UBS Group (NYSE:UBS) is mainly known for being one of the largest investment banks in the world. However, the bank changed its strategy in 2012 and has made a significant business turnaround, downsizing its investment banking operations and focusing on wealth management on growth regions. This gives it a unique profile among its closest peers, justifying a premium valuation and an above-average dividend yield.
UBS is the result of a merger between Union Bank of Switzerland and Swiss Bank Corporation in 1998, but its roots go back to the mid-19th century. It has played a pivotal role in the development and growth of Switzerland's banking tradition. UBS is nowadays a global firm providing financial services to private, corporate and institutional clients. The business strategy centers on the company's global wealth management businesses and universal bank based in Switzerland. It also has operations in investment banking and asset management. UBS has offices in more than 50 countries and about 35% of its workforce is based in the U.S. and 36% in Switzerland.
UBS is one of the world's largest banks with a market capitalization of about $53 billion and trades in the U.S. on the New York Stock Exchange. It is a global systemically important bank (G-SIB) with a buffer of 1%. Its closest competitors are other global banks like Credit Suisse (NYSE:CS), Deutsche Bank (NYSE:DB), HSBC (NYSE:HSBC), Goldman Sachs (NYSE:GS) or Citigroup (NYSE:C).
UBS is the largest private bank globally with over $2 trillion of assets under management (AuM). It has a unique footprint across the globe and benefits from significant scale within the industry. During the past few years, UBS has successfully transformed its business being now much more focused on Wealth Management than Investment Banking compared to before the global financial crisis. UBS's profits now come more from activities that are less correlated to capital markets and should therefore be more sustainable and less volatile over the long-term. The bank also has a good geographical diversification even though Switzerland continues to be its most important region measured by profits before tax.
Its operational structure is now formed by the corporate center and five business divisions, namely Wealth Management, Wealth Management Americas, Personal & Corporate Banking, Asset Management and the Investment Bank. Over the past few years, wealth management has shown good growth figures and its weight on revenues and profits within the group has increased significantly. During the past fiscal year, wealth management businesses generated 45% of the group's profit being by far the largest segment within the group. On the other hand, investment banking (IB) has lost importance over the past few years and was responsible for only 28% of the group's profit in 2015.
UBS has made a significant restructuring of its investment banking (IB) operations in 2012, and now its IB operations are among the most simple and least capital intensive within its peer group. It essentially consists of primary investment banking (advisory, DCM and ECM), cash equities, macro and prime brokerage. Additionally, it has the lowest exposure to fixed income, commodities and currencies (FICC) and debt capital markets within IB among the global investment banks.
These areas were the most hit by overcapacity and low client activity during the past few years and a major reason why most IBs report very low levels of profitability. Moreover, UBS is the only bank with an IB return on equity (ROE) above a hurdle rate of 10%, due to its focus on capital-light primary IB and equities. To a large part this is a reflection of its very aggressive strategy of deleveraging nearly all of its FICC trading businesses. Showing that UBS' strategy was right, now most of its closest competitors are also scaling back from debt capital markets and focusing more on less capital-intensive businesses.
Since its business turnaround in 2012, UBS' focus has been shifted into wealth management and to regions where it may have a better growth outlook in the long-term, namely in Asia. Indeed, UBS' growth in Asia has been rapid with AuM increasing by about 30% since end-2012. UBS is the largest private bank in Asia by some margin and this seems to be the bank's main growth engine in the long-term. It has also a strong presence in China and ambitious growth plans, with the goal to double staff in 5 years.
UBS has already benefited from scale efficiencies and is currently highly profitable compared to most of its peers. This position gives it a competitive advantage over its peers that are to some extent following its footsteps into the region, namely its closest competitor Credit Suisse. Given that UBS has already an established position in the region, it may be harder for competitors to gain significant market-share, given that its scale and superior relative cost profile that may be difficult to replicate.
Financial Overview & Dividends
Regarding its financial performance, UBS has delivered relatively good results over the past few years, despite the challenging operating environment and significant litigation costs. In Europe, UBS' revenues and profitability have been pressured by the low to negative interest rate environment that is present on most geographies, exacerbating interest margin pressure while loan growth remains subdued. On investment banking and wealth management, volatility in capital markets has been negative for revenues and higher regulatory spend is pushing up costs. On the other hand, the prospects of higher interest rates in the U.S. should be positive for its earnings growth in the next few quarters.
