Orcel's promise to end the cuts at UBS's IB looks premature

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Remember July 12th? Remember the post-Brexit period of summer sun and sideways glances at neighbours with the St. George's cross still in their windows? This was also the date when Andrea Orcel, head of UBS's investment bank stepped up and declared it was all over: that the time of cost cutting in his business had passed.

“We are exactly where we should be to face the environment that we have, to face the regulation that we have,” said Orcel, adding that the caveat this might have to be revisited if market conditions worsened, regulations tightened, or competitors upped their game.

Well, guess what? Three months later, that time has come.

1. Market conditions have worsened 

As Deutsche Bank's useful 'KPI charts' highlighted last week, things are deteriorating - particularly in the equities markets where UBS is particularly strong. In the first quarter of 2016, UBS generated CHF920m of revenues in its equities division. By the second quarter, this had fallen to CFH878m. By the third quarter, it was CHF797m. Admittedly, equities revenues were once as low as CHF174m (Q3 2012), but the direction of travel is clearly not as Andrea intended...

2. Regulations have tightened 

Regulations haven't tightened yet, but they will do soon. Basel IV and its bag of regulatory tricks is coming and Bernstein Research estimates it could cut 200 to 600 basis points from UBS's core equity tier one capital ratio.

More to the point, regulatory costs at UBS are increasing fast. As the chart below, from UBS's presentation today shows, temporary regulatory programme costs allocated to UBS's corporate centre have increased from CHF0.2bn to CHF0.7bn in three years. At the same time, annualized permanent regulatory costs allocated to business divisions have increased from CHF0.2bn to CHF0.6bn.

During today's analyst call, UBS CEO Sergio Ermotti said regulatory costs are likely to rise even higher in future.

Cost cutting in the corproate centre as regulatory spending rises

UBS regulation chart

Source: UBS

3. Competitors have upped their game

And then it looks like UBS is losing market share.

As the chart below, from Bernstein Research shows, UBS lost market share in every single business line both year-on-year and quarter-on-quarter in the past three months. Even Deutsche Bank and Barclays performed better.

UBS investment bank Q316

Source: Bernstein Research

4. Costs are eating away at profits in UBS's investment bank and it can't seem to do anything about it

The upshot of all of this is that costs are eroding the profitability of UBS's investment bank and not much appears to be being done about it.

As the chart below shows, UBS is now right behind Deutsche Bank's global markets division when it comes to costs eating away at revenues. UBS's investment bank staff are doing ok: in the first nine months of the year they accrued average compensation of CHF476k ($479k, £394k). Headcount at the investment bank was lightly trimmed in the third quarter - but it was nothing too nasty: 97 people went out of 5,014 in total. A mere flesh wound.

This matters. It matters, because as Chirantan Barua at Bernstein Research argued in August, UBS looks a lot like a bank with a fixed cost base. Revenues at UBS' investment bank fell 14% year-on-year in the third quarter and were down 6% in the first nine months.

Unless things change, Orcel will need to retract his statement of July. It's always possible to cut costs, but sometimes it's painful. Orcel spared his staff in the third quarter, but he can't do so forever.

Contact: sbutcher@efinancialcareers.com

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