LONDON (Reuters Breakingviews) - A misfiring investment bank could be the least of Sergio Ermotti’s problems. The UBS chief executive on Tuesday also reported a drop in wealth management profit during the second quarter. Overall, with revenue subdued, further cuts to high group costs may be Ermotti’s only way to hit 2021 targets.
The $46 billion Swiss bank used to be the exception to the rule that European investment banks underperform their U.S. peers. No longer. A solid performance advising on deals wasn’t enough to offset a 9% year-on-year drop in the Zurich-based lender’s bigger equities franchise, a bit worse than the average fall in equities revenue on Wall Street. That led to a one-fifth decline in the division’s pre-tax profit.
A bigger concern for Ermotti is a downturn in wealth management, UBS’s cornerstone business. The lender blamed crimped lending margins, subdued volatility and persistently low interest rates for a 12% year-on-year drop in underlying pre-tax profit. He wisely added that those challenges weren’t likely to disappear any time soon.
Nevertheless, UBS achieved a respectable 11.9% annualised return on tangible equity during the second quarter, a figure which would be the envy of many European peers. That’s because Ermotti managed to offset a 7% fall in first half operating income with an equivalent decline in expenses, including a sharp reduction in bonuses.
The rub is that such impressive cost control is not forecast to continue. True, UBS aims to get costs down to 72% of income by 2021, a 7 percentage point drop from 2018. But it predicts broadly flat expenses over the period, implying the bank needs annual revenue growth of about 3% to achieve its goal.
Yet the headwinds battering UBS’s top line – much like other European lenders – may well blow for a while. Assuming a 10% cost of equity, UBS shares should trade at around 1.2 times their tangible book value rather than below it. Cost cuts, not fickle revenue growth, provide the surest way for Ermotti to close that gap.
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