Until a few years ago, UBS (NYSE:UBS) and Credit Suisse (NYSE:CS) – the two largest Swiss banks – were nearly indistinguishable in terms of their respective business models, with identical global footprints and service offerings, ranging from wealth management to retail banking to investment banking. But the banking giants have chosen two rather distinct strategies over the last couple of years as they implemented sweeping changes to comply with new stringent Swiss capital requirement standards.
While UBS decided to expand its wealth management unit and do away with large parts of its investment banking division – shrinking its fixed-income business to a fraction of its original size – Credit Suisse opted to retain a full-scale investment bank and announced its decision to refocus its wealth management operations only in more profitable markets (see Credit Suisse Continues To Shake Up Private Banking Business). Below we compare the banks’ respective business models and take a look at their effectiveness.
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The chart above breaks down our price estimate for UBS’s stock into each of its operating divisions. The focus on wealth management is immediately evident, with 40% of the total value coming from the bank’s geographically diversified wealth management presence. The impact of the downsizing in fixed-income trading operations also stands out from the fact that it contributes less than 5% of the total share value, even as equities trading is responsible for almost 20%. The bank’s total investment banking operations – trading, advisory and underwriting – contribute less than 35% of UBS’s total share value.
In contrast, Credit Suisse’s wealth management business contributes less than 30% of the bank’s total share value according to our analysis, followed by about 22% for fixed-income trading. Taken together, the bank’s investment banking operations are the source of more than 50% of Credit Suisse’s total share value.
To get a clear picture of which model is more effective in the long run, we compare them based on three parameters: revenue potential, return on equity and risk profile.
Revenue Potential: Advantage – Credit Suisse
The wealth management business is a stable source of value, with a large proportion of the revenues being in the form of recurring fees. The only volatile revenue component here is the performance fee, which is linked to debt- and equity-market performance over a period.
However, in terms of sheer revenue potential, investment banking takes the cake. However, the fact that these revenues are more linked to debt- and equity-market performance makes them more volatile – leaving a bank which relies too heavily on it exposed to the possibility of huge losses in unfavorable environments. But if the bank ensures that it is adequately capitalized and that catastrophic losses to its investment banking operations in the event of a downturn can be isolated so as not to drag down other operating units, then such a model scores higher in terms of revenue potential. And as Credit Suisse has been reorganizing itself based on these ground rules, we rate it above UBS on this count.
Return on Equity: Advantage – Credit Suisse
While Credit Suisse’s model has a higher revenue potential, it also benefits from the fact that margins for the wealth management business are considerably lower than those of investment banking operations. To put things in perspective, margins for global wealth management giants are normally in the 20-25% range, whereas investment banks routinely report margins between 35-40%. This disparity makes a bank that is focused on wealth management more sensitive to expenses, as the impact on the bottom line from increases in operating expenses are more noticeable. This in turn has a direct impact on the bank’s return on equity (ROE) figures.
This fact is seen quite readily in the reported quarterly figures for UBS and Credit Suisse this year. While UBS reported ROEs of 8.5%, 7.2% and 4.9% for Q1, Q2 and Q3 respectively, the figures for Credit Suisse were 14.2%, 10.1% and 4.3%. Although it should be noted that both Swiss banks have incurred considerable expenses over recent quarters to meet capital requirements, these figures give a pretty good idea of what to expect from the two banks under identical economic conditions.
Risk Profile Comparison: Advantage – UBS
Needless to say, a business model focused on investment banking more is also more risky. This can be seen from the fact that UBS, which is the larger of the two banks with total assets of CHF 1.05 trillion ($1.16 trillion), had CHF 222 billion ($245 billion) in risk-weighed assets at the end of Q3 2013, whereas Credit Suisse with total assets of CHF 895 billion ($988 billion) had CHF 269 billion ($297 billion) in risk-weighed assets. So while Credit Suisse is roughly 15% smaller compared to UBS in terms of total assets, it has 21% more risk-weighed assets measured in Basel III terms.
To sum things up, an investor in UBS can expect more stable returns on investment in the future when compared to Credit Suisse. However, an investment in Credit Suisse comes with a potential for higher returns, albeit with added risk. Given the fact that both banks are among the best-capitalized financial institutions in the world, thanks to their adherence to the stringent Swiss capital requirements, one can safely conclude that the relatively higher risk involved in Credit Suisse’s business model would still be lower than the risks associated with other globally diversified banks.