Kengeter’s Thwarted UBS Plan Spurs Gruebel Cuts to Buoy Returns

UBS Investment Bank CEO Carsten Kengeter
Carsten Kengeter, chief executive officer of UBS AG's investment bank. Source: UBS via Bloomberg

Carsten Kengeter, charged with rebuilding UBS AG’s investment bank two years ago, is being thwarted by regulators and the departures of top managers. Analysts say that may be for the better.

Since 2009, when Chief Executive Officer Oswald Gruebel gave Kengeter the task of returning the money-losing unit to an annual pre-crisis profit of 6 billion Swiss francs ($6.7 billion) by 2014, its revenue has trailed that of competitors, including Deutsche Bank AG and JPMorgan Chase & Co. The Zurich-based firm’s share of fees and trading revenue declined the most of any of the world’s nine biggest investment banks over the past five years, according to data compiled by Bloomberg.

Gruebel, 67, described the unit’s performance in February as “not yet satisfactory” and said he would cut costs if revenue didn’t increase. In the past two months, four of the 10 business heads who reported to Kengeter have said they’ll leave.

“They’re not going to be able to repair this bank back to pre-crisis levels,” said Simon Maughan, co-head of European equities at MF Global Ltd. in London, who has a “sell” rating on UBS. “Too much damage has been done, and the world has moved on. Gruebel needs to revise down his targets for the investment bank, as they aren’t going to meet them. The market knows they haven’t got a chance.”

Capital Rules

Gruebel may cut his targets for the investment bank because they were set before the Basel Committee on Banking Supervision stiffened its rules last year, forcing lenders to set aside more capital for their riskiest operations. Swiss regulators have forced UBS and competitor Credit Suisse Group AG to fulfill Basel’s stricter requirements on trading-book capital since January, a year before their international competitors.

The Swiss government, which rescued UBS with a 6 billion-franc capital injection during the financial crisis, last year proposed making the country’s two biggest banks hold almost twice as much capital as the new Basel rules will require starting in 2019. That means Swiss banks would have to earn twice as much as international competitors to achieve the same return on equity, a measure of profitability.

“These banks are very big relative to the Swiss national balance sheet,” said Simon Johnson, a professor at the Massachusetts Institute of Technology’s Sloan School of Management and a Bloomberg News columnist. “They can’t afford to get into an Iceland or Ireland type of situation.”

Cutting the fixed-income unit’s 8 billion-franc annual revenue target by half would reduce the capital consumed by the division and improve UBS’s return on equity by 17 percent, according to Nicholas Watts, an analyst at Redburn Partners LLP in London who has a “buy” rating on UBS shares. The bank’s shares are up 5 percent since the start of the year.

Missing the Boom

UBS, which ratcheted down risk after taking more than $57 billion in writedowns and credit losses during the financial crisis, missed out on the boom of 2009. It was the only one of the nine biggest investment banks to report a loss from fixed-income trading that year.

More than 1,700 people were hired across the investment bank in the past two years to replace bankers who were fired or had left. As fixed-income trading revenue came close to UBS’s target in the first half of 2010, Europe’s sovereign debt crisis struck, and revenue fell by more than half in the second six months of the year.

“I don’t think investors either think that it’s particularly achievable or particularly desirable” for UBS to return earnings to their pre-crisis level, said Piers Brown, a London-based analyst at Evolution Securities Ltd. who rates the bank a “buy.” “If they came out with a more modest, realistic set of targets that would, perversely, probably increase the valuation of the securities unit.”

Kengeter Takes Charge

Kengeter, 44, joined UBS in December 2008 from Goldman Sachs Group Inc. to help restructure the fixed-income business that was most responsible for record losses in the crisis.

Gruebel, a former bond trader and CEO of Credit Suisse, came out of retirement in February 2009, and two months later put Kengeter in charge of revamping the entire investment bank along with Alexander Wilmot-Sitwell. Wilmot-Sitwell, 50, moved to Hong Kong last year to help run the bank’s Asian unit, leaving Kengeter as the sole head. UBS declined to make Kengeter or Gruebel available for an interview for this story.

The investment bank posted its first annual pretax profit in 2010 since 2006. The gain of 2.2 billion francs accounted for 29 percent of UBS’s total earnings. By 2014, the securities unit aims to generate 40 percent of the bank’s 15 billion-franc profit target. It produced a pretax return on equity of 8.7 percent in 2010 compared with the 45 percent return made by the division that includes wealth management and Swiss banking.

Market Share

“The wealth-management business is very profitable, and that is still a very, very good business to have,” said Guy de Blonay, who manages 1.5 billion pounds ($2.4 billion) including UBS shares at Jupiter Fund Management Plc in London. “Where the story has to improve and become the big driver for earnings over time is the investment bank. Nobody is really believing that Gruebel will reach his target” for fixed-income revenue.

Kengeter told Swiss magazine Bilanz in an interview published in December that he wants to bring UBS’s equities business to the No. 1 spot and fixed-income trading to a top-five place globally.

