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Thursday, 23 October 2014

Risk of rewards

Credit Suisse shoved into another restructuring

When Credit Suisse decided to shrink its fixed income business, many thought it wasn’t enough. They were right. After cutting a third of its products since 2009, the Swiss bank is renewing the assault.

Credit Suisse has the laudable aim of trying to maintain double-digit returns while taking less risk. But its success has been mixed. Third-quarter numbers were marred by a 42 percent fall in fixed income revenue - a bigger fall than at most U.S. peers. Hence the new plan to cut its interest rates trading business, which helps clients hedge, but ties up a lot of capital without consistently delivering a payback.

This latest surgery is more cosmetic than open-heart. The risk-weighted assets (RWAs) used by the rates business will only be reduced by $7 billion, or 44 percent over the next two years. That’s not seismic in the context of the $100 billion or so reduction in RWAs achieved last year. The fine-tuning allows the Swiss bank to avoid falling foul of new regulations that add to banks’ capital requirements for uncleared derivatives transactions. And the pruning will slash $60 billion in gross assets from the balance sheet. That’s helpful given Credit Suisse has been a laggard on leverage, notwithstanding a big improvement in recent months.

Still, Credit Suisse’s investment banking performance is concerning. A 4 percent return on equity in the third quarter was especially weak. A year-on-year fall in revenue broadly matched the decline in RWAs, as might be expected. But poor cost control saw pretax profit fall 53 percent.

Even allowing for some litigation expenses, Credit Suisse could have done more to reduce pay in the quarter. The compensation to revenue ratio stood at 44 percent, or 41 percent over nine months. Barclays intends to reduce this measure to around 35 percent, while Goldman Sachs did exactly that after also suffering a poor quarter.

On a nine-month view, Credit Suisse’s investment bank is not in terrible shape compared to rivals - return on equity is a creditable 13 percent. Giving staff a lower share of a shrinking revenue cake might risk defections, but it is where the industry is headed. And Chief Executive Brady Dougan may have no choice if this latest tweak to Credit Suisse’s fixed income overhaul proves inadequate.

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Credit Suisse will restructure its rates trading business to address regulator-led changes to market structures and leverage requirements, the Swiss bank said on Oct. 24 as it unveiled its third-quarter results. The bank said it was “restructuring and simplifying its rates business in order to increase returns.”

Revenue in fixed income trading was down 42 percent year-on-year to 833 million Swiss francs. Revenue in equities trading was up 8 percent to 1.1 billion Swiss francs, less than the 17 percent average hike estimated by analysts.

The banking group’s gross leverage ratio of equity to assets improved to 2.4 percent from 2.2 percent at the end of June. But Credit Suisse said that an exchange of hybrid Tier 1 notes into contingent capital securities on Oct. 23 had now taken its pro-forma leverage ratio to 3 percent, meeting regulatory requirements.

The bank also announced 100 million francs more in cost cuts. Credit Suisse has cut 3 billion francs from expenses in the year to date.

Credit Suisse shares fell 3 percent in early morning trading.

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