Huw Jenkins has had to give an unusual number of motivational speeches lately. In mid-March the CEO of UBS’s investment banking arm took the floor in London to assure an assembly of bankers not to worry: Despite the likely resignation of key rainmaker Kenneth Moelis following the departure of several of his closest aides, the Swiss bank remained committed to serving lucrative private equity clients. Then in May, Jenkins was at it again, pledging to traders in New York that UBS, under CEO Peter Wuffli, was still devoted to bond trading, even as he broke the news that its internal, debt-focused hedge fund was being shut down after big losses, forcing the exit of John Costas, Dillon Read Capital Management’s chief.
Jenkins will need to warm up his vocal cords to give another inspirational talk to the troops. In a stunning decision early this month, UBS abruptly announced that the 49-year-old Wuffli, CEO since 2003, was leaving, to be succeeded, effective immediately, by his deputy, Marcel Rohner.
Wuffli’s departure comes at a time of internal debate inside UBS about risk-taking — and of increased grumbling from shareholders, who have become uneasy with UBS’s lagging share price. Some, echoing similar dissatisfaction at other banks, like ABN Amro, have called for splitting up the giant Swiss institution.
The departures of Moelis, the investment bank’s president, and Costas, who had Jenkins’s job before setting up DRCM in 2005, underscored the internal tensions. Both U.S. executives had doubted UBS’s commitment to their businesses. Both believed that the bank was not aggressive enough to thrive in today’s markets, where top firms have been profiting by betting their money in trading and by committing heaps of capital to finance big acquisitions.
Jenkins, born in England, and Wuffli, a Swiss native, were quick to scoff at the Americans’ claim. In recent interviews with Institutional Investor, they asserted that the firm has increased its risk profile to win more business from leveraged-buyout firms and hedge funds. Even so, they vowed they wouldn’t sacrifice caution for what might be fleeting gains in what they saw as frothy, even bubbly, markets.
This internal debate isn’t new to long-cautious UBS, nor is it unique to the Swiss bank. Other lenders are also nervously watching the flood of all-too-easy credit that has poured into the market of late, not to mention the cascading blowups in the subprime mortgage market. But UBS has kept a tighter hold on the reins than most, limiting the capital it puts at risk in trading markets and insisting on a rigorous approval process under which big loans must be approved at headquarters in Zurich.
“We will see accidents and deals go sour, and that will recalibrate the appetite of investors for credit risk,” Wuffli told Institutional Investor last month. “We are trying to walk a fine line.”
Recent events in the markets show just how difficult it is to walk that line. Last month rival investment bank Bear, Stearns & Co. had to inject $1.6 billion into one of two internal hedge funds that suffered big losses in the same subprime mortgage markets that tripped up DRCM earlier this year. At the same time, wary debt market investors are showing signs of turning off the easy-money spigot that has been fueling the boom in leveraged buyouts. Several financings for LBOs ran into trouble last month, including a $650 million bond offering backing the takeover of U.S. Foodservice.
But as Wuffli tried to perfect his balancing act, some shareholders — and the bank’s board — appeared to lose patience. Over the past five years, UBS shares have soared by more than 140 percent, better than nearly all rival investment banks except Goldman, Sachs & Co., but its stock price has lagged recently, as the bank has missed earnings expectations twice in the past three quarters. In the past year UBS shares are up 16 percent; by comparison, Credit Suisse’s stock is up 35 percent, Deutsche Bank’s 39 percent and Goldman’s 52 percent. Some shareholders had a simple solution for unlocking value: Sell the investment banking arm.
The argument is straightforward. UBS’s fast-growing wealth- and asset-management businesses accounted for about half of the group’s 2006 profits of $10.1 billion. Apply a standard market multiple of 19 times forward earnings for that business and those units alone would be worth almost as much as the current $120 billion capitalization of the entire firm. The market, in other words, reckons the value of the investment bank at practically nothing, even though it provided 48 percent of UBS’s income last year.
“At what point do we get serious about moving these two businesses apart?” Marsico Capital Management portfolio manager Corydon Gilchrist asked Wuffli during UBS’s first-quarter earnings call for U.S. investors in May, when the firm disclosed that net income had fallen by 7 percent from the same period in 2006, missing analysts’ estimates by 4 percent, or 6 cents per share. “The investment bank is clearly worth more to somebody else than it is to UBS.”