UBS ranked fifth in fixed-income trading in 2004, when John Costas headed the investment bank, and was second only to Goldman Sachs in equities trading, which includes the sale and trading of stocks, equity derivatives and services for hedge funds, according to Bloomberg data. The investment bank has since gone through five CEO changes and six management replacements at the debt-trading unit.

Revenue Trails

UBS was fifth in equities last year and ninth in fixed income, Bloomberg data show. The figures may not be fully comparable because European banks such as UBS and Deutsche Bank use different accounting standards from their U.S. counterparts.

While UBS doubled its share of the more than $180 billion of revenue from trading and investment banking produced by the nine biggest investment banks last year from the previous year, it was still the smallest, trailing Goldman Sachs, JPMorgan, Bank of America Corp., Citigroup Inc., Deutsche Bank, Barclays Plc, Morgan Stanley and Credit Suisse, Bloomberg data show.

The lender’s 6.9 percent share of combined revenue last year was 2.9 percentage points lower than its 2006 level, the biggest drop among the nine banks, when adjusted for gains or losses from banks’ own credit spreads that some firms report as revenue, the data show.

‘Damaged by Events’

The firm’s share of fees from advising on mergers and acquisitions, underwriting stock and bond sales and syndicated lending this year is at its lowest level in more than a decade, according to New York-based consulting firm Freeman & Co. UBS may be missing out on some larger deals because constraints on its balance sheet limit the amount of financing it can offer, former UBS bankers said.

“The bank clearly has issues,” said Evolution’s Brown. “On the equities side, the franchise has definitely been damaged by events of the last two to three years. There is no doubt that they don’t have the same traction in either cash equity or on the advisory side that they had pre-crisis.”

In 2010, UBS was a top-three player in only cash equities trading, one of the 12 main investment-bank businesses, according to Christopher Wheeler, a London-based analyst at Mediobanca SpA. There the bank’s position is being threatened by increased competition from banks including Credit Suisse, JPMorgan and Barclays, he said.


UBS saw the biggest improvement last year in credit trading, which includes underwriting, sales and trading of bonds, derivates, notes and loans. It posted revenue of 2.3 billion francs, more than double the 2014 target. Credit trading will be one of the areas within the investment bank most hurt by the changes in capital rules, according to Wheeler’s estimates.

The bank will assess each of its investment-banking units on a “desk-by-desk basis” to boost returns, Chief Financial Officer John Cryan said in February. The bank may seek to “de-emphasize some businesses that look as though we can’t make them profitable or they use too much capital for the profit potential,” he said.

The bank is “optimizing our business mix in light of the regulatory environment,” spokesman Dominik von Arx said in an e-mail. “We are assessing the impact of the new capital standards and taking appropriate action as needed.”

With revenue slow to rebound, the bank is cutting costs. UBS probably reduced headcount at the investment bank by about 5 percent in the first quarter to reflect a “less buoyant revenue environment,” Huw van Steenis and Hubert Lam, analysts at Morgan Stanley, said in an April 13 note to clients.

Pay for Performance

Gruebel has said UBS wants to link pay more directly to performance. While average compensation in the investment bank rose last year, some underperforming bankers had their pay cut, according to current and former bankers who asked not to be identified because they weren’t authorized to speak. Levels of voluntary attrition at the bank are lower than before the crisis, von Arx said.

The four senior bankers leaving this year are Neal Shear, a 56-year-old former Morgan Stanley executive who headed UBS’s securities business for about a year; Dimitrios Psyllidis, 44, co-head of fixed income who’s leaving for personal reasons; John Wall, a UBS veteran of more than 23 years and co-head of investment banking since September 2009, who retired last month; and Matthew Koder, head of the global capital-markets business, who took a job at Bank of America. All four declined to comment, didn’t return phone calls or weren’t reachable.

‘Vicious Circle’

“It’s a vicious circle,” said Chris Roebuck, a visiting professor at Cass Business School in London, who has worked at UBS, HSBC Holdings Plc and KPMG LLP. “Once you’ve lost senior people, more think about leaving.”

Other departing bankers include European mergers co-head Pat Guerin, 40, who left for Citigroup last month; Stuart Hendel and Charlotte Burkeman, who are moving to Bank of America as global head of prime brokerage and co-head of prime brokerage for Europe, the Middle East and Africa; Michael Vasseghi, head of U.S. macro structuring, who joined the bank in 2010; and Greg Morris, head of U.S. equity structured products distribution.

“The recent comings and goings in the management team at UBS have raised some eyebrows,” said John Purcell, managing director at executive search firm Purcell & Co. in London. “In particular, the loss of Koder will smart. Some of the other departures UBS will feel quite relaxed about and are just natural attrition and the rough and tumble of City life.”

UBS needs to come up with a new plan for its investment bank to alleviate uncertainty that may be pushing some bankers to leave, said Mediobanca’s Wheeler, who has an “outperform” rating on UBS and expects the bank to disclose the results of its business review later this year.

“People don’t like uncertainty,” Wheeler said. “The problem that everyone is wrestling with is: Can you shrink an investment bank of that scale, and will that mean that you would lose a lot more people? It’s a very difficult one.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE