UBS euphoria overdone

October 30, 2012

By Dominic Elliott

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Investors are taking a rosy view of UBS’s ability to execute a radical strategy to hack back its investment bank. The Swiss wealth manager’s market capitalisation is up 4.4 billion Swiss francs ($5 billion) since the plan emerged. While UBS deserves applause, it may be getting too much credit up front.

Chief executive Sergio Ermotti has set out detailed and mainly realistic targets for a new UBS, such as lifting return on equity from below zero to 15 percent by 2015. This transformation will principally be achieved by closing the riskier fixed-income businesses of the investment bank, leaving advisory, financing and trading franchises focused on corporate and investment clients.

A lower-risk, less-capital intensive investment banking unit would delight UBS’s investors and wealth management clients alike. The group would probably then be judged alongside Julius Baer, which trades at a multiple of about 1.5 to book value versus UBS’s 0.9. On the current equity base, that would imply a market capitalisation of more than 70 billion Swiss francs.

The snag is the cost of getting there. The restructuring plan is expected to contribute to group-wide savings of 5.4 billion Swiss francs annually from 2015, costing 3.3 billion francs to achieve. Offsetting this is the loss of new business revenue in fixed income, last year worth around 4.3 billion Swiss francs. The cost-benefit analysis of this piece of the plan looks sound.

The trickier issue for investors is UBS’s dexterity in selling its existing fixed-income positions, including a large derivatives portfolio amassed during the credit boom. The target is to cut risk-weighted assets (RWAs) from about 90 billion Swiss francs to 25 billion francs by the end of 2017. Outside investors have little visibility as to how easy this will be. The pace envisaged implies that UBS regards the positions as liquid. And yes, the current benign market conditions spurred by central bank stimulus will help UBS find buyers.

The risk is that markets turn or that other banks copy UBS’s strategy and start disposing of similar portfolios, creating unwelcome competition for buyers. Either could lead to losses on the portfolio, which has a gross value of 560 billion Swiss francs. But UBS’s core tier 1 ratio of 9.3 percent under Basel III gives comfort it could cope with that scenario.

For now, UBS’s share price gain takes the pressure off Ermotti. He has a first mover advantage – and should press it home.

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