UBS Recovery Fizzles as Gruebel Sees Less Profit
Oswald Gruebel is walking a tightrope. He can encourage UBS AG’s investment bank to take more risk or watch it fall further behind rivals.
UBS, Switzerland’s biggest bank, had the lowest revenue from sales and trading in the first three quarters of this year compared with eight main competitors and was the only one to report a third-quarter pretax loss at its investment bank.
The Zurich-based firm made more from trading stocks and bonds than the average of its competitors in 2005, before more than $57 billion of writedowns and losses from the credit crisis forced it to shrink the investment bank’s risk-weighted assets 44 percent. A lack of client business, combined with the lowest value-at-risk, meant UBS barely made enough in the third quarter to pay the 17,000 bankers in the unit.
“They have to start taking risk again or to pay less,” said JPMorgan Chase & Co. analyst Kian Abouhossein, whose recommendations on UBS produced the second-highest total returns over the past year, according to data compiled by Bloomberg. “The question is do you really need the best people in the market if you’re just running a very flow-oriented business? That’s the dilemma that they need to decide.”
Gruebel, 66, will probably reiterate his profit targets at a UBS investor conference tomorrow in London, analysts said. He intends to boost annual pretax profit at the investment bank to about 6 billion Swiss francs ($6.2 billion) and overall company earnings to 15 billion francs in the next two to four years. The securities unit earned 2.1 billion francs in the first nine months of this year.
UBS’s sales and trading revenue averaged $2.58 billion a quarter this year, 45 percent less than the average of $4.7 billion at Goldman Sachs Group Inc., JPMorgan, Citigroup Inc., Bank of America Corp., Deutsche Bank AG, Barclays Plc, Morgan Stanley and Credit Suisse Group AG, and 27 percent behind its own targets, data compiled by Bloomberg shows.
Gruebel, known as “Ossie,” set goals a year ago for the investment bank to be making more than 2 billion francs a quarter from trading bonds, currencies and commodities, and more than 1.75 billion francs from equities trading.
“In equities, they’re massively off what was a leadership position before the crisis,” said Christopher Wheeler, an analyst with Mediobanca SpA in London. “In debt trading, the 2 billion-franc target is not that mad, but Ossie will clearly have to change the mix of the business. He’ll have to put a bit more capital on the table because they’re playing catch-up.”
UBS was the second-biggest equities trader behind Goldman Sachs in 2005, taking home a 14.4 percent share of the total sales and trading-revenue pool. That share was 10.4 percent in the first three quarters of this year, as Credit Suisse, Morgan Stanley, JPMorgan and Bank of America overtook it, according to data compiled by Bloomberg from company reports. In debt trading, the bank’s share of the revenue pool shrunk to 5 percent from 8.6 percent in 2005.
Gruebel told German newspaper Welt am Sonntag last month that the investment bank needs to take higher risks again to keep up with competitors.
UBS, which declined to make Gruebel available for an interview ahead of tomorrow’s presentation, said in an e-mailed comment that he was referring to the bank’s “considerably lower value-at-risk,” or VaR, numbers compared with peers. “Higher value-at-risk will mainly be driven by increased client activity levels and the rebuild of selected client businesses,” the bank said. Neither Gruebel nor UBS said how much the bank would increase its VaR.
UBS cut risk-weighted assets at its investment bank to 126.2 billion francs in the third quarter from 225.2 billion francs in the first quarter of 2008. The bank’s VaR, a measure of how much it could lose in the markets on average in a single day, was $56 million in the third quarter, the lowest among its main competitors that report the data. By comparison, the gauge of risk was $121 million at Goldman Sachs and $142 million at Morgan Stanley. The two banks are based in New York.
“Relative to peers, UBS is still fairly under-risked,” said Dirk Hoffmann-Becking, a London-based analyst at Sanford C. Bernstein with an “outperform” rating on the company’s stock. “As a client-driven bank, you’re completely exposed to client activity swings. If there is no client phoning, then literally people sit there and twiddle their thumbs because they’re not allowed to do anything else.”
UBS put aside 83 percent of the investment bank’s revenue in the third quarter as compensation for employees. For the first nine months, that ratio was 56 percent, the highest compared with Barclays, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan and Morgan Stanley. Citigroup and Bank of America don’t report such data.
Chief Financial Officer John Cryan, 49, told analysts and investors last month that while the bank would like to bring that ratio to below 50 percent, UBS has to pay its people “to some extent regardless of the performance.”
“There is obviously a balancing act between the public interest in banks reducing their bonus or compensation payments generally, and what it takes to retain and attract stars,” Cryan said. “We are a living example of a bank that experimented with not paying people, and it didn’t come off very well in 2008.”
The bank cut the 2008 bonus pool for all employees, excluding U.S. brokers, by 78 percent to 2.16 billion francs, with most of that going to wealth-management staff. The reduction in variable pay was greater than at any other competitor, the bank said at the time.
UBS shares fell 5 percent in Swiss trading on Oct. 26 after the bank reported a 406 million-franc third-quarter pretax loss at the securities unit, even as wealth-management businesses attracted the first net new client investments since 2008. The stock advanced 0.9 percent by 2:07 p.m. today, bringing the gain this year to 6.2 percent, compared with a 4 percent decline in Bloomberg’s European banks index.
