Strategic choices start to pay dividends for UBS

Strong markets contributed to UBS's 88 per cent rise in first-quarter profits, but Switzerland's biggest bank was lifted by more than volatility, as analysts saluted the lender for turning a corner on cost cuts and sticking to its strategic plan.

"We made choices about our strategy and I would say that the kind of market we saw in the first quarter played well into the strategies we chose," Sergio Ermotti, UBS chief executive, told the Financial Times. "You look across the board: all businesses, all regions performed very solidly."

Wealth management was the big winner in UBS's post-crisis fightback, with the bank's 2012 strategic plan singling that area out for growth and investment. Investment banking became the poor relative, its resources capped so that it posed smaller risks to UBS's future.

Both areas delivered double-digit rises in the first quarter, with earnings in wealth management up 54 per cent to SFr951m ($1bn) and investment banking earnings rising 66 per cent to SFr774m.

"Market conditions helped them like everyone else but unlike their peers capital trends were solid and that is a big part of what is being cheered today," said Omar Fall, a Jefferies analyst, commenting on the bank's 7 per cent share price rise after the results were published.

The wealth management performance was linked to higher levels of client activity, lower costs, and strong inflows of new money. Client activity was boosted partly by customers hedging their risks for the Swiss franc, an activity that became far more popular after the Swiss National Bank unwound a peg with the euro in January.

Volatility also played a role in higher earnings at the investment bank, though the "old" investment bank, before UBS took a knife to it, would have benefited more since the Swiss bank is now very small in the rates business, where other banks enjoyed a strong performance in the first quarter.

Mr Ermotti said UBS had no regrets. "The reason why we have been successful in the last nine quarters is because we defined a clear business model with clear resource allocations and we stick to it," he said. "I don't think that we feel remorse about that."

If anything, he said, the first-quarter results vindicate UBS's decision on the investment bank, since it was able to increase earnings there without allocating more capital to the unit - in marked contrast with the performance of the bank's European rivals Credit Suisse and Deutsche Bank.

"Being able to deliver such strong investment banking numbers without impacting capital ratios, as seen at peers, is a key part of their 'balance sheet lite' investment banking model," said Mr Fall.

Kinner Lakhani, an analyst at Citigroup, said investors were not clamouring for UBS to pile back into trading activities. "Investors are focused on returns; there are larger players in the industry making worse returns than UBS," he said, adding that while UBS's fixed income franchise is smaller, the bank still has strong positions in equity derivatives and foreign exchange, which both benefit from higher volatility and risk appetite.

Analysts said UBS's performance on costs was one of the standout features of the first-quarter results. While revenues were up 22 per cent, profits almost doubled, as the percentage of the bank's revenue paid out on operating expenses fell from 81.1 per cent to 69.2 per cent.

Tom Naratil, UBS chief financial officer, said cost was "absolutely" more within the bank's control than revenues, adding that the decisions the bank had taken on its cost base had shielded it from the negative impacts of the January revaluation of the Swiss franc.

Analysts are hopeful of further progress on costs, particularly since the bank has singled out some costs as one-offs. "We're only going to create a group holding company for UBS once," Mr Naratil told a conference call, citing one example. He added that UBS will have spent SFr1bn on its new legal entity by the end of this year.

With such a strong first quarter, preventing disappointment for the rest of the year could be a challenge. Mr Ermotti has already warned analysts that the full-year result will not be the first quarter's multiplied by four, but it can be difficult to convince the market not to put too much weight on the most recent results.

"[That's] as dangerous as the one who sold the stock in the first quarter by multiplying the fourth quarter by four," said Mr Ermotti, referring to investors who sold UBS shares on a weaker fourth quarter.

"It's clear that you always have those dynamics, [but] the vast majority of our investors understand the long-term story: they are not looking at one quarter, they are looking at a path of quarters."

Jon Peace, an analyst at Nomura, said that even though UBS trades at a premium to other European banks, it trades at a discount to other private banks and higher-yielding banks. "There is clearly the potential for re-rating," he added, given the potential for UBS to trade at a higher valuation.

Mr Naratil certainly sees that happening. "If you look at the stability - the advantages of clear strategy, predictability, early start, disciplined execution - this is not a stock that should trade on 1.5 times book value; [it's] a stock that should trade over two times book," he said. "Over time as we continue to deliver consistently, the valuation certainly has room to go."

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