UBS Adapting Business Model for Tough Times

MTPrelle says UBS's investment banking business will move away from IPOs and capital markets activity in favor of mergers and acquisitions and restructuring.
A string of negative events recently shook the reputation of UBS, the world's largest manager of other people's money, but the bank says it will stay close to Russia, refocusing its business here toward advisory and restructuring work.

UBS, Europe's second-biggest bank, does not have traditional commercial banking or retail operations in Russia, but it has an investment banking arm that has long worked for Russian blue chips such as Vimpelcom, TNK and Evraz, helping them raise money by going public or issuing debt.

In an environment where the capital markets are shut down, the business model will change because clients will need help restructuring existing liabilities or buying up weaker competitors, said Hermann Prelle, UBS's co-head of investment banking for Europe, the Middle East and Africa.

"There is a lot happening in metals and mining right now, and there will be activity in the banking sector. We expect a lot of this activity to gain speed over the course of the next few months," Prelle told The Moscow Times in an interview.

Russia is one of UBS's top three or four investment banking markets in Europe, and Prelle comes here every month, keeping the organization focused on local opportunities.

He said UBS would change the focus of its Russian investment banking business away from IPOs and helping companies get money from the capital markets and will instead look more into mergers and acquisitions and restructuring.

"Russia has been hit harder than other markets," Prelle said. "The slowdown that we have seen here has been much more dramatic, and I am sure that some of our competitors will question whether they will stay or not. We were always aware that there was going to be at some point in time a slowdown in activity, so we've taken a long-term view from the very beginning."

UBS's Strategy

UBS has an investment banking team of 25 people in Russia, and it does not plan to reduce staff. "We think this is the right size for the opportunity, so we don't need to change too much, but we want to continue being close to our clients here," Prelle said.

He said the investment banking business would generate some $100 million in revenues in 2008, accounting for up to 10 percent of total revenues across some products in Europe, the Middle East and Africa, with average growth rates of 35 percent per year over the last three years.

"This year, we have managed to maintain more or less the same growth that we achieved in 2007," Prelle said. "Next year, we will reposition some of our products and initiatives with the intention of trying to maintain that level going forward."

Prelle believes that in a financial crisis the most important thing is staying close to the client and convincing them that the firm is here for the long term. "Being here in the good days is easy, but being here when a lot of pressure builds up in the system is what makes a difference. This is how you gain market share. Then, when a market recovers, you've made a step up in the quality and breadth of your relationships," he said.

He conceded that global risk awareness within the bank has increased dramatically in recent months. But "in Russia, we have managed our risks very carefully -- we are not exposed on the loan portfolio and did not have any big trading losses because we have been disciplined and probably moved much earlier than others in not exaggerating our positions. We have never used lending to lead our relationships," Prelle said.

UBS sometimes provides loans to Russian investment banking clients; it might give a client a loan to complete an acquisition it has been advising on. But it is not in the business of providing commercial loans like other large international banks that have been active in Russia, such as UniCredit or ING.

"Our loan portfolio has always been very minimal here, and we will maintain that discipline going forward," Prelle said. "We had some trading positions, but since the summer we have been very active in managing them."

One area that has been the most pleasant surprise for the bank recently is advising governments. This is an increased trend all over the world, including Russia, and Prelle noted that even in the United States, a country that has always been reluctant to let the government play an active role in the economy, the government is now working closely with the private sector.

"We have been advising over the last two months, since the demise of Lehman Brothers, the U.K. government, the Belgian government and the German government, and we are trying to speak to as many other governments as possible," Prelle said. "These governments will have the assets for a long period of time, but at some point they will try to sell them."

Global View on Russia

One big question regarding the intervention of the Russian government into real sectors of the economy is how permanent it will be, he said. "The important thing is that it does not become structural and that they focus on sectors where they want to be involved in the long term," Prelle said. UBS currently is not advising the Russian government. "The government clearly cannot bail out the whole economy, because the Russian economy has become too large."

Another key question in international markets is how well the Russian government will be able to allocate its financial resources. "We have seen a major reduction of the foreign reserves in Russia, and that is worrying. It means that the money is being spent very fast on too many things," Prelle said. "It is going to be important for the government to concentrate their efforts and not to overstretch themselves economically and financially, particularly as nobody knows what will be needed in the coming year."

