UBS Group AG (UBS) Q2 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, good morning. Welcome to the UBS Second Quarter Results 2017 Presentation. And the conference call is recorded. After the presentation, there would be two separate Q&A session. Questions from analysts and investors will be taken first followed by questions from the media at 11 o’clock. [Operator Instructions] The conference must not be recorded for publication or broadcast. At this time, it’s my pleasure to hand over to UBS. Please go ahead.

Good morning, everyone. It’s Caroline Stewart here, Head of Investor Relations. Welcome to our second quarter results presentation. This morning Sergio will provide you with an overview of our results and Kirt will take you through the details. After that, we’d be very happy to take your questions. But before I hand over to Sergio, I’d like to remind you that today’s call may include forward-looking statements. These statements represent the firm’s belief regarding future events that by their nature are uncertain and outside of firm’s control and our actual results and financial condition may vary materially from our belief. Please see the cautionary statement included in today’s presentation and the discussion of risk factors in our Annual Report 2016 for a description of some of the factors that may affect our future results and financial condition. With that, thank you and I’d like to hand over to Sergio.

Thank you, Caroline. Good morning, Maria. Good morning, everyone. We will keep our remarks short as it is a relatively straightforward quarter and we know it’s a very busy day for everyone. Kirt will focus on the quarter which was characterized by continued positive momentum on the Wealth Management side. This is in contrast to low client activity affecting our institutional business, especially relative to the prior year on the back of low volatility levels across all major asset classes, particularly in FX markets. Considering market conditions, the second quarter results were very good and contributed to an excellent performance for the first half with adjusted profit before tax of CHF 3.6 billion, almost 20% higher than last year and net profit of CHF 2.4 billion, up 40%. Year-to-date results were solid with an adjusted return on tangible equity of 12% or almost 17% excluding the impact of deferred tax assets. Global Wealth Management delivered an excellent performance with profit before tax up 17% to CHF 2.1 billion, as increased client activity, higher U.S. dollar rates, invested assets and lending, further progress on mandate penetration, and good cost control supported profit growth. As previously highlighted, Personal & Corporate remains under pressure from negative rates, but we saw growth in transaction and recurring net fee income as we work to temper interest rate headwinds. Business dynamics remained strong with the best net new business volume in over a decade and record levels of new client acquisition in Personal Banking. Asset Management profits were roughly flat despite pressures faced by the industry as the shift from active to passive investing continues. We also saw CHF 30 billion in net new money, excluding money market flows, our best performance in over a decade. Recently the Chinese regulator granted a private fund management license for Asset Management. We are the first qualified domestic limited partner license holder to receive such a license in China and we are very glad and honored about that. This means we can offer onshore investment products for Chinese institutional and high net worth investors, which we also expect Wealth Management to benefit from. While it will take time to realize the benefits, it is a significant milestone and underlines our progress in China which remains a top long-term growth opportunity for the Group. Our Investment Bank’s profit were up 19% and its return on attributed equity was once again very strong at over 21%. Renewed strength in our Corporate Client Solutions business with growth in all areas, as well as higher equities revenues and good cost control helped offset low client activity in FRC. On Capital, our CET1 leverage ratio, which is currently our binding constraint, increased to 3.7%. Our CET1 capital ratio remained strong at 13.5% despite regulatory-driven methodology changes and other regulatory inflation in risk-weighted assets. We are very comfortable with the absolute level of capital we hold with CET1 capital growing 32 billion and over 74 billion of total loss-absorbing capital. We also remain very comfortable with both our CET1 ratios. Therefore, our capital returns policy remains unchanged. We continue to make good progress in our world-leading Wealth Management business. As we said before, our key objective for Global Wealth Management and for all our businesses is to grow profitably and sustainably over the cycle. I’m particularly pleased that we were able to generate substantial additional profits and strong net new money with fewer advisors, confirming that our growth is not dependent on aggressive hiring. Pre-tax profits for the first half were up a very strong 17% to 2.1 billion. In terms of client sentiment, improved confidence in the first half has led to higher transactional income, although trading volumes remained volatile on a week-to-week basis. Clients are also making more use of leverage. Recurring revenues were the highest we have seen in eight years as we have benefited not only from U.S. dollar rate rises and higher invested asset levels, but also from strategic initiatives, including increased mandate penetration. We continue to improve efficiency and net margins increased by 1 basis points. Last quarter we highlighted the three unique drivers for growth in our Global Wealth Management business. The Americas, APAC and ultra-high net worth continue to deliver excellent performances. Our America business has added further to its strong track record growing PBT by 25%. Our leading APAC business is clearly a highlight as we saw record PBT up 41% year-on-year, and this year the business is the second largest profit contributor of growth regionally after the Americas. Our global ultra-high net worth business delivered PBT growth of 12% and we are in an excellent position to benefit from the significant growth opportunity presented by this client segment. This is especially true thanks to our strong and competitive investment bank. In summary, we had a very strong second quarter and first half for the Group, and some of the dynamics we are seeing are encouraging. But we probably need a few more quarters of strong performance across Wealth Management before we call this a trend. Thank you. And now Kirt will take you through our results for the quarter.

Thank you, Sergio. Good morning, everyone. 2Q 2017 was a strong quarter with net profit attributable to shareholders of 1.2 billion, up 14% year-over-year and adjusted returns on tangible equity up 11.4% or nearly 16% excluding DTAs, which we believe is much more comparable with our competitors. For the second quarter, adjusted PBT was 1.7 billion with adjusting items of CHF258 million in net restructuring expenses, a CHF107 million gain on the sale of our remaining investment in IHS Markit, and CHF22 million of net foreign exchange translation losses. My comments compare year-on-year quarters and reference adjusted results unless otherwise stated. Our leading Global Wealth Management businesses delivered another excellent quarter increasing PBT by 15% to over CHF1 billion on good operating leverage. Revenues rose by 7% with increases in all categories due to improved client sentiment and activity levels as well as the effects of management actions. The increase in recurring fee income reflects invested asset growth and increased mandate penetration, partially offset by the impact of cross-border outflows and a shift to retrocession-free products. At the end of the second quarter, mandate penetration was over 32%, up a 130 basis points on a larger asset base. With higher mandate penetration, we increased our recurring revenue along with improving our overall margin. Transaction based revenues increased 13%, reflecting improved sentiment in activity levels globally. Asia was the biggest driver followed by the U.S. and Switzerland. Net interest income growth reflects higher short-term U.S. dollar rates, particularly for WMA and a 4% year-on-year growth in lending balances globally, which offset higher funding costs and the effects of negative rates on WM. After a period of client deleveraging, we are encouraged that Wealth Management saw its second consecutive quarter of strong loan growth, reflecting continued improved client sentiment and risk appetite. Costs increased by 5% as a result of higher compensable revenues and litigation expenses in WMA, partially offset by lower cost in WM from actions taken last year. Looking at the last 12 months, we reinforced our status as the only truly global wealth manager with a very balanced regional contribution to profits. Approximately 1/3 of profits were generated in the U.S., 1/3 in Europe including Switzerland, and 1/3 in emerging markets in Asia Pacific. We are particularly pleased with a continued strong growth and profitability from our market-leading franchise in Asia. For the first half, Wealth Management had net new money of over CHF32 billion, a 6.6% annualized growth rate on an invested asset base of over CHF1 trillion. We delivered very strong growth as we continue to focus on both quality and profitability as evidenced by the CHF5.3 billion outflows related to the introduction of euro deposit fees and despite CHF3.2 billion of cross-border outflows. We also improved productivity as we reduced our client advisors by 4% from the previous year. For the second quarter, Wealth Management attracted CHF14 billion of net new money, the highest second quarter figure in a decade, with growth in all regions. For the second half of 2017, we expect around CHF3 billion of outflows related to euro deposit charging as well as cross-border outflows of around CHF 11 billion with the typical peak in the fourth quarter. WMA had net outflows of CHF 6 billion, reflecting both seasonal tax payments of around CHF 3.3 billion and lower recruiting in the quarter. As we further transition our operating model, we expect net new money to stabilize over the next few quarters as the effect of recruiting policy normalizes and we see a pickup from same-store FAs. Personal & Corporate’s PBT declined 18% to CHF 379 million. That said, we are pleased with the strong growth in transaction-based and recurring fee revenue, up 7% and 8% respectively, which partially offset expected net interest income headwinds. Net credit loss expense was CHF 28 million compared to the CHF 2 million recovery in 2Q ‘16. This was driven by a small number of newly impaired corporate client positions across a range of sectors. Operating expenses increased by 7% to CHF 556 million due to the increased expenditure on strategic and regulatory initiatives as well as higher variable compensation. Asset Management generated CHF 133 million in PBT, down 10% year-on-year but up quarter-on-quarter. Performance fees increased significantly as nearly 80% of eligible hedge fund assets were above high-water marks at quarter end. Net management fees decreased from ongoing margin compression due to client shifts to passive strategies as well as lower transaction fees and higher custody fee charges, partly offset by market performance. Operating expenses increased driven by higher variable compensation, partly offset by lower salary and D&A expenses. We attracted over CHF 10 billion of net new money, excluding money market flows, with over 70% into passive strategies. This follows the substantial inflows already seen last quarter and underlines the strength of our passive franchise. With over CHF 700 billion of total invested assets, we’re now at the highest level since 3Q ‘08. Nearly CHF 250 billion of these are in passive strategies. Earlier this year, we announced the sale of our Swiss and Luxembourg fund services units, which is expected to close in 3Q ‘17 and reduce quarterly PBT by roughly CHF 10 million. The IB delivered an attributed -- a return on attributed equity of 18% for the quarter, a good result in challenging market conditions. PBT declined by 6% as lower operating expenses and increased CCS and equities revenues couldn’t fully offset 36% lower FRC revenues. Corporate Client Solutions was up 10% driven by higher ECM revenues from both private transactions and public offerings. In ICS, equity revenues increased 3%, mainly as derivatives benefited from increased client activity. As a reminder, our FX-dominated Foreign Exchange, Rates and Credit business is flow driven and balance sheet light, making it highly dependent on client activity, especially institutional client flows. The low volatility in volume seen throughout 2017 have therefore created a particularly challenging environment for our business. The year-on-year comparison also reflects a strong 2Q ‘16, which benefited from increased flows around Brexit. Operating expenses were down 3%, partly as a result of the cost actions taken in 2016 and a UK bank levy credit. The IB’s LRD fell by CHF10 billion in the quarter mainly due to foreign currency translation and continued prudent management. I’ll discuss RWA developments in more detail shortly. The Corporate Center loss before tax was CHF269 million. Services loss before tax was CHF137 million, a CHF76 million improvement mainly as a greater proportion of costs are allocated to business divisions this year. We expect Corporate Center allocations to business divisions to increase somewhat in the second half of the year consistent with the pattern we have seen in previous years as well as an increase related to strategic and regulatory initiatives. Group ALM’s loss before tax was CHF81 million, mostly due to accounting asymmetries related to losses on economic hedges, which mean-revert to zero over time. Non-core and legacy portfolio posted a pre-tax loss of CHF51 million, an improvement of CHF73 million as a result of litigation provisions releases and a U.K. bank levy credit. During the quarter, we increased our net cost reduction run rate to CHF1.8 billion with contributions from both Corporate Center and business divisions. We remain confident that we will achieve the full CHF2.1 billion target by year-end. We expect restructuring cost to be around CHF700 million in the second half of this year and then to significantly taper from 2018. In the last 6 quarters, we have seen CHF25 billion of regulatory-driven methodology changes in other regulatory inflation in RWA, nearly half of which in the second quarter of 2017. This accounts for substantially all of the RWA increase in the last 1.5 years. Business growth during this period has been offset by foreign currency translation and efficient resource management. We believe that the majority of this quarter’s increase is essentially in advance on changes that are expected once Basel III is finalized. For the second half of 2017, we expect around CHF6 billion of regulatory-driven increases. After that, the extent and timing of further increases will depend on regulatory developments. Once these are finalized, we will assess the impact and develop an appropriate response. On a fully-applied basis, our CET1 capital increased by CHF600 million to nearly CHF32 billion, mainly as a result of profits in the quarter. Our capital position remained strong with a CET1 capital ratio of 13.5%. Our LRD reduced by CHF20 billion to a historic low of CHF861 million, largely on foreign currency translation along with continued prudent resource management. This in combination with our higher CET1 capital pushed our CET1 leverage ratio up to 3.7%, a level which we’d also be happy with in the longer term, although it may still fluctuate during the transition period. In conclusion, we’re pleased with our overall performance. We saw a continued progress on our cost reduction program in double-digit profit growth in Global Wealth Management, which offset the headwinds faced by our other businesses, underlining the benefits of our diversified business model. With that, Sergio and I will open it up for questions.

We will now begin the question-and-answer session for analysts and investors. [Operator Instructions] The first question comes from Al Alevizakos, HSBC. Please go ahead.

Both of the questions are going to be on the Core Tier 1 capital ratio. First of all, I know you talked briefly about the RWA inflation. I just want to understand a bit the timing for the increases. What actually caused the increases coming this quarter rather than being phased in through the end of 2017? And basically how much of that relates to just Swiss rules and how much is basically in anticipation of Basel IV? And the second question is given that your risk density, risk-weighted density is increasing and this is going to be a long-term trend, would you be considering reducing the 13% Core Tier 1 target, especially given that the numbers that we see from the U.S. are actually smaller? And what is the kind of long-term plan?

Just to explain what we saw during the quarter in terms of what we referenced is RWA regulatory methodology-driven increases, including a regulatory inflation. And we actually guided on this previously where FINMA has intended and has been implementing multiplier increases, particularly across our credit portfolio and for different counterparts across our different businesses. So these multipliers were transitioned and we expect them to be transitioned over a the several year period. Then we saw CHF 12 billion -- CHF 13 billion, excuse me, of those increases up until the second quarter of this year, and this year we saw an acceleration. Now the acceleration was driven by the fact that there were a number of specific multipliers where we were incorporating the multiplier into our models, FINMA was reviewing that and then approving our models as they went into effect. And as that happened, what we saw is FINMA actually increased the effective multiplier through that process. And we had several of those models that were up for approval and were approved during the quarter, and that resulted in the acceleration. It impacted our income-producing real estate portfolio, it also impacted the LGD and the losses across our counterparties in the Investment Bank, and it affected to a lesser to a lesser extent our Lombard lending portfolio. So essentially what’s happening is FINMA is pushing up the difference between the advanced model output and the standard that we would expect under the finalization of Basel III. As we indicated, we expect about CHF 6 billion further increases through the end of this year. Now looking at what percentage we think is likely to be in advance of what we’re going to see under Basel III, we estimate around 75% of the increases that we saw during the quarter. Now in terms of our current dividend policy, as Sergio highlighted, that remains unchanged currently. Obviously, we will review that once we see the regulatory developments, particularly around the finalization of Basel III.

The next question comes from Jeremy Sigee, Exane BNP Paribas.

Two questions, so the first one is really following on from the previous discussion around CET1 and RWAs. And it’s really how you’re thinking about your medium-term expectation numbers, the CHF 950 billion of leverage, given the current leverage is just going down and down and down and the gap versus that is now quite big. But conversely, your RWA number is actually getting quite close now to your 250 billion. And I know I mean you described that 250 billion medium-term expectation as based on currently applicable rules but including known FINMA multipliers. Does that include things like this op risk add-on, and I’m just wondering how close we are to having to sort of think about higher RWA numbers than that 250 billion, but also coupled with probably quite a much lower leverage exposure numbers than the 950 billion. Sorry, that’s a bit long, but that’s my first question. The second question more straightforwardly was really around your outlook commentary which I thought had become quite a bit more positive on client activity presumably relating to Wealth Management, which isn’t yet visible in your numbers, the relatively soft revenue numbers I thought in Wealth Management this quarter. But I thought your outlook commentary was notably more positive, and I just wondered if you wanted to talk about that a little bit.

Let me start with the second one. I think that’s a yes, you picked up a slight change in our outlook statement which nothing else than having for a second quarter in a row observing a pickup in client activity levels. As you can see in our results, if you look at the Wealth Management combined businesses, the transactional revenues are up substantially around 20%. You look at across the board, mandate penetration, the willingness of clients to deploy cash in combination of the willingness to take a little bit more leverage is playing out. As I mentioned in my remarks, it’s a little bit early to call this a trend, but the momentum seems to be there. There is indeed on the other end, when you talk to clients, still some higher reservation, particularly in respect of the outlook on the geopolitical front and people are still quite insecure about what everything means. You go from the Middle East to the U.S. and including the Brexit discussions, I mean people are still quite unsure about what it could play out, but there is a willingness to think positive and you can see that being played out in the market. In contrast to that, we continue to see institutional investors’ activity levels being subdued because of the low volatility levels on all asset classes. But I’d like to see another couple of quarters of this momentum in Wealth Management to be there, and particularly we welcome the fact that indeed from Asia we see a pickup in activity.

And, Jeremy, I’ll take your first question. Just one point of correction. You mentioned the op risk increases and actually we didn’t see any increases in op risk. As we’ve indicated before, we’re already on our AMA model for op risk, which has been agreed with FINMA and that’s fully reflected in the numbers. The increases that we saw during the quarter were predominantly credit risk, although there was also a market increase as well. Now in terms of our overall trajectory, we guided in the third quarter, we guided the 250 billion, the 950 billion. You might recall at that point we highlighted CHF 30 billion of regulatory inflation. And in terms of what we’re seeing, clearly the level of inflation is higher than we anticipated back then. Now having said that, our guidance around the 250 billion stands until we see any further regulatory developments, as I mentioned. And really we need to see whatever comes out of Basel III for us then to reconsider what the impact is. And, of course, also as I highlighted, once we see those final rules, clearly we’ll incorporate and we’ll assess their impact on the business, what actions we can take to offset them, what changes we need to make in order to be able to fully align to the new rules. And that would be part of the process. In terms of the CHF950 billion, obviously we’re operating well below the CHF950 billion. The CHF950 billion remains intact as well and that really is just dependent on client activity levels. And if we do see a significant pickup in client activity levels, we would expect our LRD naturally to increase, although we still would expect that CHF950 billion in the medium term to be the top level of what we expect out of LRD. Of course, as that activity picks up and as LRD picks up, we would also expect to see better results flow through to the business.

And so on the CHF250 billion, so apologies, that’s my mistake to call it op risk rather than credit risk, but the CHF250 billion that’s consistent with this methodology change that you’ve printed today. We don’t need to restate the CHF250 billion to a higher number to reflect today’s methodology change. You’re saying that’s within the expected methodology changes that you’ve already guided, even if it’s like being…

What I said actually is we’re seeing an increase in that inflation, but that’s not impacting our current guidance on the CHF250 billion in terms of what we can see in the near term. As I mentioned, CHF6 billion to go in the second half, and by then we would expect hopefully around that period of time to have clarity on Basel III, and we’ll guide accordingly once we know what those developments are.

The next question comes from Andrew Coombs from Citigroup. Please go ahead.

I will stay on this theme of capital, if I may. You talked on CHF6 billion of additional inflation coming through in the second half of 2017. Can you just provide any insights even if you can’t quantify the magnitude? Are there another whole host of models that we should be aware of that are set to be updated in 2018 as well? So could there be further RWA inflation in 2018 even absent Basel IV? Secondly, would be on Basel IV. Presumably, the impact of putting through these FINMA adjustments today means that when you’re thinking about the Basel IV credit flows coming through, the impact should be less on a relative basis. Otherwise, you’ll be double counting. Is that a fair assumption? And on FRTB, which is obviously the one area in which we are further along on, is there any quantification you can give in terms of guidance for that one?

So if we look at the model changes that are taking place and where we’re seeing those multipliers, that the level of change that we’ve seen and what we expect for the rest of the year, as we indicated, just to be clear, that definitely is in advance on Basel IV. And as I mentioned previously, it is a reduction in the gap between the advanced models and what the standard models would suggest, which of course is the direction of a Basel IV finalization. And at this point, we wouldn’t even speculate on what might happen after the end of this year because we would expect to see the finalization of Basel III; of course, what’s being called Basel IV. But clearly, if we don’t see that, it’s the intent of our regulator to continue to apply multipliers. And what we’ve guided before is that we see that taking place until we see Basel through certainly through the end of 2018. Now, in terms of FRTB, at this point we really couldn’t provide any guidance because there still is a lot of uncertainty as to the definition of a specific desk and how actually that applies to those desks. I will, though, make a comment that one area of increase that we are incorporating into our current numbers is risk not in VaR, which is very much part of RTB or FRTB. So that is an area where we do expect to see part of that CHF 6 billion that I mentioned in the second half. Is it going to be driven by risks not in VaR, which effectively is an advance on what we’re going to see once FRTB is finalized?

Andrew, you’re raising a very good point and it’s a fair point. And as Kirt mentioned, we do expect and we do hope that at least if Basel -- the Basel reforms are not finalized, I think that you are right and we are also looking forward to be able to clarify with you all that. What it means? I think this situation is totally unsustainable and unacceptable. I think that we are going through too much degree of uncertainty, and our goal is to create clarity and transparency as quickly as we can.

Yes. I think if we get confirmation that Basel IV is off, then we’ll be able to clarify exactly what will happen with our current regulator without the Basel IV environment.

I guess one follow up on that point. Your closest peer has said post-Basel IV they would actually expect the hurdle rate to decline by as much as a couple of percent. So given that this is in advance essentially on Basel IV, is 13% still the appropriate hurdle rate?

I think, again, it’s very difficult to make a forecast on something you don’t know. I mean, at the end of the day, we can really judge the hurdle that we want to guide for capital returns once we know exactly what it is. One thing I can tell you that no matter what, new models will be adopted. The bank is not more risky than before. I mean, that’s clear that there is absolutely no desire to keep unrealistic and unsustainable capital levels. And, if necessary, we will adapt our thresholds to reflect that. The bank is in a very sound and strong position. We are increasing our actual CET1 ratio. Every quarter we have been -- we are CHF 2 billion above what we described to be an ideal target of CHF 30 billion. We are at CHF 32 billion. And there is a point in time in which we’re going to have enough capital to sustain our business and to make our shareholders, bondholders, and clients comfortable with where we stand. So, hopefully, we will be able to create that. But the 13% is not a sacrosanct level. If necessary, we will adapt it.

The next question comes from Magdalena Stoklosa, Morgan Stanley. Please go ahead.

I actually thought we could go back to the actual kind of business performance here. And I’m kind of particularly interested in your view on the kind of net margin sustainability going forward. Because as we look at your kind of Global Wealth Management performance this quarter, we pretty much kind have steady margins across the board, kind of apart from APAC but that’s, of course, kind of quarter-on-quarter probably unfair of a comparison. We are seeing significant kind of net new money growth, again across the board excluding U.S. But there you’ve told us about the seasonal levels. But what interests me is how do you see those net margins developing going forward and particularly the split between the kind of structural medium-term revenue pressures and what you’re doing to offset that on the cost level? That would be my first question.

It’s nice to go back to a business discussion. In terms of our margins overall, I think as you saw that if you look at the combined businesses for the first half, we had a reduction in gross margin from 76 basis points to 74 basis points, but we did have an increase in net margin. And clearly, that reflects the fact that we have positive operating leverage. And so, we’ve been able to offset some of the margin pressure within productivity improvements and the actions that we’ve taken on the cost side. Now, maybe if we talk about each business independently, if you look at Wealth Management, Wealth Management had a reduction in gross margin from 78 basis points to 73 basis points. But their net margin went up from 26 basis points to 27 basis points, and that’s partly as a result of the fact that their costs were down 2% year-on-year. In fact, our cost margin at 46 basis points is the lowest that it’s ever been. And when we said before about that business, we would expect it to be able to operate in a net margin range of between 25 basis points and 30 basis points. And we still feel very good about that range over the longer term through a combination of remaining market pressures that are offset through actions we’re taking with mandates, what we will continue to do in terms of productivity improvements, what we’re doing in the pricing and discount management, et cetera. So there still are quite a bit of levers that we have available in order to impact the business. Now conversely, if you look at our Wealth Management Americas business, its gross margin was down from 73 basis points to 72 basis points, but net margin was flat at 11 basis points. What we said for that business is we expect to operate around 11 basis points to 13 basis points in that margin and we still feel very good about our ability to maintain that net margin level. Obviously, we still have tailwinds from interest rate increases. We also have positive tailwinds from the increased mandate penetration. Our clients remain active in the U.S. and we expect to be able to improve our margins, particularly as we realize the benefits of the reduction of our employee forgivable loans where we’ve indicated we expect about CHF100 million run rate improvement by early next year.

The next question comes from Nicholas Watts, Redburn.

I had 2 questions. The first was around the ultra-high net worth segment. You gave some guidance on slide 4 that profitability in that segment in H1 was up 12%. If I look at the AUM progression on that business, it’s up about 18% year-on-year. I know that segment is a bit closer to the institutional market. So any color you could offer on client activities in that segment relative to, perhaps, lower high net worth individuals would be very useful. And then I had a separate question. Just following on the U.S. Wealth Management business, do you expect in the second half of this year, beginning of next year, as you move into full implementation of the fiduciary rule, any impact given the guidance that you gave a little bit earlier on the various tailwinds? Is there a headwind from that we should just think about to incorporate our numbers?

In terms of our ultra-high net worth business, I think, as we’ve shown, that continues to be a very key driver for us and we do have a global leadership position with that segment that is supported, of course, by our Investment Bank. Now if you look at the growth overall for pre-tax profit, the first half was up 12%, actually slightly less than the business overall. And the dynamic that we saw during the first half is during the first quarter in particularly our larger, more institutional-like ultra-high net worth clients were impacted by low volatility levels that we actually saw a reduction in trading from those clients on a year-on-year basis and a reduction in transaction revenue. But then as we got into the second quarter, we actually saw that they picked up their transaction revenue levels. And so there was a little bit of a pattern of actually behaving very much like our institutional clients in the Investment Bank to actually diverging a little bit and showing a little bit more activity as they were putting more risk on their portfolios. Now how those clients behave going forward is a little bit of an open question and we’ll continue obviously to track that very closely. In terms of the fiduciary rule, as we indicated, we implemented the first installation. That, of course, is implemented in the U.S. And the way we approach that, which we think is different from our competitors, is that we ensure that we minimize the impact on our clients in particular and also on our FAs. And we think that that actually is going to be positive overall in terms of the impact to the business divisions. Now, there’s still some uncertainty as to when and if we’re going to see a second installation. That remains under review. But if you look at the initial rules as they were guided, assuming they stay intact, what we’ve indicated is, on a net basis we don’t expect a large impact to our business overall. We have less reliance on brokerage accounts than our competitors because we’re very ultra-focused. And we will expect though, of course, to incur some expenses to be able to implement and manage. But beyond that, not a lot of P&L impact from our perspective.

