Oct. 29, 2010
So, the quarterly numbers for Credit Suisse and UBS are finally out. What we see in the private banking business divisions is not very reassuring. On the surface the situation doesn’t seem to be too bad: UBS has just reported the first net money inflow in wealth management and private banking in two years (only SFR 1 bn – but out of negative territory at least). Credit Suisse keeps on sucking in net new money – although the 3rd quarter inflow of new assets, at about SFR 12 bn, was only slightly higher than in the 2nd quarter.
On the surface all seems fine but private banking profitability is in serious trouble
However, if one bothers to dig more deeply into the numbers, the situation appears to warrant serious cause for concern for the Swiss wealth management and private banking giants. For instance, the Credit Suisse gross margin on private banking has fallen from 125 basis points (1.25%) 12 months ago to 118 basis points in Q3 2010. The gross margin shows gross income generated from private banking clients divided by assets under management. This 5% decline is not huge but points to a bigger problem: that the contribution to revenues that stems from transactions (i.e. from trading fees) has declined significantly, dropping from 33 to 28 basis points in the last 12 months. Back in 2007 this margin was at 38 basis points – more than a third higher than today.
UBS shows a similar trend: while in the 2nd quarter the gross margin was at 95 basis points, it has declined to 89 basis points in the 3rd quarter. At least UBS can point to the fact that 12 months ago its gross margin was even lower at 88 points – a steep fall from the 100 points in 2007.
Costs are rising while private banking clients are sitting tight
The cost-income ratio for UBS has risen to 72.2%. The number shows the percentage of costs coming with every unit of revenue generated from private banking clients. At Credit Suisse, the number is even higher at 74.0% - one year ago it was at 70.4%. Operating expenses are rising while revenues are falling. The core of the problem is that, although more private bankers have been hired and are earning higher salaries, private banking clients are sitting tight, not buying or selling much of the expensive wealth management products offered to them. Credit Suisse has 1300 employees more in its private banking division than one year ago – an increase of more than 5%. While UBS has fewer employees compared to last year, as a result of CEO Grübel’s brutal cost cutting strategy, it has lately increased the numbers and employed 4% more client advisers in the 3rd quarter than in the 2nd quarter.
In particular, the expansion in the Asian markets is an expensive adventure for the global private banking giants. Under pressure from the decline in the private banking business of looking after clients' offshore assets in Switzerland, the banks have moved swiftly to develop new businesses in booming Asian emerging markets, administering the onshore assets of the tens of thousands of people who become millionaires in China, India, Singapore, Malaysia and elsewhere in the region every year.
But entering foreign markets is expensive, especially as, simultaneously, private banking strategists from Morgan Stanley, HSBC, Barclays, Bank of America (to name but a few) have had the same idea. Many other global players are intent on capturing these Asian markets with the result that the price for client advisers is soaring.
Private banking clients skeptical with regard to product innovation and portfolio churning
Lower revenues from transactions indicate that many private banking clients have become tired of trading in and out of products all the time – the industry term for this practice is churning. A growing segment of private banking clients desires nothing more than simple, transparent products and a stable portfolio; customer preferences that are detrimental to fee generation arising from heavy trading. It’s no coincidence that private banking strategists keep preaching that “buy-and-hold is dead and timing is everything”. Unfortunately for the banks, clients’ ears are ever more deaf to this kind of indoctrination.
Credit Suisse has just confirmed that it will increase flat fees on assets under management while transaction fees should become lower. This is a direct response to the more passive client behavior. Credit Suisse justifies the price increase on the grounds of the better advice and improved tools it is offering its private banking clients. However, the new pricing scheme will punish clients who follow a rational buy-and-hold strategy while rewarding clients who are frequent traders.
In the long run however, only private banks with a unique strategic positioning will save their margins from further deterioration. There is no doubt that many private banking clients are in need of sound financial advice and are willing to pay for it. Yet, client surveys and the analysis of private banking services show that today’s advice is ridden by conflicts of interest and does not live up to private banking clients’ legitimate expectations. Only real change in these areas will bring long-term, stable, even rising private banking profitability.