On a separate call for European investors earlier that day, William Johnston, an AllianceBernstein portfolio manager, pressed CFO Clive Standish about a breakup. “This is the second time in the past three quarters you’ve missed earnings because of the investment bank, and it’s impacting the value of the business,” he said. “Is it not time you consider separating the asset management division and the private bank from the investment bank?”
Wuffli dismissed the idea of a split-up, asserting that the asset management and investment banking units complement one another. Senior corporate executives who go to UBS for acquisition or capital markets advice, he reasoned, will also seek the counsel of UBS private bankers to manage their personal finances, just as superrich wealth management clients will tap the investment bank for sophisticated financial products. “Our wealth management growth would not be possible without a very high-performing investment bank and institutional asset management business,” asserted Wuffli, who served as UBS’s CFO and asset management chief before becoming CEO.
Jenkins, also 49, got his start working in operations before moving into a series of trading assignments around the world. “UBS without an investment bank is like British Airways without the airplanes but still with the duty-free goods.” he tells Institutional Investor. “It does not work.”
In its July 5 announcement, UBS said that Marcel Ospel would remain as bank chairman for at least three more years. A year ago, it said, Ospel had expressed his desire to retire in the near future and had proposed Wuffli as his successor. After deliberation, the board rejected Wuffli as prospective chairman, setting in motion the management shift. Rohner, 42, has been chairman and CEO of UBS’s global wealth management and business banking unit, and deputy group CEO since January 2006.
Though Wuffli’s ouster came as a surprise, some shareholders understood the decision. “Dillon Read was a public embarrassment, investment in the investment bank has yet to yield results, and the board recognizes the share price should be significantly higher,” says Adrian Darley, portfolio manager at London-based Resolution Asset Management, a UBS shareholder.
But Ospel rejects the idea that Wuffli was pushed aside as a result of pressure to increase earnings and boost the stock price. Nor does he see any need to change UBS’s strategy. “Nothing changes. There was no disagreement over the strategy,” he told Institutional Investor in an interview following the announcement. “We don’t particularly appreciate being compared with ABN Amro both in terms of our strategic remit and the way we manage our group. We feel entirely supported by our shareholder base.”
Ospel acknowledged recent difficulties, saying, “We’ve had issues at the investment bank for the past few quarters.” But he insists that Jenkins, who was promoted by Wuffli in 2005, is secure. “Huw is a strong leader of our investment bank, fits well with our leadership team on the group executive level and has our full support,” Ospel says.
To be sure, this is not the first time that UBS has had difficulty finding a successor to Ospel. In December 2001, Luqman Arnold, then president of the group executive board, left following a disagreement with Ospel over capital commitments to the troubled Swissair. Wuffli replaced him.
In one sense, unease among UBS shareholders is remarkable, given the extraordinary run the bank has had over the past two decades under the guiding hand of the visionary Ospel, who transformed the then–Swiss Bank Corp. from the third-ranked bank in tiny Switzerland into a global power. Ospel engineered a series of deals that began with the 1992 purchase of derivatives-trading firm O’Connor & Associates in Chicago and reached its peak with the 1998 merger with SBC’s bigger rival, Union Bank of Switzerland. (The three keys that are part of the UBS logo are from SBC’s old insignia.) Along the way he also acquired U.S. mergers and acquisitions boutique Dillon Read & Co., British investment bank S.G. Warburg Group and U.S. brokerage PaineWebber Group.
One of the world’s ten biggest banks, today’s UBS is dominant in wealth and asset management, boasting client funds worth $2.4 trillion, more than any other competitor. Also a rising power in investment banking, it turned in a record profit of $4.9 billion last year, 15 percent higher than in 2005. Its banking business is mightiest in Europe and Asia, where it ranks fifth and second, respectively, in revenues from merger advisory and securities underwriting mandates, according to New York–based research firm Dealogic.