The next question comes from Andrew Stimpson, Bank of America.

Few questions on the wealth businesses, please. The first one, you said that it’s the second quarter of loan growth signaling the better confidence. I’m just wondering how far that can go and what numbers you can give us around client leverage, where it’s been, or where it’s peaked in the past, et cetera. And then secondly, I think you said the advisor numbers are down 4% year-on-year, but the inflows across the business are still very good, especially in the context of the euro deposits, which you’ve out phased, which you’ve flagged. So I’m just wondering are we seeing a change in the industry model there. Are you less dependent on advisor headcount to grow the assets there? And if so, is that just that you’ve got better quality advisors left or is there some technology aspect there which is helping you perform better?

So just in terms of levers, I think as we mentioned, really our loan growth is very related to our clients’ total wealth and approach to their total wealth management. And it’s reflective of the fact that they are taking more risk particularly versus last year where we observed that they were delevering. And you see kind of an aligned trend between what happens with cash and what happens with leverage often. Last year deleveraging went more into cash. We saw cash increase. This year we’re seeing relevering, so they’re borrowing because they’re more positive. They’re putting more risk on. We’ve seen a reduction in the overall percentage of cash from 23% to 21%. Now some other factors driving that, but clearly there is also an underlying trend that our clients are putting money to work. If you look at our loans overall for the international Wealth Management business, in the second quarter we had 4 billion of growth year-on-year. In the first quarter, there was another 2.4 billion on growth. In addition to that, there was a recovery of 1.6 billion of deleveraging. So for the first half, we’re up 7.9 billion year-on-year. Now whether or not that increases, it is going to continue to depend on our clients’ risk attitude. If they continue to put risk on, we expect that they actually will continue to use leverage. And that should increase the relative penetration of our loans to overall invested assets. So, as I said, that’s going to very much depend on their risk orientation over the next several quarters.

[Indiscernible] to add on this point is that if you go back into a longer time period, the levels of percentage of loans to lend new money is more or less at historical level. So I think that one has to try to look at maintaining a healthy balance of those ratios because I’m not so sure that it’s sustainable to get infinite growth in lending without taking at a point in time a credit risk profile that wouldn’t really fit into a wealth management business. So, from our standpoint of view, we are really focused to serve and give lending and provide lending when there is appropriate underlying dynamics to support that. Now, in terms of your point on the advisor, I think it’s a combination of the factors that you mentioned. Of course, it’s not up to us to say we have better advisor than others. What I can tell you is that for sure we have been pursuing a path not only in Wealth Management international but also globally to look at quality and productivity of client advisor and financial advisor rather than quantity. And using the point about technologies is also very important because as we keep rolling out, for example, in Wealth Management International, our Swiss platform to Europe and soon into Asia, we are helping our client advisor, their assistants to become more productive to serve more clients not only in an efficient way but also effectively, adding value to content rather than administrative work. So it’s a combination that will continue going forward that we will grow and we will hire, of course, but we try to focus really on trying to look for quality rather than quantity.

Maybe, Andrew, just one final comment on your first point. If you look at overall loan penetration, loans to invested assets, in the past they’ve been as high as around 13%. Currently, we’re at about 10.7%. So that kind of gives you a little bit of an idea of a context historically on where loans could go.

The next question comes from Kian Abouhossein, JP Morgan. Please go ahead.

Two questions. One is you are on track on reaching your cost target clearly, and I’m just wondering how should we think about cost beyond this year. And in that context, can you share any light on the allocated cost in the Corporate Centers? Are there any changes that you’re thinking or will be done to minimize that cost? And the second question is, Sergio, if you can maybe discuss with us a little bit what are the three key focus discussions that you have in the executive board?

In terms of our cost, as you said, we’re sort of in the last mile of our announced cost reduction program and we do expect to hit the 2.1 billion. Now beyond that, it’s currently not our intention to come out with a large number that we expect to hit, but rather we will focus -- it’s just part of the way we manage business -- on ensuring that we maintain efficiency, that we constantly are looking for opportunities to continue to transform the business front to back, to implement automation robotics, digitization, continue to refine, improve our processes, to pursue for example external deals around potential collaboration that we’ve spoken about in the past. And we do think that there’s significant additional opportunities. Just as the industry will likely transform, we expect to be right at the leading edge of ensuring that we’re doing everything possible to improve the efficiency and effectiveness of our business. And from our perspective, that really comes down to ensuring that we meet our efficiency targets, our business divisions stay within their efficiency target ranges, and we modulate what we invest versus how we’re trending with revenue to ensure that we keep that level of responsibility and overall performance for the group. From an allocation standpoint, we don’t expect any material change in allocations going forward. Naturally, as we’ve said, we are allocating, of course, the majority of our costs out to the business divisions. What we retain is really related to some group functions or some other items that we think are really not driven by the business divisions. We expect over time for those retained costs to be relatively de minimis and to continue with that approach as we go forward.

