UBS prepares for a less profitable future

UBS prepares for a less profitable future

Be more careful. Like a driver who has just had a harrowing accident, the new management team at UBS has learn its lessons. For the Swiss bank’s shareholders, the future ride will be less profitable.

The accident was frightening. Losses of $4.4 billion (Rs17,336 crore) on US mortgages dragged UBS to a loss of swiss franc 830 million in the third quarter. Both those negative numbers were a little worse than the bank had suggested a month ago. Marcel Rohner, the new chief executive, also made it clear that more mortgage write-downs are likely. Delinquency trends on the bank’s mortgage portfolio, valued at $39 billion, are discouraging.

So Rohmer wants to pull back. He realizes that hedges don’t always work—in the mortgage businesses, they only reduced the losses by 21%. The only sure way to take fewer risks is to make fewer and smaller bets.

But the bank’s balance sheet has been moving in the wrong direction. The tier 1 capital ratio, the industry’s standard measure of capital strength, has declined from 12.2% to 10.6% in the last year. In other words, UBS needs to cut its risk-weighted assets—a measure of exposure to risk—by 15% just to get back to where it was a year ago. If it wants to become truly conservative, the cutback will have to be greater.

The declining tier 1 ratio stems largely from the peculiarities of bank regulation. But the message is not an accounting fluke. For the past few years UBS’s trade-off of risk and return was actually less attractive than it thought at the time.

So now the investment bank—which contributed 40% of the company’s operating profits in 2005 and 2006—will try to be less daring. That should allow the solidly profitable and steadily growing wealth management businesses to shine.

But with lower risks come lower returns. UBS’s return on equity is likely to fall from the 27-28% reported in 2005-06 to the company’s 20% target—generating earnings per share of about swiss franc 5.60. The shares are selling at 11 times this base earnings level. That’s not high, but it isn’t likely to increase until the mortgage write-downs come to an end.