And UBS has shown a willingness to be aggressive in its expansion. Since taking over for Costas in 2005, Jenkins has hired thousands of staff, raised the size limit for which bankers need to obtain authorization from Zurich for credit commitments and spent freely to beef up in such fast-growing areas as emerging markets, commodities and prime brokerage. In 2005, UBS got a leg up on rivals by spending $210 million on a 20 percent stake in Beijing Securities, which has helped the firm beat competitors to a host of lucrative and much-sought-after underwriting assignments, including a pending $5.9 billion equity offering by state oil company PetroChina. In December, UBS spent $2.5 billion to acquire Brazil’s leading investment bank, Banco Pactual.
But the firm also has stumbled of late, most notably in the U.S., where it has struggled to gain traction in investment banking and lags competitors in wealth management. The departures this year of Costas and Moelis, who were hired with much fanfare in 2001 to jump-start the efforts, were the latest blows.
The bank’s senior managers remain unbowed. “Our commitment in the U.S. market has not changed an inch,” Ospel asserted in April.
Still, these setbacks highlighted broader, persistent problems that raised the question of whether Wuffli and his team could pull off their so-called one-bank strategy globally. That question must now be answered by Rohner.
The biggest challenge is weakness in fixed income, which has powered Wall Street profits in recent years. UBS’s revenues in this business, which encompasses the trading and underwriting of an array of financial instruments as well as private equity and other principal investments, were higher than all but three rivals’ in 2003 but have fallen behind badly since then, growing only about half as fast as the industry last year. One reason: the 2005 creation of DRCM, which siphoned off scores of top traders. Now, in the wake of $124 million in losses reported by DRCM during the first quarter, the firm is spending some $300 million to fold the hedge fund, most of it severance for Costas and many of his key deputies.
UBS remains a laggard in U.S. investment banking, ranking just ninth in revenues from advisory and underwriting mandates thus far in 2007, according to Dealogic; its weakness in the region pulls down the firm’s global ranking to seventh, despite its stronger positions in Europe and Asia. The unit has been bleeding top bankers: financial institutions group head Michael Martin, star consumer banker Blair Effron and U.S. banking co-head Jeffrey McDermott have all left since the beginning of last year. Other bankers are expected to follow Moelis to a new firm he has started.
“If they don’t show they can stabilize the investment bank, their hand may be forced,” says Meredith Whitney, an analyst who covers UBS for CIBC World Markets. “The next several quarters are make-or-break.”
Wuffli understood the market’s worries. After the DRCM shutdown was announced, he spent much of his time on the road, visiting more than 600 investors and analysts to assuage their concerns over his firm’s recent stumbles.
“Some shareholders are frustrated that UBS is not adding up to the different pieces, and is underperforming some of our peers in the short term,” he acknowledged. “The vast majority of investors and analysts express to us their comfort level with our strategic position.”
UBS WAS SUPPOSED TO HAVE learned its lesson about U.S. investment banking a long time ago. The current difficulties recall an earlier stumble that took years for the firm to bounce back from. In October 2001, UBS suddenly and unexpectedly withdrew a commitment to provide a portion of a $5.5 billion bridge loan in support of EchoStar Communications Corp.’s $25 billion takeover bid for rival satellite television provider DirecTV. EchoStar dropped UBS as an adviser on the deal, turning instead to archrival Deutsche Bank. Ultimately, EchoStar’s bid failed, but UBS’s pullback — prompted by senior executives in Zurich who, in the aftermath of 9/11, insisted that the bank be allowed to cancel its commitment because of a material adverse change in the market — dealt a serious blow to its credibility. Clients couldn’t be sure the Swiss would stand behind the commitments of their bankers in the U.S. Morale suffered, and so did results. “It was the grand slam of blowing it,” one competitor told II at the time.
Even though it is the top equity underwriter and merger adviser in Europe so far in 2007, UBS hasn’t been able to crack the top ranks of advisers and underwriters in the U.S. One big reason is its inability to win over private equity firms, which generate billions in fees annually and are concentrated in the U.S. During Costas’ last year at the helm in 2005, UBS ranked eighth among all investment banks in terms of global revenues, but 13 firms took in more money from private equity shops. Exclude LBOs and the firm would have ranked fourth in the advisory and underwriting league tables.