So, Kian, in respect of the priorities for the business, what we are really focusing on is really executing on our strategy and challenging ourselves all the time in respect of not the strategic direction because the strategic direction is quite clear, but rather any need for any tactical adjustments and a reconsideration. And we put a lot of efforts in really understanding clients, client trends, and so on. I think from a medium- to long-term perspective, we are focusing on organic growth and, of course, we are investing a lot of time and effort in fueling the engine of growth in Wealth Management and particularly in respect of the U.S. and the Asian opportunities. And China continues to be a top priority for us and we are very, very active on that front. And last but not least, I could say that we still unfortunately have to spend some degree of time in understanding our regulations may or may not impact our business and also understanding and managing through the outstanding legacy issues that are somehow going to help us to have a more clear pattern in terms of defining our medium- to long-term capital return strategy.

If I may add, if I look at, you mentioned that within the board, you look at your performance also against some of your peer group. And it seems that on the top line in particular in the asset gathering, especially in the WM business, you can take the view that it’s been now over longer period of time that some of the peers have been maybe outgrowing you. Is that something that is of concern or is this something that, as you mentioned, that is maybe more risk space and hence we are not going to go that direction or you have a different view about the world in the future? Just trying to understand how we should think the performance on a relative basis and how important that is to you at the moment.

Yes. Well, it’s a good point and actually we do indeed always look at on a critical level any competitive comparison. We like to take time series that goes from quarter-on-quarter to multi-years since we are in a business that has to be managed on a long term with long-term views. If I look at our last three, four, five-years horizon and you look at the base we are starting from, I think I’m pretty comfortable that we are in a strong competitive position. And again, I’m not trying to make comments about orders, but I can only tell you that looking at the time series that is mixed between short term and long term, the picture that we get is a picture that allow us to continue to look at that in a favorable way. I’m just taking one example. In the first half of the year, we had a 6.6 percentage growth in net new money, which is, as you know, we are not over-focused and paranoid about net new money. But since people are talking about growth, net new money as a function of growth, we can take a figure of 6.6% done with fewer client advisors. And at the same time, as we took out CHF 5 billion of deposit in euros that were value-destroying. So I’m confident that staying critical about ourselves but also taking longer term view will pay off.

Just perhaps just if I could add to Sergio’s comment, first just staying on that point of the 6.6% growth. If you adjust -- and some of our competitors do much more overtly -- for the cross-border as well as the euro outflows, that number would’ve been 7.9% for the first half, 7.9% growth. And I think our 17% in PBT growth holds up quite well. If you look at our Wealth Management Americas business, first of all, of course, we focus mostly on pre-tax profit. Our reported pre-tax profit growth year-on-year of 26% ranks number one across all of the broker dealers, all of our peers. And our revenue growth of 11% also ranks number one. So I think if you do compare against our relative competitor set, I think we feel pretty good about how we hold up in terms of what’s most important to us.

The next question comes from of Andrew Lim, Societe Generale. Please go ahead.

In Wealth Management Americas, you don’t seem to be having as much positive momentum as your peers. Your net margin seemed static at 11 basis points, your cost/income ratio at 85%. Whereas if we look at your peers, they’re benefiting from positive operating leverage, record high AUM, net new money very strong, whereas you’re suffering a CHF 6 billion net new money outflow. Can you talk about what the differences are there versus yourselves versus your competitors in the U.S.? And then, secondly, can we return back to risk-weighted assets and the dividend policy here? I’m a bit surprised about the concern expressed by some others. I mean, your CET1 leverage ratio is 3.7%. That’s clearly the constraining fact of the capital, but that’s strengthening your CET1 ratio at 13.5%. I mean that’s still quite strong. You’d have to have a 35% increase in your risk-weighted assets for that to be an issue for you, i.e., your CET1 ratio to fall down to about 10%. At the same time, you’re talking about a potential revision to your dividend policy. So perhaps you can give some clarity there. Are you saying that you would revise that if that CET1 ratio fell below 13%, yet stayed above 10%, or are you saying that there’s a recognizable possibility here that that could fall below 10%, and then you would have to revise that policy?

Let me just add before Kirt addresses the other points. I’ll go straight to the point. We haven’t talked about any change in our capital return policy until the Basel III rules are clarified. Today we have a 13% trigger with a 10% post-stress that triggers the policy of paying at least 50% of net profit attributable to shareholders. So should we see an inflation in risk-weighted assets, we may take down those 2 ratios to reflect the fact that the absolute amount of capital necessary to sustain the business is still adequate, and the ratio have only changed. But it’s totally premature to talk about a new levels of triggering levels. And by the way, we may even not have one in the future. We may change it. I mean, it’s a really hypothetical question. So the only thing that is clear that as we speak, our binding constraint is a leverage ratio constraint. We do not expect any changes to come in that’s in the next few weeks per se. Hopefully, by the end of the year, we’re going to get more clarity on this matter, and we’re going to be able to outline to you a new situation as facts are getting more concrete.