“Going forward Gruebel will be measured on what happens at the investment bank,” said JPMorgan’s Abouhossein, who is based in London. “The private bank has had a continuous improving trend, whereas the investment bank has not.”
Gruebel, who joined UBS out of retirement in February 2009, appointed Carsten Kengeter, 43, as sole head of the investment bank in September. The former co-head, Alexander Wilmot-Sitwell, 49, took on a new role this month as co-CEO of Asia Pacific. In January, the bank named Rajeev Misra, 48, and Dimitri Psyllidis, 44, formerly with Deutsche Bank and Merrill Lynch & Co. respectively, as co-heads of the fixed-income unit, and in May UBS appointed Yassine Bouhara, formerly with Deutsche Bank, and Francois Gouws, 45, to head the global equities business.
Gruebel hired more than 850 people to expand trading units and promised to pay bankers “market rates” after bonus cuts in 2008 led to defections. This produced some dividends: UBS beat its target in debt trading in the first three months and surpassed Goldman Sachs in revenue from stock trading in the second quarter.
“Unfortunately the recovery fizzled away a little bit,” said Mediobanca’s Wheeler, who cut his rating on UBS after third-quarter results to “neutral” from “outperform.”
Gruebel knows about trading and risk-taking first hand. His 37-year career at Credit Suisse, which he headed before retiring in 2007, started at the bank’s Eurobond trading desk in 1970. By 1991 he had become head of global trading. Under his leadership, the Zurich-based bank started cutting its holdings of U.S. subprime mortgage bonds in 2006, when competitors including UBS were still buying them.
Perils of Risk
UBS’s writedowns and losses from the credit crisis --second only to the Royal Bank of Scotland Plc among European lenders -- forced it to tap investors and the Swiss government for capital. Some of those losses were the result of a strategy pursued by the investment bank under the leadership of Huw Jenkins to boost debt-trading revenue after part of that business was spun off to the Dillon Read Capital Management LLC hedge fund in 2005.
“We saw what happened five years ago when UBS decided to catch up to rivals and take more risks, and that wasn’t a good idea,” said Dirk Becker, a Frankfurt-based analyst at Kepler Capital Markets who has a “buy” rating on UBS.
While the bank doesn’t need to build up big positions again, UBS could benefit from more inventory to help its market- making, he said. The bank’s trading assets amounted to 246 billion francs in the third quarter, less than half of the 654 billion francs it had at the end of 2005.
Gruebel told investors a year ago that he wants the investment bank to focus mainly on clients. To keep risks under control he started weekly calls with management of the securities unit and top risk officers. Kengeter is having risk calls and talking to traders every day, something that didn’t happen during the past four to five years before he joined, Cryan said in July.
A Swiss government-appointed committee, which examined how to limit risks from the country’s biggest banks, ruled out banning proprietary trading as the U.S. did in the Dodd-Frank Act. The Swiss regulator instead is raising capital requirements on trading assets from the beginning of next year.
UBS could benefit from increasing risk-taking in foreign exchange, equity derivatives and rates products, said Abouhossein, who has an “overweight” rating on the shares.
The bank’s revenue from equity derivatives fell 46 percent in the third quarter from the second, to 268 million francs, posting a bigger decline than cash equities and prime services. Revenue from the firm’s macro business, which includes foreign- exchange and rates trading, slumped 56 percent to 291 million francs in the same period, while credit trading, at 587 million francs, rose 27 percent.
Cryan said in an interview on Oct. 26 that UBS benefited from a higher frequency of trading in credit in the quarter -- a strategy Kengeter and Wilmot-Sitwell outlined a year ago. Instead of accumulating assets, the bank would trade more frequently, making higher returns without expanding its balance sheet, they said.
“They’ve been trading a lot,” Cryan said. “In credit they traded, and it moved up and down enough that they actually made very good revenue. In equities they traded, but it was moving sideways, and volatility wasn’t changing.”
The bank couldn’t benefit from the volatility in foreign- exchange markets, the business Cryan called “the big disappointment” in the third quarter, because it doesn’t do any proprietary trading there, he said.
UBS was ranked the second-biggest currency trader in the foreign-exchange market in 2009 behind Deutsche Bank, according to a survey by Euromoney Institutional Investor Plc. Deutsche Bank said foreign-exchange trading helped to boost the bank’s fixed-income revenue in the third quarter.
Deutsche Bank is probably benefiting from higher risk- taking in the business, while UBS lost market share during the crisis, Wheeler said. UBS’s share in the currency market shrank to 11.3 percent last year from 15.8 percent in 2007, according to the Euromoney survey.
“It’s going to be very difficult to wrestle market share from Deutsche Bank,” Wheeler said.
UBS may also try to build up commodities trading, which “has been one of the most enormous revenue machines” for U.S. banks, said Wheeler. UBS sold all of its commodities businesses during the credit crisis, except index and exchange-traded commodities and precious metals.
The bank in January hired Neal Shear, 56, a former Morgan Stanley executive who specialized in commodities for at least 18 years of his career there, to head its global securities business. In August, UBS appointed Jean Bourlot, a former head of agriculture trading at Morgan Stanley, as head of commodities in London.
As the bank tries to boost its trading revenue, the main target for UBS is not to let risks spiral out of control, said Hoffmann-Becking of Sanford C. Bernstein. “For UBS, the focus is on wealth management, and that means the first priority is nothing must ever blow up again.”
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