UBS, the biggest European casualty of the U.S. subprime crisis, said it was shrinking its investment banking business, cutting staff and drastically scaling down its exposure to risky investments.

The bank's CEO Marcel Rohner also said in a memo to staff it will spin off its distressed mortgage-backed securities holdings into a separate unit -- set up to wind down positions -- as part of a shake-up of its troubled investment bank.

Rohner said the bank was slashing staff in its real estate securitization business by half and scaling down the use of its balance sheet by the unit by two-thirds.

The move showed that UBS is struggling to get to grips with its damaged investment banking business after it made disastrous investments in securities backed by U.S. subprime mortgages.

These are in a state of meltdown after a growing number of borrowers with poor credit histories defaulted on loans, triggering a global credit crisis which has forced banks to take charges of more than $100 billion on their exposures.

It also highlighted that the crisis at the investment bank, which is being run by Rohner after the departure of its former head Huw Jenkins last year, is far from over.

It gives you the feeling there is still a fair degree of chaos at the investment bank and it points to the need for an overall manager, said a London-based analyst with a U.S. investment bank. It seems like a stabilization plan until they bring in someone new to head the business later this year.

UBS appeared to be having trouble finding a high-profile replacement for Jenkins to take charge of the investment banking business, adding fuel to speculation about the division's future, said analysts.

Rohner has said that investment banking is vital to the success of UBS's wealth management unit, the world's largest, and allows both businesses to prosper by referring clients and new business to each other.

UBS shares fell 1.7 percent to 44.74 francs by 1035 GMT.

BROKEN STRATEGY

Analysts said the memo implicitly recognized that UBS's former expansion strategy in investment banking was broken-backed.

The previous CEO spent a lot of money trying to build this business and this has failed. They are now cutting their losses here, said Dirk Becker at Landsbanki Kepler.

UBS said it was cutting proprietary trading -- or the risky buying and selling of securities on the bank's own account - which played a large part in its subprime woes.

UBS's peers in investment banking, including Citigroup and Merrill Lynch, are also trying to restructure their business and have laid off thousands of staff.

UBS has taken charges of $14.5 billion on its exposures to U.S. subprime mortgages and last month announced a 13 billion Swiss franc ($11.82 billion) capital injection from Singapore and an unidentified Middle East investor.

The Swiss bank's huge losses, which have prompted calls for it to spin off its investment banking business and concentrate on its highly successful wealth management activities, stem from a disastrous hedge fund venture into subprime mortgages.

UBS tried to stop the rot when it shut down the unit, Dillon Read Capital Management, in May but losses on its exposures mounted in the second half of the year as the global credit crisis worsened.

Rohner also said in the memo, obtained by Reuters, that UBS wanted to cut the concentration of risk on its balance sheet, exit U.S. principal finance and simplify its credit unit.

We have already improved efficiency and expect a total headcount reduction of close to 50 percent from the peak of last August, said Rohner, referring to the real estate securitization unit.

It said the unit, known as a workout group, set up to wind down the bank's tainted exposures to mortgage and asset-backed securities would reduce exposure to this asset class in an orderly manner while minimizing further downside risk.

Most of the headcount strike in the unit will affect UBS employees in the United States as the bulk of the bank's real estate securitization business is based there.

Some jobs in the unit have been slashed as part of the 1,500 job cuts UBS announced in October, a source close to the bank said. But the memo means that UBS will most likely announce further redundancies beyond that number, the source added.

The bank, which employs around 80,000 people worldwide, declined to comment.

UBS said in December that its estimated net exposures to high-risk super senior debt at the end of November was about $13 billion and exposure to subprime residential-mortgage backed securities was $16 billion.

(Reporting by Andrew Hurst; additional reporting by Olesya Dmitracova in London; editing by David Cowell)

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