Rogue Trader Blows A $2 Billion Hole In UBS's Balance Sheet

Talk about bad news coming at an inopportune time...Swiss banking giant UBS (NYSE: UBS) revealed on Thursday that a rogue trader lost $2 billion for the firm through unauthorized trades. While the loss may not amount to a knockout punch, it is sure to sting the bank, which was already on the ropes in the wake of the European sovereign debt crisis.

UBS warned that it could report a loss for the entire third quarter as a result of the rogue trade, which may cost them as much as they were hoping to save ($2.28 billion) by cutting 3,500 jobs over the next two years. Today's news brings up a lot of questions, with the foremost being "how the hell did this happen?"

It was not that long ago that Jerome Kerviel racked up some pretty epic losses at Societe Generale through alleged rogue trades that involved bets worth around $68 billion. Those trades resulted in around $6.7 billion in losses at the French bank.

It is hard to fathom how UBS could have allowed a similar debacle to occur within its investment bank after seeing the fallout at Societe Generale in the wake of the Kerviel episode, which was heavily publicized across the world. But, it appears that UBS management has allowed it to happen to them.

The consequences are going to be painful - UBS shares have already lost 11.50% in Thursday's trading session. The culprit behind the losses is 31-year-old UBS trader Kweku Adoboli according to London police. This morning, UBS has been tight-lipped about the incident, saying that that no client money was lost and that the trades are still under investigation.

The bank put out a statement prior to the opening of U.S. markets which read, "UBS has discovered a loss due to unauthorized trading by a trader in its investment bank. UBS's current estimate of the loss on the trades is in the range of $2 billion. It is possible that this could lead UBS to report a loss for the third quarter of 2011."

A letter sent to employees underscored the unfortunate timing of the news. "While the news is distressing, it will not change the fundamental strength of our firm," the note said. "We urge you to stay focused on your clients, who are counting on you to guide them through these uncertain times."

UBS shares had already been under significant pressure prior to this incident. The stock has now lost around 32% in 2011 and better than 38% over the last year as investors fret over the bank's exposure to Europe's sovereign debt crisis.

UBS was also severely impacted by the U.S. mortgage meltdown in 2008 and nearly went bankrupt. The bank required a $60 billion bailout from the Swiss government amid massive losses on toxic debt.

On the professional networking site LinkedIn, Adoboli's profile shows that he spent the last five years working at UBS's European Equity Trading division and had previously spent three years as a trade support analyst at the bank. He graduated from the University of Nottingham in 2003 with a degree in E-commerce and digital business.

He is of African origin and was described by his former landlord as being quiet, well-dressed, and very well spoken. According to the landlord, Philip Octave, the trader lived in an expensive loft on Brune Street near London's Brick Lane. His rent amounted to $6,320 a month, suggesting that Adoboli was well payed in his role with UBS.

Swiss banking regulator Finma told the Associated Press today that they have been in contact with the Swiss bank regarding the incident. A spokesman added, "From the scale of this case you can be sure that it's the biggest we've ever seen for a Swiss bank."

The incident, which will prove to be quite costly for shareholders, is raising serious questions about UBS's risk management. "The real issue … over and above the financial impact is the reflection on risk management at UBS," said Fionna Swaffield, a banking analyst at RBC Capital Markets.

She added, "UBS was seen to have recovered significantly from the credit crisis and to have improved its risk management in the investment bank in spite of its struggle to improve returns. This obviously brings this very much into question."