Jenkins has tried to rev up investment banking globally, pushing into fast-growing parts of the business. Since he spearheaded the firm’s investment in Beijing Securities, UBS has taken management control of that company, making it the first foreign-managed securities firm with licenses to trade and underwrite securities, manage assets and publish research in China. (Goldman Sachs is the only competitor to have followed suit thus far.) In May 2006, Jenkins bought ABN Amro Holdings’ global futures and options trading business for $386 million, a move designed to expand the number of products UBS could offer hedge funds to trade. That same month he agreed to pay $2.5 billion for Brazilian investment bank Banco Pactual, giving UBS a higher profile in that fast-growing market. These deals have paid off: In addition to its recent mandate for PetroChina, UBS underwrote share sales in 2006 for Bank of China, China Merchants Bank and China Communications Construction and is the second-leading equity underwriter in Asia so far this year, up from third last year, according to Stamford, Connecticut–based Thomson Financial. In derivatives trading it ranks second in the world, according to Boston Consulting Group. And through Pactual it is garnering new business in Brazil, including a $715 million bond offering in February for the Brazilian government.
Jenkins has also made efforts to enhance risk-taking. In the middle of last year, he persuaded UBS’s group executive board to double lending limits for LBO firms and corporate clients. Jenkins argued that changes in the credit markets in recent years — including an explosion in credit derivatives and other risk-spreading products, as well as a shift from banks holding loans on their books to distributing them to hedge funds and other institutional investors — meant that the preternaturally conservative Swiss could feel more comfortable increasing the firm’s risk profile. In the past banks lent money to corporations; today they mostly arrange big loans and distribute them in pieces to investors. According to Jonathan Calder, chairman of New York–based Loan Syndications and Trading Association, in the 1990s there were as few as 50 nonbank investors buying loans in the U.S. Now there are close to 500.
“We clearly had very strong views about concentrated and illiquid risk,” says Jenkins. “I think in particular our views around liquidity in the credit markets were superseded by the capital flows we’ve seen in the last three years.”
The change in strategy has paid some dividends. In June 2006, UBS advised Anadarko Petroleum Corp. on its $23.3 billion acquisition of Western Gas Resources. Along with Credit Suisse and Citigroup, UBS provided a $24 billion, 364-day unsecured credit line to support the takeover. UBS’s willingness to go on the hook for almost $9 billion, the largest commitment in its history, has helped win further business from Anadarko. In September, UBS led the company’s $5.5 billion bond sale.
A bigger test came last summer, after UBS agreed to provide private equity firm Blackstone Group with a $2.6 billion loan to finance its $4.3 billion buyout of Travelport, the former travel agency unit of conglomerate Cendant Corp. Blackstone president Hamilton James says his firm awarded UBS the transaction because the bank offered the most competitive bid in terms of leverage and price. The deadline to sell pieces of the loan to investors was August 10. At 4:30 that morning, Christopher Ryan, global head of credit fixed income at UBS, called Brendan Dillon at his Upper East Side Manhattan apartment and told him to switch on the television, which carried reports that U.K. authorities had thwarted a terrorist plot to detonate bombs aboard ten aircraft.
“My first thought,” says Dillon, global head of loan sales for UBS, “was that this was the worst possible news for a company like this.”
It also could have been awful news for UBS: Had investors balked at buying the loan because of fears that the news would hurt the travel business, the bank could have been responsible for the entire $2.6 billion. Dillon’s team calmly reached out to potential investors and reaffirmed their participation. By day’s end the loan had been placed with more than 200 institutions at a rate of 3 percent over LIBOR, a level that fell within the pricing promised to Blackstone.
“UBS’s performance was night and day with the past,” says James. “Even in the face of a terrorist event, they delivered.”
As with Anadarko, UBS’s new approach won it follow-on business. In March, Blackstone asked UBS to sell $1.1 billion in bonds for Travelport.
But in spite of its newfound aggressiveness, UBS still lags rivals, which also have been increasing their risk profiles. In 2006, UBS arranged $22.4 billion of leveraged loans globally, an increase of 26 percent from 2005, according to Dealogic. But its ranking among global lenders actually fell, from No. 15 to No. 16. So far in 2007 it has recorded $27.3 billion in lead-arranged leveraged loans — an increase of 180 percent over the same period last year; but it ranks just 12th in this category, dwarfed by the likes of JPMorgan Chase & Co., which has led $157.9 billion in loans so far this year, and Bank of America Corp., which has handled $87.4 billion. In the U.S., where most high-yield lending occurs, the disparity is even more pronounced. UBS last year set up deals worth $18.4 billion, an increase of 56 percent, but it fell from No. 12 to No. 13 in the league tables. So far in 2007 it has led transactions worth $19.5 billion, more than doubling its level through this point in 2006, yet still ranks at just No. 10.
