UBS can afford to delay radical surgery

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UBS, which kicked off Europe's bank earnings season on Monday, couldn't disguise its miserable fourth quarter.

Earnings from most divisions fell short of analyst estimates: margins in wealth-management stagnated and investment-banking revenue was its lowest in at least a year. The lack of market volatility and negative interest rates in Switzerland and Europe are hurting.

Still, CEO Sergio Ermotti is right to resist the temptation of a drastic reboot and stick to his strategy — setting out on Monday what he called an upgrade, with fresh financial targets and a share buyback.

UBS’s challenge is not turning itself around or restructuring itself on the scale of Deutsche Bank or Credit Suisse. It took the big decisions to shrink massively, slash jobs and focus on wealth management over risky trading years ago.

The challenge is more in its valuation: at 1.3 times estimated book value, the Swiss bank trades on par with U.S. or Scandinavian peers and well ahead the European average. That’s hard to justify at a time when Donald Trump is giving his home team a leg-up with corporate tax cuts and a deregulation drive, and the Fed is raising interest rates.

There are a few reasons to be confident. UBS’s pledge to buy back 2 billion Swiss francs of shares over the next few years and increase its dividend is a sign the bank thinks it can handle tougher financial regulations that force it to carry bigger capital buffers.

At 13.8%, UBS’s capital ratio is no longer a world-beater as struggling peers like Deutsche Bank catch up, but the difference is that the Swiss bank has a long-term, multi-year track record of balance-sheet strength, cost cuts and paying dividends.

The buyback puts more water between UBS and its European peers, several of which have, by contrast, tapped investors for more capital. And the fourth quarter was unlikely to be much better for the rest of UBS’s peer group.

Ermotti is taking care to rule out any strategic back-sliding on business diversification. Wealth management will still be the focus over investment banking. That, again, is probably right. There is still little evidence that now is the time to be splurging cash or taking risks on trading, with volatility still low and jobs still being cut on Wall Street and in the City.

UBS says it will take care to limit the proportion of its balance sheet devoted to the investment bank about to a third. If volatility returns and M&A volumes rebound, it should benefit as well. And as competitive as the wealth-management market is, with passive products swallowing flows and low rates pressuring margins, UBS has the scale and market share to offset these pressures through controlling expenses. Again, there’s precedent: UBS has cut a net 2.1 billion francs of costs since 2013.

The final point of UBS’s message is that technology, rather than trading, is the big long-term challenge for banks. About 10% of revenue will be invested in tech, or a cumulative 1 billion francs by 2020. This should help to bolster efficiency, client relations, and regulatory compliance. But it also helps keep disruption at bay.

UBS has proven it can ride out the big challenge of the past decade — regulation — and wants to make clear it is getting ready to ride out the next one. In that context, an upgrade looks more sensible than a reboot.

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