Which Swiss Bank Has The Better Business Model: UBS or Credit Suisse?

Before the economic downturn of 2008, the two largest Swiss banks – UBS (NYSE:UBS) and Credit Suisse (NYSE:CS) – had essentially the same business model. Both of them offered a complete range of banking services, from wealth management to retail banking to investment banking, and both of them covered similar geographies. But when faced with stringent new Swiss capital requirement standards in late 2011, the banking giants chose two distinct strategies to maintain their profitability in the future.

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. Below we compare the banks’ respective business models and take a look at their effectiveness, and discuss which model has a better outlook for the future.

See our complete analysis for UBS | Credit Suisse

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 almost 50% 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 4% of the total share value, even as equities trading is responsible for almost 15%. The bank’s total investment banking operations – trading, advisory and underwriting – contribute less than 30% 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 21% 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 has a better outlook, we compare them based on three parameters: revenue potential, return on equity and risk profile.

Revenue Potential: Advantage – UBS

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. But revenue figures for both banks between Q1 2012 and Q2 2014 indicate that UBS’s business model is capable of churning out more revenues. We consider this ten-quarter period because both banks began to revamp their businesses in early 2012, and so these revenues are good indicators of their strategic focus. While the average revenue for UBS over this period was just under CHF 6.8 billion ($7.4 billion), Credit Suisse reported roughly CHF 6.3 billion ($6.9 billion) in average revenues.

It can be argued that investment banking services – especially trading activities – should have an edge over wealth management services in terms of sheer revenue potential. But it must be remembered that one of the reasons many global investment banks have slashed their trading operations is because the more stringent regulatory requirements have made securities trading a less profitable affair. Revenues from trading activities are unlikely to reach the peak levels witnessed pre-2008. At the same time, UBS’s strength as the world’s largest private bank promises strong growth in wealth management revenues as it expands its presence in developing countries.

This points to a faster rate of revenue growth for UBS in the future compared to Credit Suisse. Based on our analysis of the two banks, we estimate that revenues for UBS will grow at roughly 5% annually in the long run, while Credit Suisse is likely to see 3.5% annual growth in revenues over a similar timeframe.

Return on Equity: Advantage – Credit Suisse

Although UBS’s model has greater revenue potential, margins for the wealth management business are considerably lower than those of investment banking operations, giving Credit Suisse an advantage here. To put things in perspective, margins for global wealth management giants are normally in the 20-25% range, whereas investment banks routinely report margins around 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 in the reported quarterly figures for UBS and Credit Suisse over recent quarters, with the latter consistently reporting higher RoE figures (adjusting for one-time restructuring and legal expenses). But in the long run, RoE figures for the two banks are not expected to be very different, as both of them target an RoE of 15% by the end of 2016.

Risk Profile: 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 983 billion ($1.07 trillion), had CHF 227 billion ($250 billion) in risk-weighed assets at the end of Q2 2014, whereas Credit Suisse with total assets of CHF 892 billion ($975 billion) had CHF 285 billion ($311 billion) in risk-weighed assets. So while Credit Suisse is roughly 10% smaller than UBS in terms of total assets, it has 26% more risk-weighed assets measured in Basel III terms.

Conclusion

To sum things up, UBS’s business model is likely going to be more stable going forward when compared to Credit Suisse, with a lower overall risk profile. While Credit Suisse’s business has the potential for very high margins and profitability, there will likely be more volatility in its results, as well as more risk. Our analysis of the two Swiss banks values UBS at around $22 a share – an upside of almost 25% to the current market price – while we value Credit Suisse shares at $33, about 15% ahead of the current market price).

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