UBS also has been losing top bankers, including McDermott, who announced his resignation just days before Moelis said he would be leaving. Consumer-sector specialist Effron, who advised Gillette Co. on its $57 billion merger in 2005 with Procter & Gamble Co., left one year ago to start his own firm, Centerview Partners. In January, Centerview advised Altria Group on its $61 billion spin-off of Kraft Foods. UBS played no role. In February 2006, Martin, global co-head of the financial institutions group, quit months after advising credit card company MBNA Corp. on its $35 billion sale to BofA.
Moelis’s departure adds to the woes. Sources close to the veteran rainmaker say he was happy that the firm was making progress, yet frustrated at the trans-Atlantic bureaucracy that slowed down decision making and, he believed, kept the firm from challenging elite competitors like Goldman, Citigroup, JPMorgan and Morgan Stanley. Though he was president of the investment bank, his views often were not heeded by the multiple committees that must consider and approve requests for big credit commitments or decisions to work with particular clients, these sources say. UBS may have been prepared to sanction bigger commitments, but deals still had to be cleared by the group executive board in Switzerland. Approval could take weeks, whereas rival banks like JPMorgan could act in days. When Moelis calculated that this fundamental decision-making structure would not change, he decided to start his own firm, Los Angeles–based Moelis & Co. Holdings. Among those joining him is Warren Woo, who left as UBS’s co-head of leveraged finance in March 2006, five years after Moelis recruited him from Credit Suisse First Boston. Jeff Raich, another Moelis hire, left last month as global co-head of M&A and is expected to join the new firm. UBS is bracing for other bankers to jump ship.
Moelis, who declined to comment for this article, takes with him strong relationships with private equity firms and leveraged companies. In November, he advised the special committee of casino operator Harrah’s Entertainment on its $27.8 billion sale to private equity firms Apollo Management and Texas Pacific Group. He also was among the advisers on the recent megabuyouts of Univision Communications and Clear Channel Communications. Especially in M&A, clients tend to stick with the bankers they trust, regardless of the firm they work for.
“You deal with the people at a bank, not the institution,” says Stephen Bollenbach, chief executive and chairman of Hilton Hotels Corp., a longtime Moelis client. “To lose a senior executive of his caliber is a major loss.”
On July 3, just days after Moelis left, Hilton announced that it would be taken private by Blackstone in a $26 billion deal. Moelis’s new firm was a co-adviser to Hilton, along with UBS.
THE DRCM HEDGE FUND DEBACLE Also raises questions about UBS’s investment banking strategy. The fund was created as Costas and his team sought to put more of the bank’s capital at risk in proprietary trading — and as several of them mulled leaving for more lucrative jobs with hedge funds. Wuffli and others in Zurich didn’t want to expand the proprietary book but saw an opportunity to retain the firm’s best traders and profit from increased risk-taking by moving the bank’s $3 billion in proprietary positions into DRCM and raising further funds from outside investors. UBS kept 40 percent of the gains on those outside assets as an incentive fee, a big portion of which went to Costas and his team as compensation.
But some 80 top traders were shifted to DRCM, forcing Jenkins to spend millions on hiring from outside the firm to rebuild fixed-income trading. That helped to send the 2006 cost-to-income ratio — operating expenses divided by operating income — at the investment bank up 2.4 percentage points, to 72.9 percent, significantly higher than its rivals’. That irked shareholders, not to mention some investment bank staff who wondered why Costas and his team had been awarded such privileged — and lucrative — status within the firm. In the end, neither UBS’s trading for clients inside the investment bank nor its proprietary book, effectively transferred to DRCM, performed well. Another problem: Swiss regulators raised objections to running the firm’s money alongside that of clients, causing it to delay outside fundraising for six months while devising a management structure that would separate the two. By the end of the first quarter, Costas’ group was losing money on subprime mortgage debt and had raised just $1.2 billion from clients.
