UBS stumbles towards a solution
The annual report for 2012 released by UBS in March demonstrated that its management continues to flounder, while offering perverse hope that the disaster-prone bank might be stumbling towards a sustainable business model.
The disclosure in the report that investment bank head Andrea Orcel was paid SFr24.9 million ($26.4 million) to join UBS last year drew widespread condemnation, and rightly so. The simple act of handing such a lavish ‘golden hello’ payment to a new hire speaks very poorly for the judgement of UBS group CEO Sergio Ermotti.
UBS was still reeling from Kweku Adoboli’s unauthorized trading loss of $2.3 billion when Orcel was hired, and senior managers were already involved in negotiating a settlement of charges of Libor manipulation that would lead to payment of a $1.5 billion fine in December.
Ermotti might have thought that hiring his former colleague Orcel from Bank of America Merrill Lynch would send a signal that UBS was replacing a focus on sales and trading for its investment bank with a move towards reliance on Orcel’s expertise of corporate finance.
That never made much business sense. The revelation that Ermotti thought it was worth forking out $6 million in cash and 1.76 million shares valued at SFr18.5 million to persuade Orcel to act as figurehead for this change in course makes the hire seem even more egregious.
Ermotti also thought it was appropriate to take a 2012 payment of SFr8.87 million for himself, despite the fact that UBS lost SFr1.77 billion during the year. The compensation totals for Orcel and Ermotti were just two of the many jarring disconnections between rhetoric and reality in the UBS annual report.
UBS is in some ways a leader in terms of disclosure among global banks. It provides a more granular breakdown of the revenue generated by different business groups within its investment bank than its peers, for example. And it certainly cannot be accused of trying to skip over business-model issues – the 2012 annual report runs to almost 500 pages.
But page after page of the report demonstrates either a woeful lack of ambition or a tacit admission that senior managers at UBS have few good ideas about how to address the many problems at the bank.
The lack of ambition is most glaring in the provision of details about recent cost-to-income ratios in different parts of the bank and the targets for future ratios. The traditional investment banking industry practice of handing much of its revenue to employees in the form of generous compensation deals has at least undergone some modification since the credit crisis.
JPMorgan, for example, managed to cut its compensation-to-revenue ratio to 32% for its investment bank in 2012, after recording a 36% ratio in both 2010 and 2011. JPMorgan’s total investment bank overhead ratio, including non-compensation costs, was a respectable 62% for 2012, which compared well with other firms such as Credit Suisse, Deutsche Bank and Morgan Stanley, which all recorded ratios above 80%.
UBS was even less efficient than these banks. The cost-income ratio for the investment bank at UBS deteriorated from 107.7% in 2011 to a shocking 132.3% in 2012. After stripping out impairment losses, restructuring charges and assorted benefits credits, the cost-income ratio for 2012 was 94.5%, meaning that UBS only just managed to generate enough revenue to cover employee compensation and other direct costs, even when it ignored actual losses.
In terms of future efficiency goals, UBS said that it has a target of 60% to 70% for a group cost-income ratio from 2015 onwards. That seems attainable, if far from ambitious, given that its wealth management and retail banking businesses already have lower costs as a proportion of revenue than its investment bank.
The goal of achieving a cost-income ratio of 65% to 85% for the investment bank, while delivering a pre-tax return on equity in excess of 15%, seems far more of a stretch, given the poor performance of the unit in recent years.
But here is where the grim details in the 2012 annual report might actually provide some perverse cause for optimism on the part of UBS shareholders. UBS has already given its stock price a shot in the arm by its public commitment to a withdrawal from much of the fixed-income sales and trading markets. Since its retreat from fixed income was announced last October, UBS shares have outperformed a broader banking sector that was itself staging an impressive rally.
Pre-announcing a withdrawal of this type that cannot be executed swiftly does not make much tactical sense to senior bankers at other firms. They point out that it places UBS in a weak position when it comes to pricing exit trades and deters existing customers from rolling over deals, leaving aside the devastating effect on motivation and morale among the employees left in the rump fixed-income business. But there is no disputing the effect the announcement had on the UBS stock price.
The outrage over the golden hello paid to Orcel in 2012 and other examples of a failure to control compensation costs might encourage the bank’s board members and external shareholders to press for further radical changes at UBS in the form of cuts at the investment bank.
Chairman Axel Weber does not have any reason to buy into spurious reasons for elevated investment banker pay levels, given his own background as a regulator who ran the Bundesbank and an academic. Weber got only a measly 200,000 UBS shares as a ‘golden welcome aboard’ for 2012, for example, compared with the 1.76 million shares awarded to keep Orcel in the lifestyle to which he had become accustomed at Bank of America Merrill Lynch.
Given that Weber, Ermotti and Orcel have an aligned interest in a further rise in UBS shares, the trio can perhaps be expected to reach an accommodation on lowering costs in the investment bank. Orcel has already been a big beneficiary of the withering of the investment bank. The 1.76 million shares that were valued at SFr18.5 million when they were granted to Orcel on his arrival last year are now worth around SFr28 million.
Indignation about his golden hello is likely to prevent any similarly extravagant hiring gestures in the future and to constrain any expansionary policies he might have had in mind for remaining portions of the investment bank. Orcel is not an obvious choice for the cost-effective management of a declining investment bank, but his hiring fee might at least signal the beginning of the end of a culture of over-payment at UBS.