ADM cranks out the corn- and soy-based products to feed them.

McKesson was around during the old days of the American medical industry. In 1833, John McKesson and Charles Olcott formed the company in New York, starting out stocking medical ships coming to port with chests full of herbs, roots and spices from Pennsylvania Shaker communities.

Medical services, of course, have come a long way, and so has the company, which is now the largest pharmaceutical distributor on the continent. McKesson (MCK) peddles more than 150,000 medical-surgical products, including bandages and exam tables, and, it claims, offers healthcare solutions that touch "more than 160 million covered lives."

No more a conduit for Shaker spices, the industry today involves selling a much murkier product called "health solutions," which guides clients through the coverage levels they should offer, among other things, and "provider technologies," which aim to help clients deal with the digitization of medical records. Over half of all "health systems" in the United States use McKesson's technologies in this category. It's lucrative -- McKesson nets more than $123 billion in annual revenue.

Also, McKesson is building a medical robot army. Every year, according to the company, "More than 300 Robot-Rx pharmacy robots deployed in North America dispense 350 million medication doses error-free." The future of medicine, ladies and gentlemen.

Lurking behind the health care debate are, of course, the companies that provide health care. Though it sounds like some kind of futuristic supercontinent, Humana (HUM) is actually the fourth largest provider of health care in the United States, with nearly 30 million policyholders.

The company, with its headquarters in Louisville, Ky., is poised to thrive as health care reform shapes the industry. Humana brought on 2,900 new care management professionals in 2012. Though costly, the price of that and other operational solutions should be offset by other areas in which the company made a profit. For example, the flu, though bad for your respiratory system, was good for Humana's bottom line. Incremental costs from increased hospital admissions, thanks to the flu, should earn Humana $75 million for 2012 and 2013.

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