UBS AG's admission that it may not reach profit goals and that new regulation has changed the game in investment banking is likely to fuel further doubts over its ambitions in fixed income, where it still trails rivals.
Calls to scale back or even scrap the business, which will consume more capital under new industry rules, have dogged the Swiss bank for much of this year, with some analysts forecasting an inevitable restructuring of the investment bank.
Chairman Kaspar Villiger's comments in a recent newspaper interview that UBS is reviewing the group's mid-term goal of 15 billion Swiss francs ($17.9 billion) in pretax profit will only fan these flames.
Not that this target review comes as a shock -- consensus forecasts for pretax profit in 2013, the mid-point of UBS's targeted timeframe, stand at 11.1 billion francs, according to the average of 22 analysts polled by Thomson Reuters I/B/E/S.
Many have also long had low projections for UBS's ability to bolster its fixed income, currency and commodities (FICC) unit, even though it did account for 50 percent of investment bank revenue in the first quarter of this year.
It's a market that's becoming trickier to navigate even for top players, as a jittery economic backdrop hits income and capital requirements pile on pressure -- leading to questions over whether newer contenders such as UBS should bother at all.
As spreads normalize and capital requirements rise due to new regulation, all investment banks will need to rejig their (FICC) offerings, said Florian Esterer, senior portfolio manager at Swisscanto, which holds more than $180 million in UBS shares.
UBS is particularly impacted by these trends as they have missed much of the profits over the past 24 months and have just restarted a rehiring of personnel and an increase of their risk-taking capacity.
Credit Suisse and Morgan Stanley may also need to rejig their FICC divisions, according to analysts at JPMorgan, who call a restructuring at UBS inevitable.
In the first three months of this year, UBS was only 200 million francs short of its mid-term 2 billion quarterly FICC revenue target.
But it could fall far shorter than this throughout the rest of this year, with fixed income revenue across top banks projected to fall by over 20 percent in the second quarter, analysts say.
Last year FICC revenue at UBS was about 2.5 billion francs below its 8 billion mid-term goal. Analysts at Santander last week predicted these would be down another 7 percent this year.
That drop-off could be in line with the market, but UBS already has a long way to go to close the gap with rivals and gain market share. It was more than $4 billion behind Goldman Sachs and Deutsche Bank in terms of FICC revenues last year.
Insiders at UBS say the bank never set out to be a number one FICC bank, and that the contribution the unit makes to revenue more than justifies its existence.
A strategic overhaul of that magnitude would also be a blow to investment bank chief Carsten Kengeter, who led a hiring drive last year after being brought in like his boss Oswald Gruebel to help steer UBS's turnaround.
The bank took on more than 420 extra fixed income bankers, bringing headcount across the division worldwide to over 2,000, out of about 17,600 investment bank staff in total.
But costs associated with these hires have helped created the very headwinds, beyond the strong Swiss franc and tough markets cited by Villiger, that may force UBS to streamline its investment bank.
And if not fixed income, other core areas may have to suffer.
UBS is grappling with much higher-than-average compensation costs, fueled in part by its 2010 recruitment in FICC and In equities trading, which it may not have the revenue to counter.
Its weaker U.S. investment bank franchise may be one area it could target, although Villiger was again forced last weekend to scotch rumors of a sale, circulating after a string of high-profile defections among dealmakers there.
However, UBS will want to maintain its overall advisory business, which is key to its plan to better serve its powerful wealth management franchise.
If something has to give, a pullback in fixed income, however painful, is the preferred option for many observers.
Ironically, shrinking the investment bank would likely be taken relatively well by the market, analysts at RBC Capital Markets said in a recent note, adding that FICC was the obvious area to streamline.
($1 = 0.840 Swiss Francs)
(Editing by David Holmes)