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4 February 2014 By Dominic Elliott

Sergio Ermotti should beware of breakneck expansion. The UBS chief executive’s strategy – revamping the Swiss group into a smaller investment bank tacked on to a market-leading wealth manager – continues to pay off. But he should spend the fruits of success carefully.

UBS is churning out solid profit across all its main businesses. In wealth management, it’s attracting far more money from rich clients than it was pre-transformation.  The likelihood that 50 percent of net profit will be handed to shareholders in 2014 sent shares up as much as 6 percent on Feb. 4.

Operational strength probably reflects UBS’ greater solidity. UBS’ year-end Basel III core Tier 1 ratio stood at a best-in-class 12.8 percent, and the leverage ratio was 4.7 percent on Swiss rules. Swiss regulator FINMA agrees: while it still wants UBS to hold extra capital against the risk of further litigation or other hazards, it will now allow Ermotti to negotiate the size of this buffer rather than stipulating an arbitrary amount.

With everything ticking along, Ermotti will be tempted to go for growth – especially in U.S. investment banking, where UBS is ranked outside the top 10 for underwriting and advisory. There’s an enticing engine for expansion. Even after UBS used 470 million Swiss francs of deferred tax assets in the fourth quarter to double profit, there’s still 22.6 billion francs left.

The irony is that this benefit is down to the socking losses that the Swiss bank sustained during the crisis in subprime, which can be offset against taxes. It means UBS can, if it wishes, expand and effectively pay zero tax in America for the foreseeable future.

But management shouldn’t let tax freebies dictate strategy. As it happens, UBS probably could do with more U.S. research analysts and investment bankers. But attempts to compete in debt advisory and trading with fixed income “flow monsters” like Bank of America Merrill Lynch, JPMorgan or Citi can only end in tears. It will be hard enough battling other global investment banks with subscale U.S. operations, like Nomura.

FINMA’s hawkish approach may stop UBS overreaching anyway. But with a 29 percent investment bank return on equity in 2013, there’s no need for Ermotti to go any faster.


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