UBS, which has seen its chief executive resign to be replaced by an interim CEO in the wake of a $2.3 billion rogue trader loss, is likely to suffer weaker profitability in its wealth arm and only break even at its investment bank in 2011, Morgan Stanley said in a note yesterday.

The Wall Street bank predicts that UBS will struggle to restructure its investment banking operations and return capital freed up by shrinking this side of its business, especially the capital-hungry credit segment. Morgan Stanley said its “base case” is that UBS needs to cut around SFr100 billion (around $109 billion) of risk-weighted assets – at a time when European wholesale banks are looking to cut RWAs by up to €2 trillion (around $2.65 trillion) over the next 18 months.

The comments come at what has been a difficult time for UBS in recent weeks. Over a week ago, its CEO, Oswald Grübel, resigned and was replaced by Sergio Ermotti, an existing senior UBS executive who had previously worked at UniCredit. UBS told journalists it intends to accelerate changes to the investment bank.

The Swiss and UK national financial regulators, as well as UBS itself, are investigating circumstances leading up to the discovery of the unathorised trading loss. Kweku Adoboli, the UBS employee at the centre of the saga, has been arrested and charged.

Morgan Stanley said it has cut its stock recommendation on UBS from “overweight” to “equal weight”.

On the wealth management side, Morgan Stanley said: “Our initial conclusion is that the risks to asset and wealth management franchises are likely to be more muted, although we trim expectations for flows over the next 15 months. However we think profitability will suffer as UBS needs to retain key staff in such a volatile period and is more likely to pay more cash and less stock to units to retain these 'jewel' businesses.”

Morgan Stanley has a price target on the firm of SFr13 per share – or 15 per cent upside on Morgan Stanley’s base case scenario; it also predicts, on the basis of forecast earnings for 2012, a price-to-earnings ratio of 11 per cent in 2011 and 8.2 per cent in 2012 (figures are based on consensus methodology).

The note pointed out that the investment bank accounts for a disproportionate chunk of risk-weighted assets despite contributing a minority of overall UBS profits. The investment bank accounted for 70 per cent of group RWAs after the introduction of the Basel III capital standards, even though this segment of the bank accounts for just 30 per cent of first-half 2011 profits, likely to fall to around 15 per cent of profits next year.