Fitch Ratings lowered its outlook for UBS AG and wholly-owned subsidiary UBS Ltd. from ‘stable’ to ‘negative,’ citing the effect of market volatility on brokers’ earnings.

“The change in outlook reflects Fitch’s opinion that, in common with other banks with substantial investment banking businesses, ongoing market volatility throughout [the third quarter] will adversely affect earnings from UBS’s investment bank,” it says.

“Fitch would normally expect earning streams from the group’s more predictable global wealth and asset-management businesses to offset weak investment bank earnings, but believes that in severe market conditions this ability could become stretched and could test Fitch’s tolerance to earnings volatility,” it adds. Fitch says it will review the outlook over coming quarters in the light of evolving market conditions and the group’s performance levels.

The rating agency notes that UBS has stated that its investment bank would probably report a very weak trading result if turbulent market conditions continued. “Market volatility has continued unabated in the weeks since that announcement, with no clear sign of an improvement in the near term. In Fitch’s opinion, the prospect of a weak Q3 result appears likely to become a reality,” it says. “Earnings pressure is likely to emanate principally from the fixed-income division, a business that UBS’s management identified as a relative weakness in comparison to peers’ and which had been marked for investment and build-out, but which has also been affected by the loss of a number of senior bankers and the recent closure of Dillon Read Capital Management, its alternative investment vehicle established in 2006.”

Fitch says that UBS, and other global banks, are likely to suffer from market-to-market valuation losses on subprime assets held in its trading portfolio. “Given management’s historical focus on prudence, Fitch would expect a conservative approach to valuation of these assets, albeit recognising the challenges in obtaining reliable and realistic market prices in the current environment. Such an approach would lend itself to the possibility of future write-backs in the event of market stabilisation, although the timing of this is anything but clear,” it notes.

On the upside, UBS has the strength of cashflows and liquidity to allow it to fund illiquid assets on its balance sheet over the longer term, should this prove necessary, Fitch says.

“UBS’s strong ratings continue to reflect its excellent private banking/wealth management franchise, which results in a soundly diversified group, historically consistent profitability, a sophisticated approach to risk management and strong capitalization,” it concludes.