Ermotti's Headache

For UBS, the Best Isn’t Yet To Come

A jump in trading revenue can't hide the sense the best is past.
Photographer: Christopher Goodney/Bloomberg
JPMORGAN CHASE & CO
-1.83
At Closing, May 18th
111.13 USD
UBS GROUP AG-REG
-0.14
At Closing, May 18th
15.99 CHF

UBS Group AG CEO Sergio Ermotti is running out of goodies to sustain the Swiss bank’s premium valuation.

After a poor end to 2017, he tried to placate shareholders with buybacks. Now, he is counting on growth at the investment bank to drive future returns. But with a blowout quarter for trading behind us, and more work to do to reduce costs, investors are selling. UBS has had a head start on its peers in turning itself around, but the outlook from here looks tougher.

Premium Problem

Unlike many of its peers, UBS trades at a premium to book value

Source: Bloomberg Intelligence

Ermotti's problem is of the first-world kind. UBS trades at a 20 percent premium to book value after the lender opted to shrink its investment bank in favor of lucrative wealth management. That means the bank isn't under pressure to restructure its operations in the way that Deutsche Bank AG or Credit Suisse Group AG are -- but it does need to keep returning capital and trimming costs.

Even after its results beat analyst estimates, the Swiss bank's stock fell four percent -- much like UBS's Wall Street peers, which, despite strong jumps in first-quarter trading revenue, saw their shares fall after earnings.

Bumper Quarter

Revenue at UBS's investment bank jumped to the highest in more than a year

Source: UBS

Part of the issue is that, for trading, the best now looks to be behind us. As good as UBS’s 25 percent jump in equities trading revenue was (in dollar terms), it's unlikely to be repeatable in the short term as stock-market volatility has subsided since February. That’s good for the deal-making and underwriting businesses, but less so for the trading operation, which generates almost half of UBS's investment-banking revenue.

Ermotti told Bloomberg Television that investment banking was a business ripe for growth -- indeed, division head Andrea Orcel is targeting “aggressive” U.S. expansion -- but the market’s animal spirits still seem a lot tamer.

Another issue is that even UBS’s money-management arm, whose Swiss heritage is seen as a key competitive advantage, isn’t immune to some of the big structural shifts taking place in the business. The rise of passive investing, the pressure of low interest rates and the drive for technological efficiency are eroding margins and eating into costs. Net margins on invested assets at UBS’s global wealth-management unit have ticked down year-on-year on an adjusted basis, and costs are eating up almost three-quarters of revenue -- even more so in the U.S. business.

One shouldn’t overstate the scale of the challenges facing UBS. These are fixable problems, and the bank has a track record of cutting costs and handing back cash to investors. The buybacks, while not exactly a long-term strategic solution, should count in the firm's favor.

But the similarity with other bouts of post-earnings sell-offs on Wall Street shows that investors are more concerned about the headwinds facing the industry. Interest rates, though close to record lows, are on the rise. The regulatory burden is still a drag. The past decade’s borrowing binge from corporate clients is unlikely to continue. Global trade is vulnerable to geopolitical tensions. You don't have to be especially gloomy to see that the horizon is darkening.

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:
    Edward Evans at eevans3@bloomberg.net

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