Finance

Lionel Laurent is a Bloomberg Gadfly columnist covering finance and markets. He previously worked at Reuters and Forbes.

Nobody expected UBS to dodge the pain of a very grim first quarter for banking. But the scale of its profit slump suggests more must be done to justify its premium valuation.

UBS reported a 64 percent plunge in first-quarter net profit, missing analyst estimates and looking weak next to rivals. BNP Paribas enjoyed a surprise increase in quarterly profit, for example, while HSBC earnings were better than expected. Even beleaguered Deutsche Bank beat forecasts last week with a mere 61 percent quarterly profit drop. UBS shares sank more than 6 percent on Tuesday.

The Swiss bank's reversal is all the more surprising as it's been an exemplar of post-crisis restructuring -- in an industry where foot-dragging is the norm. Under CEO Sergio Ermotti, UBS has moved aggressively to cut its reliance on volatile investment bank earnings and expand in wealth management, its crown jewel. The bank posted a best-in-class return on equity and revenue growth last year, as Bloomberg Intelligence's Alison Williams notes, and paid its juiciest dividend since the crisis.

Steady Payer
Ordinary dividends per share at UBS have risen
Source: Company data

Yet the first quarter shows the limit of UBS's power, especially where the global economy and client sentiment are concerned. Interest rates are stuck at rock-bottom, squeezing margins, while rocky financial markets hold back trading. UBS said transactional revenues from wealth management were at record lows for a first quarter, while declines in invested assets held back recurring fee income. "Paralyzing volatility," was how Ermotti described clients' risk-aversion.

It would be wrong to suggest that one poor quarter means he should change direction. Wealth management inflows have bounced back after a rough end to 2015, while operating expenses fell to their lowest in at least a year.

New Wealth
Net inflows at UBS in the first quarter were their highest in more than a year
Source: Company data

The profit drop was also exaggerated by one-off restructuring charges and currency effects. UBS offered some bright spots on its analyst call, saying the recent market turmoil was not yet a "new normal" and that the bank would act to lessen the impact.

Nevertheless, being one of the rare European banks trading above book value means it has to meet inflated expectations. It has delivered rising dividends, a strong capital base and high returns, with much of the good feeling around the Swiss bank to do with its discipline on cost.

That's why a cost-to-income ratio of 85.7 percent in the first quarter is worrying, marking a deterioration from the same period last year (when it was ahead of rivals). 

Costly Quarter
UBS's cost-to-income ratio looked lackluster in Q1
Source: Company data

Blaming the economy won't help if UBS doesn’t keep its reputation for leading the way on cost control. The ratio needs to be about 70 percent to get profit back on track, according to Kepler analyst Peter Casanova. 

It has certainly been willing to make hard choices: it's cut 10,000 jobs in three years and 2015 was only the second annual increase to overall bonus payouts since 2010. If the economic clouds don't clear soon, it's going to need to hang tough on spending. Staying ahead of Europe's wounded banking pack depends on it.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lionel Laurent in London at llaurent2@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net