“FAIL fast, fail early” is a management mantra in many industries. Identify the projects that will not pay off quickly, and the costs of failure are capped. Banks have developed their own version of this rule — “fail completely, fail catastrophically” — but one of the earliest victims of the crisis may yet be among the first to recover.
UBS was one of the first to feel the effects of America’s subprime meltdown. That had some advantages. The Swiss bank started raising capital while private money was still available (although it has since had to call on government help). It installed a new leadership team relatively early. And it cut staff numbers hard, which will help during chilly times ahead.
True, UBS is also fortunate in not having big loan books to drag it down as the real economy sinks. That helps to explain why the bank’s share price has outperformed an index of European banks over the past four months (see chart). But it has taken other steps which may point the way forward for the rest of the industry.
Start with the state of its balance-sheet, which is now cleaner than those of most of its investment-banking peers. The bank got a huge helping-hand from the Swiss central bank, which agreed in October to house up to $60 billion of UBS’s bad assets in a separate entity. Analysts at Morgan Stanley reckon that UBS now has the lowest ratio of problem assets to tangible common equity, a particularly pure measure of capital, of any of the big European and American wholesale banks. The idea of the “bad bank” may yet win more traction elsewhere because of the UBS example.
UBS has done more than spruce up its books. It has also shrunk them. The value of its assets has come down by a whopping SFr590 billion ($550 billion) since the second quarter of 2007. Most of that reduction has come not from write-downs or asset transfers but from running off short-term trading assets. UBS is already pretty close to meeting the 3 percent leverage ratio initially imposed upon it (and Credit Suisse) by the Swiss authorities. The people who run banks used to crow about growth in assets; now they plot their reduction.
These changes do not protect UBS from harm. The bank retains a significant gross position in leveraged loans, for example, and hedging is difficult for everyone when markets are so volatile. Despite the reduction in assets, the bank remains leveraged to a huge degree. Its balance-sheet at the end of the third quarter was still $2 trillion. Marcel Rohner, the bank’s chief executive, gives warning against reading too much into the volume of nominal assets. Buy a share and sell a call option on that same share, he says, and your balance-sheet has grown but your risk has not.
Maybe so, but investors are right to question the ability of banks to judge risks precisely. That lack of certainty extends within UBS, which promises to become a more humble institution as well as a smaller one. The bank has made several changes to its governance under the guidance of Peter Kurer, its chairman.
A self-excoriating review of the bank’s failures of risk management in April was followed by the abolition of the chairman’s office, a power centre developed under Marcel Ospel, Mr Kurer’s immediate predecessor. The upshot has been much greater contact between outside board members and executives than before.
The bank is also in the process of separating into three autonomous units: wealth management, investment banking and asset management. Central to this reorganisation is an overhaul of the bank’s internal funding mechanisms — many of UBS’s problems lay in absurdly cheap financing for its investment bank. Such reforms do not impress everyone. “It just brings UBS out of the dunce’s corner,” says an analyst. But other changes are more pioneering. In November, UBS unveiled a new set of pay policies that included the idea of a “malus,” or negative bonus, a way of clawing back deferred compensation in the event of poor performance.
Importantly, the reorganisation has also made it clearer what UBS is for. The bank has affirmed the importance of its market-leading wealth-management arm as its main franchise. That was not always the case. “It was less clear under Ospel that wealth management was the core business,” says a former UBS executive.
The investment bank is ditching proprietary trading and concentrating on client-focused activities: “We will end the blurring between risk-takers and flow businesses that we have seen in past years,” says Mr. Kurer. It is also zeroing in on areas where it has particular strengths, such as equities and foreign-exchange trading. That marks a shift. UBS’s disastrous foray into mortgage-backed securities aimed to close the gap in areas where it lagged. The revamped bank will not try to compete in every market, although that is easier said than done given client demands. “The unanswered question is whether you can be a good golfer with only three clubs,” says Jeremy Sigee of Citigroup.
UBS is nowhere near being out of the woods. The biggest uncertainty it faces is the extent of the reputational damage that its wealth-management business has suffered. But if UBS can stanch the outflows that it started to see in the second quarter of 2008, and reach a deal with the American authorities in their investigation into its offshore services, it may soon dare to think about future success. Come what may, its efforts to become a smaller, less cocksure and more focused bank chart a route to recovery for many others.