A third concern is the need to find the right balance between the devaluation of the ruble -- which will help exporters weather the crisis and the general population, whose income is primarily in rubles -- and dollar liabilities, which may become difficult to fulfill if the ruble continues to depreciate. "It is very important for the government to find the right balance soon because this will probably become a reality in the next two to three months," Prelle said. "The 1 percent devaluation against the basket that we saw before is clearly not sufficient, and probably another 1 percent would not be sufficient too."

Political issues are much less in the spotlight than economic ones. For example, the recent Kremlin decision to extend the presidential term to six years did not get much attention on international capital markets, Prelle said.

"In this crisis, people are so focused on today, tomorrow and the next few months that I don't think that is something that has more than nuisance value right now," he said. "The decisions the Russian government takes over the next six months are going to be much more relevant for the future and for the way you come out of the crisis than whatever might happen in two or four years."

Despite an array of new opportunities and optimism about the future of its investment banking business, UBS still has a lot of corners to turn internationally before things brighten up. In 2007 and 2008, UBS has booked record losses from its investments in the U.S. subprime mortgage market, taking a $48 billion hit to date. It posted a loss of $12.3 billion for the first three quarters of 2008 and will post a net loss in 2008.

The head of UBS's wealth management business was indicted by a federal grand jury in Florida in November on charges of defrauding the United States of tax revenues by helping U.S. citizens conceal $20 billion of tax payments. And in the first nine months of 2008, UBS clients have taken out approximately $120 billion, with 58 percent of this amount withdrawn in the three months between July and September -- the highest decline in deposits the bank has ever seen.

The bank announced earlier this year that it would cut staff by 5,500 by the middle of next year, and its investment banking arm has already seen the dismissal of 2,000 people.

As for the global staff cuts, the bank "was adjusting to the lower activity levels, not changing our global footprint," Prelle said. "We like to be where we are -- we are very strong in the BRIC countries, in Europe, Asia and have a very meaningful presence in the U.S., and we do not want to change that."

12-Month Outlook

One result of the Russian financial crisis in the coming months will be an increase in restructuring work as companies review their portfolios and dispose of noncore assets, Prelle said.

"Russian companies, for example, need to consider whether they really need to have foreign assets in Africa, in Australia, in the U.S., or should they consider exiting them to generate some cash that they can utilize in Russia," Prelle said.

Another new source of revenues for investment banks will be debt renegotiation. "A lot of debt has been entered into over the past few years, and some of this debt needs to be renegotiated or restructured," Prelle said.

The crisis is also expected to bring about a wave of consolidation activity.

"The crisis is hitting Russia in a very intense way, so consolidation may be even more intense here," Prelle said. "One of the things that we see right now is that there are clear winners and losers -- however, there are very few winners and a lot of losers. The winners have the chance to decide, 'How do I consolidate here?' As this crisis has happened so quickly, this is much more dramatic than ever before."

Prelle said consolidation will create lucrative opportunities for banks that will maintain relationships with the clients who are "winners."

"There are going to be good deals because right now there are a lot of distressed situations. If you take a long-term view, you can add real value to your client and generate good business."

The crisis will probably hit a low point in the second or third quarter of 2009, Prelle said, and at that time valuations will hit their low points and companies will start picking up distressed assets.

Right now, investors and companies are doing their homework, deciding where to slash costs and reduce capital expenditures, which areas are going to generate cash, who is paying and who is not and which clients need help. "When they have done their homework, the winners will start looking around and find a lot of very attractive opportunities. It's not going to be very big transactions, but it may be very valuable ones as the upside is enormous," Prelle said.

Prelle said some of the opportunities for investment banks are not necessarily in the same areas as in the past few years. One new area is the real estate portfolios that banks held for years but will now try to sell to raise cash. Another area of interest is asset management -- some banks have funds that were repackaged and sold to retail clients but are now becoming a drag on profitability and may be sold. Investment banks that can help these clients will find lucrative business opportunities, Prelle said.