UBS 'business model is gone' — and rich clients could follow

Sergio Ermotti, installed as UBS AG's interim Chief Executive Officer after Oswald Gruebel's exit, inherits the twin tasks of boosting client confidence and shrinking the investment bank after a $2.3 billion trading loss. Ermotti, the bank's European head and a former derivatives banker, succeeded Gruebel two days ago, after the Zurich-based firm's risk controls missed “unauthorized trading” that will probably trigger a loss in the third quarter. Chairman Kaspar Villiger announced Gruebel's departure after two-and-a-half- years following a board meeting in Singapore. Ermotti will take over in “difficult times,” Villiger told reporters. The 51-year-old will have to rebuild investor confidence shaken by the failure of the bank's risk controls. He will have to shrink an investment bank to conserve capital as well as bolster the bank's wealth management operations, which generate about 41 percent of the bank's revenue. There, he will have to prevent wealthy clients from pulling funds from the country's largest wealth manager. “They have to accept the reality that the business model is gone,” said Enrico Racioppi, an analyst at Hammer Partners in Lugano, Switzerland. “They have to reduce leverage and close proprietary trading.” Ermotti, who worked at Merrill Lynch & Co. for 18 years, joined UBS from UniCredit SpA in April. A Swiss national, he remained based in Lugano when he worked at both Milan-based UniCredit and UBS. ‘Knows Investment Banking' “His background in markets will be fundamental to his success in the role,” Alessandro Profumo, UniCredit's former CEO, said in a telephone interview. “On the whole he knows investment banking very well.” Reducing risk at the investment bank won't necessarily hurt earnings, Ermotti told reporters, adding that it's too early to evaluate whether the trading loss will have an impact on jobs or pay. The bank declined to make him available for an interview. “They've got to change the aspirations of the investment bank and they've got to shrink it,” said Peter Thorne, a London-based analyst at Helvea SA. UBS fell as 2.9 percent in Swiss trading today and was up 0.7 percent at 10.19 francs as of 9:24 a.m. The stock has dropped 8.4 percent since the trading loss was announced, and 35 percent this year. That compares with a 38 percent tumble in the Bloomberg Europe Banks and Financial Services Index, which tracks 46 companies. Kweku Adoboli, 31, the UBS trader charged with fraud and false accounting that may have resulted in the loss, remains in custody after a hearing in London on Sept. 22. He has yet to enter a plea. Booms and Busts Ermotti inherits a legacy of booms and busts that have jarred the firm for more than a decade. UBS had hired Gruebel, 67, out of retirement to stabilize the lender, the flagship for Switzerland's wealth-management industry, after bets on U.S. mortgage-backed securities backfired. The bank posted the biggest loss in Swiss corporate history and took a capital injection of 6 billion Swiss francs from the government in 2008. Gruebel, during his 37-year career at Credit Suisse Group AG, had earned the moniker “Saint Ossie” for helping restore that bank's profit. At UBS, he returned the bank to profit about six months after arriving, resolved a dispute with the U.S. over banking secrecy that threatened the firm's existence and stemmed nine straight quarters of client defections at the private bank. Kengeter Stays Put He also began by cutting jobs and curbing risk-taking, missing the 2009 boom in fixed-income trading that allowed competitors such as New York-based Goldman Sachs Group Inc. and JPMorgan Chase & Co. to profit. Then in 2009, he set a target of reaching 15 billion francs in pretax profit by 2014. To get there, he expanded the fixed-income unit under Carsten Kengeter, added staff at the investment bank and took on more risk. By November 2010, Kengeter, 44, was in sole charge of the investment bank. Kengeter did an “excellent job” in covering positions and there is “no doubt” about his future, Villiger, 70, said on the conference call yesterday. The bank's bigger bets haven't translated into more profit. UBS increased so-called value at risk, a measure of how much the firm could lose in securities markets on a single day, to 75 million francs from 48 million francs in the year-earlier period. Meantime, pretax profit at UBS's investment bank slumped to 376 million francs in the second quarter from 1.31 billion francs in the year-earlier period. The unit's cost-to-income ratio, the highest among the nine biggest investment banks last year, rose to 86 percent in the quarter. “This is a bank now in disarray,” said Chris Wheeler, an analyst at Mediobanca Securities SpA in London. “They've let the CEO walk away. They've left themselves in a vacuum.” Mediobanca today cut its rating on UBS to “underperform” from “outperform.” ‘Task Ahead' Market turmoil and rising capital requirements had led UBS to begin reversing the buildup of the investment bank even before the trading loss. About 45 percent of 3,500 job cuts announced last month were slated for the division. “I'm fully aware of the magnitude and the complexity of the task ahead,” Ermotti said on the call with reporters on Sept. 24. “I'm counting on my colleagues on the executive board to support me in this challenge.” The bank will announce further changes to the unit in a presentation to investors scheduled for Nov. 17, Ermotti said. “My impression is that they haven't fully decided what they want to do,” said Matthew Czepliewicz, an analyst at Collins Stewart Hawkpoint Plc in London. “If they had decided, they wouldn't need to wait until the investor day before saying whether they would scale back investment banking and how they would scale it back.” UniCredit Retreat For Ermotti, scaling back an investment bank isn't entirely new. After joining UniCredit as investment banking chief in 2005, the former head of derivatives and equities at Merrill Lynch first attempted to expand the business to compete with the world's top securities firms. It was the first quarter of 2007, mergers were soaring and UniCredit helped finance Kohlberg Kravis Roberts & Co.'s 10.1 billion-pound ($15.6 billion) bid for Alliance Boots Plc. The collapse of the subprime market and the credit crunch that followed left Ermotti little choice but to retrench and refocus the investment banking business on the firm's historic markets of Germany, Italy, Poland and Austria. Under Ermotti's leadership, UniCredit established its lead in corporate lending, while the firm struggled to turn the relationships into advising on mergers and dealmaking. UniCredit last year wasn't among the top 20 merger advisers in its home markets, data compiled by Bloomberg show. Power Struggle Ermotti left Milan-based UniCredit after a power struggle that led to the ouster of Profumo, 54, and the promotion of Federico Ghizzoni, 55, to the CEO post. Roberto Nicastro, 46, was named general manager, the No. 2 position at the company, in the shakeup. Ermotti sits on the board of Hotel Residence Principe Leopoldo SA, owner of a luxury hotel near Lugano, the Swiss companies register online shows. The Oxford University graduate, also faces the challenge of steering a fresh management team in a time of crisis. Tom Naratil, 49, replaced John Cryan, 50, as the chief financial officer in June and Maureen Miskovic, 54, took over as chief risk officer in January. Ermotti, who became deputy CEO at UniCredit in July 2007, will be a candidate for the permanent top job at UBS, Helvea's Thorne said. The position isn't assured, as some investors say the board should look outside. “UBS needs a leader with long experience, but also needs to signal a break with the past management,” said Angelo Drusiani, who manages about 3 billion euros ($4 billion) at Banca Albertini Syz & C. in Milan. “Ermotti could be the right person in the short term to move toward a new step and to an external candidate.” --Bloomberg News--