UBS franchise strength drives sound 1Q18

London: UBS Group AG’s (UBS) sound 1Q18 results reflect the value of a globally diversified leading wealth manager with investment banking capabilities, says Fitch Ratings. UBS’s reported pre-tax profit of CHF2 billion was 17% higher yoy. Excluding a non-recurring pre-tax gain of CHF225 million related to the Swiss pension plan, pre-tax profit would have risen by 3% yoy. The group generated a sound 11.8% return on equity for the quarter, which we estimate equates to a sound 2.8% operating return on risk-weighted assets (RWAs). In 1Q18, UBS was above its target of around 15% adjusted return on tangible equity excluding deferred tax assets.

UBS noted that client activity in February and March slowed from a strong January, in a typically seasonally strong first quarter. Despite a fairly positive outlook statement, the group stated that geopolitical tensions and macroeconomic uncertainties are to some extent delaying wealth management and corporate clients’ investment decisions. We expect UBS’s leading wealth management franchise and diversified business model should mitigate the impact of a more challenging operating environment, should it materialise. The group adopted IFRS9 in 1Q18, with no material impact on capital ratios.

For the first time, the group reported results for its Global Wealth Management (GWM) division, which combines the former Wealth Management Americas and Wealth Management divisions. Excluding the Swiss pension impact, pre-tax profit rose 14% yoy to CHF1.1 billion, accounting for half of the group’s pre-tax profit excluding the corporate centre. Revenue improved across all revenue lines, with a particularly strong increase in net fee and commission income. This resulted largely from a yoy increase in assets under management (AuM), of which just under a third related to net new money. Operating expenses rose 5% yoy excluding the Swiss pension impact, reflecting higher variable compensation and to a lesser extent additional technology investments.

UBS’s wealth management profitability is underpinned by a large (CHF2,302 billion) and well-diversified AuM base across the Americas (52%), EMEA (23%), Asia Pacific (16%) and Switzerland (9%), as well as the high proportion of more remunerative ultra-high-net worth clients (half of AuM) and discretionary and advisory mandates (a third). In the Americas, the bank continues to work on reducing the importance of recruitment loans to financial advisors, which are prevalent in the market, to focus on financial advisor retention. Compensation arrangements in the Americas weigh on net margins on AuM, the lowest regionally (13bp in 1Q18) within GWM. The bank is continuing investing in and growing its franchise in Asia Pacific, where net AuM margins of 32bp were the second-largest after Switzerland (37bp) in 1Q18.

In the Investment Bank (IB) division, higher volatility in equity markets drove a 17% yoy increase in equity trading revenue, mostly on the back of improved activity and performance in equity derivatives. This led to 10% higher revenue and 23% higher pre-tax profit yoy for the IB, to CHF589 million in 1Q18 (26% of the group, excluding the corporate centre). Performance was particularly strong in Asia Pacific, where pre-tax profit more than doubled yoy. Debt and equity capital markets as well as advisory also did well, with revenue in Corporate Client Solutions rising 15% yoy. More muted activity in rates and credit products yoy led to an 11% fall in foreign exchange, rates and credit trading revenue, which accounted for a limited 5% of the group.

Personal & Corporate Banking pre-tax profit fell 8% yoy to CHF384 million, excluding the Swiss pension plan impact. Higher regulatory and technology expenses increased operating costs, 6% higher, as the yoy revenue decline was marginal and mainly attributable to lower net interest income from low interest rates. Higher net fee and transaction income partly offset this impact.

In the Asset Management division, pre-tax profit of CHF96 million was 7% lower yoy excluding the Swiss pension plan impact. Despite strong net new money inflows (15% excluding money market flows, and largely reflecting one large institutional mandate for an equity index), we expect the continued client shift into passive funds to weigh on management fees, which were up 1% yoy in 1Q18. In this context, we expect cost management to play an important role in meeting the targeted 60% – 70% cost/income range by 2020 (76% in 1Q18).

Wider US Treasury – overnight indexed swap spreads resulted in a higher than expected risk management loss after allocations of CHF169 million, compared to the expected CHF100 million quarterly average loss. In our view, the higher level of group funding and liquidity costs from issuance of capital instruments and greater fragmentation of liquidity pools are likely to persist.

UBS’s fully-loaded Basel III CET1 ratio fell 70bp qoq to 13.1% at end-1Q18, just above its guidance of around 13% for 2018 – 2020. The decline mainly reflected a 7% qoq increase in RWAs, as the impact of the implementation of IFRS9 was marginal. The RWA increase mostly reflected higher market risk RWAs stemming from higher equity market volatility, as well as regulatory model updates and changes and to a lesser extent higher credit risk RWAs. We expect the CET1 leverage ratio, which stood at 3.8% at end-1Q18, to remain the group’s binding constraint in the near term.