In April, Wuffli decided to pull the plug. Beyond the losses and embarrassment, there was damage to UBS’s investment bank. In 2003, before DRCM got off the ground, UBS’s securities unit brought in fixed-income revenues of $5.9 billion, more than most competitors, including Goldman and Morgan Stanley. By 2006 fixed-income revenues had grown to $7.2 billion, but other firms had poured more capital into the business and grown faster. Goldman rang the register for $13.9 billion in fixed-income revenues last year, while Credit Suisse brought in $7.7 billion, for example. Last year UBS’s growth rate in this business was 14 percent, less than half the industry average of 31 percent.
“It was painful, difficult and disappointing,” Wuffli said of the fund’s closure. “It was a distraction to management and diluted accountability, no question.”
Now UBS is once again trying to restore its credibility with banking clients and shareholders.
“Once in a while you lose senior individuals, like Ken Moelis,” chairman Ospel told II in April. Still, he said, having a strong U.S. business is critical to the firm’s long-term prospects. “That is very much a part of the business and happens to everybody.”
Jenkins is relying increasingly on his bench. Among the up-and-coming bankers who are answering the call is Oliver Sarkozy (the brother of newly elected French President Nicolas Sarkozy), who replaced Martin as financial institutions group chief. Sarkozy recently advised student lender Sallie Mae on its $25 billion acquisition by leveraged buyout firm J.C. Flowers & Co. and is counseling ABN Amro on its proposed sale to U.K. banking giant Barclays Group.
Jenkins also has been making belated investments in real estate finance, securitization and commodities, moves that helped the fixed-income division’s revenues grow by 42 percent during the quarter, excluding the losses recorded by DRCM. That’s the kind of growth the market wants to see, but Jenkins needs to sustain it.
He also must reinvigorate the investment bank and lower expenses significantly. Since he began his overhaul of the bank, operating costs have skyrocketed — by 32 percent in the fourth quarter alone, compared with the year-earlier period. The cost-to-income ratio at the investment bank rose from 70.6 percent in the third quarter of 2005, where it was for seven prior quarters, to 76.1 percent a year later. More recently, in the first quarter, it moderated to 71.3 percent, but this is still far higher than competitors’ ratios. Goldman Sachs’, for example, is just 61 percent.
And even as Jenkins says he’s changing the way the Swiss institution looks at risk and decision making, he acknowledges that UBS will never be as limber as competitors like Goldman Sachs and Morgan Stanley, or as determined about committing capital as giant U.S. banks like Citigroup and JPMorgan.
Consider the months-long debate over whether to dedicate $10 billion of the firm’s capital to investing in leveraged buyouts alongside private equity clients. One New York–based UBS banker speaks optimistically of the prospect. “It looks like we’re going to get it,” he says. “That will make a big difference.” But Piero Noveli, UBS’s London-based global head of M&A, says only that the fund is being debated internally. He concedes that private equity firms are increasingly demanding such “equity bridges” from investment banks, which allow the LBO firms to put up less money for big transactions, but adds that the benefits of such equity investments might not be worth the risk of their going sour. Coming from someone stationed in UBS’s home base of Europe, where the bank has strong corporate relationships and where corporations account for a far bigger majority of M&A transactions than they do in the U.S., that comment isn’t surprising.
“Ken believed there was an opportunity to get more authority and have more independence around an advisory and principal-investing model,” says Jenkins. “He could more easily achieve that outside UBS.”
In the meantime, with every passing quarter grows a risk that even conservative UBS may not be able to avoid: investors becoming more restless with UBS’s underperformance and intensifying their call for a breakup.
Together AllianceBernstein and Marsico own about 1.5 percent of UBS shares. That’s hardly a groundswell in favor of splitting the firm apart, but recent events in the financial services industry show that it doesn’t take a huge position to have an influence. On April 23, Dutch banking giant ABN Amro agreed to be acquired by British rival Barclays, after months of agitation by activist hedge fund manager Christopher Hohn of The Children’s Investment Fund, who had amassed more than 2 percent of its shares and pushed for a sale or breakup.
Ospel is confident that he has the long-term support of shareholders. But not everyone thinks it is that simple.
“What TCI did with ABN Amro,” says CIBC World Market’s Whitney, “shows that no one is safe.”
