UBS Needs ‘Strong’ Investment Bank Amid Cost Cuts, Naratil Says

UBS AG needs a “strong and competitive” investment bank, Chief Financial Officer Tom Naratil said, as analysts suggested the lender may scale down the business amid a review of financial targets.

UBS will cut expenses in “any places where cost-income ratios aren’t in line with our expectations,” Naratil said today in an interview in Zurich. “However, I really do want to emphasize the importance of an investment bank to our wealth management franchise.”

The investment bank’s cost-to-income ratio of 78 percent was the second highest in UBS, after the 90 percent posted by its wealth management Americas unit. UBS said earlier today it won’t reach a 15 billion-franc ($18.7 billion) pretax profit target by 2014 and will cut jobs to help save as much as 2 billion francs over the next two to three years.

“We expect that the investment bank, especially the fixed income, currencies and commodities business, will bear the brunt of the costs initially, but cost cuts are likely to come across the organization,” Peter Thorne, an analyst with Helvea SA, said in a note. “We look for capital to be taken out of the investment bank eventually.”

Without scaling back and reducing the capital it uses, about 90 percent of the cost cuts would need to come from the investment bank to increase the unit’s pretax return on equity to 12 percent, Huw van Steenis, a London-based analyst at Morgan Stanley, said on UBS earnings conference call today. The unit’s return on equity, a measure of profitability, was 7.9 percent in the second quarter compared with 21 percent a year earlier.

‘Big Question’

UBS didn’t provide details on the cost cuts because they’re still in the “early stages” of planning, Naratil said. More than half of the investment bank is needed to support UBS’s wealth management business, Chief Executive Officer Oswald Gruebel told analysts and journalists.

“I think in the end, it comes down to 50 percent to 75 percent probably would be needed to keep our wealth management going,” Gruebel said. The “big question” is how large the trading business needs to be.

Gruebel and Carsten Kengeter, 44, who runs the investment bank, have been trying to revive earnings at the division for two years. They hired more than 1,700 people across the investment bank and brought in new business heads, including Rajeev Misra and Yassine Bouhara, former executives at Deutsche Bank AG, Europe’s biggest investment bank by revenue, to replace people that left or were fired.

Risk Taking

UBS’s revenue from sales and trading of stocks, bonds, currencies and commodities fell 28 percent in the second quarter from a year earlier even as the bank’s risk-taking increased. The investment bank’s average value-at-risk, a measure of how much it could lose in the markets in a single day, rose to 75 million francs from 48 million francs a year earlier, with the biggest increase in risk from credit spreads.

“We did take on more risk in credit in particular earlier in the quarter,” Naratil said. “We did take that down” and “started the third quarter in a more conservative position.”

UBS’s investment bank piled up 57.1 billion francs in cumulative losses during the three years through 2009.

The bank may seek to reposition the securities unit toward businesses that use less capital because of the stricter regulatory requirements and reduce some fixed-income activities, said Teresa Nielsen, an analyst at Vontobel Holding AG in Zurich.

“UBS and a lot of other investment banks will probably focus on businesses such as advisory or cash equity trading where balance sheet isn’t used,” Nielsen said.

Stricter Rules

The Basel Committee on Banking Supervision proposed stricter capital rules for lenders worldwide last year and the Swiss government, which rescued UBS with a 6 billion-franc capital injection in 2008, came up with additional demands for UBS and Credit Suisse Group AG. This may make some investment-banking businesses unviable at the same time that risk aversion among clients concerned about Europe’s sovereign debt crisis is hurting earnings.

The bank may also cut some costs among the support functions for wealth management, even though UBS said that client advisers won’t be affected, according to Nielsen.

“There is probably still some fat to cut in wealth management,” she said.

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