In 2015, UBS was also hit by the end of the Swiss peg in January due to the consequent sharp appreciation of the currency. UBS has a larger cost base in the Swiss Franc than revenues, thus a rise of the currency is bad for its profitability. Nevertheless, UBS was able to report higher profits of about $6.4 billion, an increase of 79% from the previous year. Its return on tangible equity (RoTE) was very good at more than 13%, among the highest in its industry. In the first quarter of 2016, like most of its peers, UBS has been negatively affected by the weak environment across capital markets that impacted customer activity, leading to a lower RoTE of 8.5%.
Despite its good profitability, UBS can even improve it through better efficiency given that its cost-to-income (C/I) ratio is still high at above 80% in 2015. The bank has reduced costs during the past few years, but it still has room for further cost cutting through investments in technology, digitalization and exit of non-core operations. Its target is for a C/I ratio of 60-70% or a cost reduction of $2.1 billion by 2017, which would be supportive of earnings growth and higher profitability and is an important driver for UBS to achieve its target of a RoTE higher than 15% in the medium term.
Regarding capitalization, UBS has increased significantly its ratios over the past few years due to higher requirements from regulators. The Swiss regulator has been one of the most conservative on this issue due to the large scale of the country's two largest banks. Therefore, it's no surprise that UBS has a good capitalization with a fully loaded equity tier 1 (FL CET1) ratio of 14.5%, at the end of 2015. UBS' CET1 ratio has increased by almost 8% since 2011, showing the efforts made by the bank to improve its balance sheet position during this period. In the first quarter of 2016, its CET1 ratio decreased to 14%, but it still is above its target of at least 13%, which means that by this measure UBS has an excess capital position.
However, for investment banks the leverage ratio is also widely used and on this factor its capital still needs some improvement. New Swiss requirements were announced in October 2015 for its two largest banks, UBS and Credit Suisse. New requirements were set at CET1 leverage of 3.5% and total leverage ratio of at least 5%. The difference between the two ratios should be held in the form of Additional Tier 1 (AT1) instruments, a type of hybrid debt that can be converted into equity if the CET1 ratio falls below 7%. These targets will be phased in over the next few years and must be met by the end of 2019.
On a fully-loaded basis, usually the requirement that investors care about, UBS has a CET1 leverage ratio of 3.3% and total leverage ratio of 5.4%. UBS targets a leverage ratio based on CET1 capital of at least 3.5%, but currently is at 3.3%. This means it needs to retain some earnings or reduce even further its asset exposure to reach this goal. Even though UBS still needs a little improvement in its core equity component, this should be easily achievable through retained earnings over the next few quarters and does not seem to be a big issue.
Regarding its shareholder remuneration, UBS also has progressed positively over the past five years, resuming dividend payments in 2012 related to the previous fiscal year earnings after several years of omitted payments. Its dividend per share has increased markedly and has good growth prospects going forward. In the past two years, its remuneration was made of ordinary and special dividends, amounting to $0.87 per share in the last year. At its current share price, UBS offers an attractive dividend yield of about 6.3%. The dividend payout ratio was 52%, close to its target for a total dividend payout ratio of at least 50% of net profit.
Going forward, UBS' commitment is to increase its ordinary dividend progressively and it may continue to pay special dividends if it remains above its capitalization targets. Indeed, according to analysts' estimates, its 2016 ordinary dividend per share should be $0.67 and for 2017 it should increase to $0.81, a significant increase from its $0.61 ordinary dividend per share paid in the past year. On top of this, UBS may announce special dividend that would increase even further its attractive shareholder remuneration.
The investment banking industry has suffered since the global financial crisis due to overcapacity and low client activity leading to very low levels of profitability for some players, like Credit Suisse or Deutsche Bank. However, UBS changed its strategy a few years ago focusing more on wealth management and that shift has been clearly successful. UBS has a superior profitability and growth prospects, enabling it to offer an interesting high-dividend yield making it quite attractive for income investors.
Disclosure: I am/we are long UBS.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.