Bloomberg News

ZURICH - Four months ago Luqman Arnold expressed optimism that he could scale back costs at UBS Warburg, the securities and investment banking arm of UBS AG, Switzerland's largest bank, without "cutting into the muscle.''

Mr. Arnold, UBS AG's executive board president, told a financial services conference in April that he wanted to add jobs in investment banking at UBS Warburg - just as its rivals had begun firing. "We are in a war for talent, because the danger is that looking back, people would accuse us of not taking advantage of this opportunity,'' Mr. Arnold said.

But after having posted a 33% drop in second-quarter net income on Tuesday, he may find he has no choice but to cut some muscle - bonuses, salaries, jobs - to keep profits from falling further, according to investors and analysts.

UBS said its second-quarter profit of $820 million had been dragged down by losses at UBS Capital, its private equity arm.

Private equity firms typically fund about 60 percent of their acquisitions with debt that they then repay from the acquired company's earnings. They aim to sell their investments at a profit after three to seven years, usually through initial public offerings of stock. In the current slumping market for initial public offerings, such profits are not being realized.

UBS executives "have to get a grip on costs,'' said Sandro Monti, a fund manager at BSI-Banca della Svizzera Italiana, whose Multihelvetia fund includes UBS shares. "When you talk about cutting costs, you're talking about cutting salaries, reducing bonuses or, if that fails, letting people go. You can't rule that out."

On Tuesday, Mr. Arnold reiterated that UBS would try to pare costs in some areas as it adds staff in others.

"Discipline on costs is essential, but we will not take drastic cost-cutting measures that will jeopardize client relationships," Mr. Arnold told analysts and reporters in Zurich.

UBS Capital's $207 million second-quarter loss accounted for half of the UBS profit decline. Writedowns also caused the unit to lose $160 million in the first quarter. Mr. Arnold said in a prepared statement that UBS Capital "does not expect significant additional losses this year.''

In May, Mr. Arnold had told investors: "We expect UBS Capital to be profitable for the next nine months.''

Also in May, after a quarter in which revenue from stock trading and underwriting fell 20%, UBS Warburg said it planned to fire as many as 240 employees, or 4%, of its 6,000-employee London staff.

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