So, Andrew, maybe just to address your first question, and actually, I highlighted some of these points on the previous answer. If you look at our WMA business and if you compare us with the other broker dealers, first of all, our year-on-year revenue growth was 11%. The average of the peers was 8%. We were number 1 amongst peers. Secondly, our invested asset growth was 9%, which was basically spot on with the average of 9%, and we were number 2 in terms of our peers. Our reported pre-tax profit growth was 26%. We were number 1 amongst our peers. Our cost/income ratio, if we exclude litigation, improved 2 percentage points to 82.5%. That was basically in line with our peers, and versus first quarter we’re down from 86% to 82%. So, actually, I feel that our level of growth, our efficiency, our performance is very much in line and, in most cases, better than peers. I would also finally highlight, if you look at our productivity levels at an FA level, we remain, we have the most productive FAs in the industry, and that’s something that we’ve maintained for a number of quarters.

Can I follow up with a very quick third question? Sorry. On page seven, you talk at the very bottom about CHF5.3 billion of net outflows due to the introduction of fees for large euro-denominated deposits. Is that specific to UBS and why did you introduce that? And can we consider those outflows as a one-off or was that something that’s going to continue?

Yes. I mean, essentially, what we did is if you look at deposits and particularly euro deposits with their negative interest and the fact that we actually don’t have a large euro asset portfolio, they are dilutive to our capital overall and dilutive to our P&L. And so what we did is we identified clients with a high concentration of euro deposits and repriced them. We offered them the opportunity to put their money at work. A large percentage did put their money at work, some accepted the higher pricing, and some left. We were happy to see them leave because they were dilutive to the business overall. So the net result of this program will be accretive to our P&L and accretive to the group. We mentioned that we do expect probably around CHF 3 billion more of outflows related to this program, and this is unique to us. And I think it’s consistent with our focus on quality. We are, I believe, much more aggressive than our competitors of giving up optics in favor of making sure that we focus on quality and that we focus on profitability.

The next question comes from Stefan Stalmann, Autonomous Research. Please go ahead.

I have three questions, please, two on business and one going back to the risk-weighted asset issue. On business first, you had a pickup of loan loss provisions in the Personal & Corporate Banking unit. Does that reflect an underlying deterioration or is it just because there are no recoveries anymore that would offset new provisions? Second point on the lending penetration in Wealth Management. You talked about this, but maybe just to summarize this. Are you actively doing anything to increase the lending penetration, or is this really a reactive function of the clients’ demand for credit at any given point in time? And then, finally, going back to the risk-weighted asset question, you will have about CHF18 billion of risk-weighted asset inflation from these various model changes and multiplier effects that you outlined. Your competitor across the street does not seem to have this and did not guide about this for the rest of the year. Why do you think there is this divergence, if that is something that you can comment on? Is it something that reflects, let’s say, FINMA’s work processes and then priorities and it’s differences in the way your books are managed, et cetera? I would be very glad if I could get a bit of color on that.

In terms of your first question, there’s a CHF28 million credit loss expense. It’s not an abnormal loss expense for a portfolio of this size and it’s not anything that we’re concerned about. As I highlighted, it reflects a number of relatively smaller client positions across a number of segments. It’s not indicative of any trend that we expect to continue. And if we look at the fact that we’ve been operating with very, very low losses and in fact in many quarters we’ve actually had releases, again, this is not a surprising number at all. So we feel very good about the credit quality of that business. In terms of Lending and Wealth Management, as we mentioned, this is very reflective of the fact that our clients are looking to put leverage on as they become more active, more risk on, reduce their cash, increase their loan. From our perspective, we just want to make sure we’re there advising them on when we think leverage is appropriate. We want to ensure that we capture our fair share of the loans that they borrow with us because we want to keep their entire relationship with us. But it’s purely driven by client demands and how they view and what their level of confidence is on the market. In terms of your RWA question, we really just won’t comment on other competitors or what others may or may not be doing.

Could I maybe follow up with one additional aspect on the lending question. I mean, we had, for instance, this transaction that was publicly in the market where UBS apparently helped HNA to buy a large stake in Deutsche Bank, and that required a lending package and derivatives around that. Would that be accounted in Wealth Management or in the Investment Bank? And is that the kind of business that you would actively push for more than in the past or is it again very reactive to what clients want to do?

So, first of all, I think that, in general, of course, I’m not going to comment on specific client situation, but as you mentioned this is fairly public issue. But one thing is clear. This kind of business is booked into the Investment Bank which is -- and I think considering that the characteristic of the transaction has nothing to do with the Wealth Management transaction, and we are very disciplined in the way we segment loans and growth of balance sheet usage in that respect. So in respect to the kind of lending business on liquid assets on a structured way that fits our risk appetite and, yes, this is a kind of business that we do, and we feel very comfortable about any aspect of both the market risk involved and any credit risk involved in the transactions.

The next question comes from Jon Peace, Credit Suisse. Please go ahead.

So the first question was on costs. So I think you said earlier that you didn’t plan another big cost-cutting program for next year. Your cost/income ratio at the moment is running in the high-70% against your target of 60% to 70%. So, I mean, absent another big cost program, do you think you’d get into that range anytime soon or are you dependent on some degree of market recovery to get you into that range? And then, my second question was just about DTA recoveries. Normally in the third quarter, you would expect to book a recovery, and last year it was about 582 million. And as you look at the outlook this year for sort of profitability, what sort of expectation should we have for any further DTA recoveries?