Swiss bank UBS, the world's largest wealth manager, beat forecasts with record second-quarter profits on Tuesday but warned market turmoil was likely to hit its investment banking business in the second half of the year.

In an explicit warning that the upheaval in credit markets is likely to take a heavy toll, UBS said if turbulent conditions prevailed throughout the third quarter, UBS will probably see a very weak trading result in the investment bank.

UBS shares were down 3.26 percent at 63.90 francs at 10:00 a.m. EDT compared with a 0.6 percent decline in the Dow Jones Stoxx European banking index.

UBS is the first big bank to comment on trading conditions since last week's havoc in financial markets forced central banks to intervene in the interbank lending market to restore order. Some analysts were taken aback by the grim outlook.

The gloomy outlook surprised after the fairly positive commentary in July from Credit Suisse and Deutsche Bank a fortnight ago, said Matthew Clark, an analyst at Keefe, Bruyette and Woods.

Net second-quarter group profit rose to 5.622 billion francs ($4.7 billion) from 3.147 billion in the second quarter of 2006 and 3.275 billion in the first quarter. It exceeded an average forecast of 4.751 billion by 11 analysts in a Reuters poll.

The result included a 1.926 billion franc windfall from the sale in June of UBS's 20.7 percent stake in Swiss private bank Julius Baer.

The results are fine. It's all about the outlook. You have some earnings downgrades coming, said Kinner Lakhani at ABN AMRO. It shows the extent of the drag from the investment bank, another example of the tail wags the dog.

UBS drew a line under its hedge fund, Dillon Read Capital Management, which it said it was closing in May after running up big losses. It said there would be no further costs after taking a pretax charge of 384 million francs in the second quarter.

Trading losses on the Dillon Read portfolio were 230 million francs in the second quarter after the fund lost 150 million francs in the first quarter, Chief Financial Officer Clive Standish told a news presentation.

The bank also said it had paid back 1.5 billion francs to outside investors following the closure.

ASSET MANAGEMENT BULWARK

The results are the first to be unveiled since Peter Wuffli's abrupt departure and replacement as chief executive officer in early July by Marcel Rohner, who formerly ran the bank's wealth management business.

Rohner said he was comfortable with the level of the bank's exposure in leverage finance with a market share of about 4 percent. He also said trading in U.S. mortgage-backed securities market was satisfactory.

In July we have experienced significant dislocation in the U.S. mortgage market, but we have had a satisfactory trading result, Rohner told a conference call with journalists.

Rohner said he believed opportunities would present themselves as the market turbulence played itself out.

We can use risk capacity more proactively when it comes to taking advantage of market opportunities. After the current disruption there will be opportunities, said Rohner.

Analysts said UBS may be erring on the side of caution by emphasising the risks ahead in its investment banking business.

A cynic would say it is in Rohner's interest to get all the bad news out now so he can concentrate on overdelivering, said Clark of Keefe, Bruyette and Woods.

The bank said its traditional strength in wealth and asset management would help see it through the second half, with weaker investment banking results offset by predictable earnings from wealth and asset management.

Rohner said the second-quarter results were outstanding even with the windfall from the sale of Julius Baer stripped out.

Net new money in wealth management was 35.2 billion francs, ahead of the average forecast for 32.2 billion.

Profits were boosted by record net fee and commission income of 8.099 billion francs, a rise of 26 percent over the same quarter last year.

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