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Under the hood of UBS’s Q2 results

Analysts liked the look of UBS’s Q2 numbers this morning, giving CEO Sergio Ermotti a fairly comfortable time in their question-and-answer session.

And with good reason – the bank beat expectations, with higher deposit margins and lending counteracting net new money falls in global wealth management, and the trading businesses leading the investment bank numbers.

Ermotti complained about regulatory costs: TLAC has led to increased funding costs of about $700 million per year; the bank spends more than $1.5 billion on regulatory matters each year; anticipated changes related to Brexit will cost UBS over $100 million.

But the big picture is a good one.

He repeatedly name-checked Asia and the Americas as the key regional drivers of growth for the firm across all its franchises. China will continue to be a particular investment focus, while a rebalancing of the investment banking businesses will come from “dozens” of hires to come in the US, where the bank recently appointed a new head of corporate client solutions in ECM veteran Sam Kendall.

[Activity levels] were not skewed towards our strengths

 – Sergio Ermotti

On the face of it, however, some bits of the investment bank looked oddly off-colour and are worth taking a closer look at.

Let’s recap the story from last week’s US bank numbers first. Revenues and profits were generally up at both group and CIB level. Within investment banking, DCM was either down or weakly up from what had been a very strong same-quarter period the previous year.

ECM had a quarter that was nothing short of barnstorming, and advisory was strong if you were not Bank of America Merrill Lynch – although that too was off a strong quarter 12 months ago. FICC was up, particularly at Goldman Sachs, which had lagged there last year.

UBS certainly ticked some of those boxes. Revenues rose a bit, but the action was in pre-tax profit, where Ermotti’s drive on costs and efficiency saw the firm’s investment bank post a 26% jump, equal to the leap at Morgan Stanley. Adjusting for one-off gains the previous year as well as some restructuring expenses took that increase to about 44%.

The markets businesses looked solid. Higher client activity was cited all across the franchise – cash equities, equity derivatives, and all products in foreign exchange, rates and credit. Fixed income jumped 35%, surpassed only by the recovery at Goldman, but this was at least partly down to a particularly poor quarter last year for UBS. Its business has historically been skewed towards FX, so low volatility and low turnover there hurt it badly.

UBS CEO Sergio Ermotti and CFO Kirt Gardner

Ermotti thinks this is changing: he argues that at least part of the recovery is down to the way in which the bank has focused its investments during the last 12 months on positioning it to gain market share and to capture a more normalized market environment, and that’s why he thinks it is now more sustainable. Year-to-date revenues are up 27%.

Investment banking didn’t look as pretty. Advisory inched up just 2% on the back of private transaction revenues that helped to mitigate the 4% fall in the global mergers and acquisitions fee pool. DCM dropped 9%, which wasn’t too unexpected given the performance of peers.

Investment-grade volumes were down, with the fee pool dropping 3%, although UBS would have fared a lot worse were it not for its rising leveraged finance revenues – the global levfin fee pool was up 1%.

But the really confusing result was equity capital markets. While the US firms all enjoyed strong increases in the quarter, UBS’s business seemed to plummet, with revenues falling 35%. It’s the only real outlier across all the IB numbers the bank reported. And as so often before, it’s not an entirely straightforward story.

Mixed message

It doesn’t help that Ermotti has a slightly mixed message on this. On the one hand he wants us to understand that wobbles in any of the primary businesses during the past couple of years are not down to a shortage of mandates.

“The problem was never the pipeline,” he told analysts this morning. “It was always market conditions – can you execute?”

At the same time, however, he concedes there are times when UBS is more bystander than participant: to use his delightful euphemism, activity levels “were not skewed towards our strengths”.

What he means is that there was less action from financial institution names recently than there was in 2017, and he’s right enough on that. In EMEA and Asia-Pacific, where UBS is most relevant in ECM, global financial institution ECM volumes were down 50% year-on-year in the second quarter.

A few things have led to the firm looking like an outlier this time around…

And FIG accounted for fully one third of all UBS’s ECM credit in 2017: so, when the capital increases slow down, it tends to hurt.

That doesn’t get us all the way to a 35% revenue drop, though. The global ECM fee pool is down 2%, said Ermotti, and Dealogic data show the bank’s overall ECM attributed credit falling 16% year-on-year in the quarter.

Yes, the bank has been suspended from Hong Kong-listed IPO sponsor roles after a regulatory decision that the bank is appealing, but that certainly hasn’t moved the needle.

A few things have led to the firm looking like an outlier this time around, though. Its second quarter 2017 was its best for ECM for quite some time – you have to go all the way back to the first quarter of 2015 to find a better result – so the comparison is from a high base.

And that high base was boosted by things that peers don’t all treat as ECM.

We’ve looked before at how UBS’s ECM revenue line is a noisy one: private transactions are a major part of the franchise, and at UBS they are booked through the ECM revenue line. They were an important part of the result last year, but this time around the bank said they had fallen.

Also popping up in ECM at UBS is corporate equity derivative business. It’s not broken out, but CFO Kirt Gardner gave an indication of its effect when he noted that if it had been included in the equity sales and trading line – to be more comparable to peers – it would have cut revenue growth there from 17% to 11%.

So, less financial institution business, less of the profitable private business and a less active corporate equity derivative market have all conspired to hit UBS’s ECM business this time around.

Sometimes the noise helps and sometimes it doesn’t.

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