Bloomberg News

Credit Suisse Value Lags UBS as Dougan Keeps Debt Trading

April 15, 2014

Credit Suisse CEO Brady Dougan

Brady Dougan, chief executive officer of Credit Suisse Group AG, center, walks through the hallway of the Dirksen Senate Office building following a Senate Permanent Subcommittee on Investigations hearing in Washington, D.C. on Feb. 26, 2014. Photographer: Andrew Harrer/Bloomberg

Credit Suisse Group AG Chief Executive Officer Brady Dougan could take a lesson from Zurich neighbor UBS AG as he seeks to boost his company’s stock: scale down the investment bank.

Shares of Credit Suisse, Switzerland’s second-largest bank, are valued lower than UBS’s, and the gap has widened since UBS decided in 2012 to exit most debt trading, according to data compiled by Bloomberg. UBS, the biggest Swiss lender, has a market value 52 percent higher than Credit Suisse, even as analysts estimate it will earn only 7.6 percent more next year.

Dougan needs to cut Credit Suisse’s dependence on the investment bank’s fixed-income business, which is volatile and lacks scale, said Kian Abouhossein, a London-based analyst at JPMorgan Chase & Co. He also said the securities unit, which had 19,700 employees at the end of last year, or 100 more than at the end of 2008, should cut its workforce by about 15 percent.

“All market participants, analysts and investors, would welcome an investment-bank restructuring beyond what has been announced so far,” Abouhossein said in a telephone interview last week after cutting his recommendation on Credit Suisse shares to underweight from neutral.

Credit Suisse rose 0.1 percent to 27.85 Swiss francs by 12:28 p.m. in Zurich trading, compared with a 0.9 percent decline in the Bloomberg Europe Banks and Financial Services Index.

Lower Earnings

Dougan, 54, has resisted calls for radical cuts in debt trading while adjusting the investment bank’s strategy for more than five years with the goal of boosting profitability and making earnings less volatile. Having failed to deliver on the target to produce a “superior total shareholder return” in terms of stock performance and dividends compared with peers, the pressure is mounting to do more.

UBS gained 43 percent from the announcement of its reorganization in October 2012 through yesterday’s close of trading, outpacing Credit Suisse’s 35 percent increase.

Credit Suisse, which reports first-quarter results tomorrow, may show a 17 percent drop in net income to 1.08 billion francs ($1.23 billion), according to the average estimate of six analysts surveyed by Bloomberg. Revenue from fixed-income trading probably fell 19 percent, an average estimate of seven analysts showed.

Marc Dosch, a Credit Suisse spokesman, said the company can’t comment before the earnings release.

Weak first-quarter earnings may push the company to further shrink the investment bank, said Kilian Maier, an analyst at Mainfirst Schweiz AG in Zurich.

Dark Pool

Credit Suisse’s dependence on fixed-income is greater than that of other banks. The firm derives 27 percent of its revenue from debt trading and underwriting of debt securities, behind only Goldman Sachs Group Inc. (GS:US) and tied with Frankfurt-based Deutsche Bank AG and Japan’s Nomura Holdings Inc., according to data compiled by Morgan Stanley analysts.

Still, Credit Suisse ranks only eighth by share of fixed-income revenue globally, having produced about one-third of the revenue made by top-ranked JPMorgan, the analysts wrote in a March report, “Mis-allocated Resources: Why Banks Need to Optimize Now,” prepared with consulting firm Oliver Wyman & Co.

In equities, Credit Suisse had the second-highest market share, according to the report, with revenue last year almost as much as from fixed-income. Its businesses include Crossfinder, a dark pool that operates without the same regulatory oversight as public exchanges. The platform’s volume ranks it among the top three U.S. equity dark pools, according to estimates from Andrew Upward, a market-structure analyst at Rosenblatt Securities Inc. in New York. New York Attorney General Eric Schneiderman is investigating whether dark pools and exchanges give high-frequency traders improper advantages.

‘Significant Optimization’

The bank is the fifth-biggest manager of money for the wealthy, according to the most recent annual study by Scorpio Partnership, which ranks UBS as No. 1.

“We see outsize returns for banks who focus on where they have real advantage and scale,” the Morgan Stanley report said. “The case for significant optimization is strongest in fixed-income given the disruptive forces at work including vast changes in market structure, new leverage rules biting and revenues that are likely to disappoint again in 2014.”

Dougan and Chief Financial Officer David Mathers indicated in February that they don’t plan to cut the fixed-income unit further after previous restructurings and the decision last year to scale down interest-rates trading. Investment-banking businesses that Credit Suisse isn’t exiting produced a return on capital last year of 19 percent, a level Dougan called “very good if not best in class.”

‘Volatile Things’

“If you look at our credit, our structured products and our emerging-markets business last year, I think actually the performance of those businesses was very, very strong, including competitively versus other players in the industry,” Dougan told analysts in February.

Investors lack confidence that the business will keep delivering such returns, said Thomas Bruhin, who manages about $1 billion, including Credit Suisse shares, at Zuercher Kantonalbank in Zurich.

“Investment banks have seven or eight good years and then one bad year erases all of their profits,” Bruhin said. “How much is such a business worth? I’m not a fan of volatile things, and would prefer if banks focused on stable wealth management.”

About 36 percent of 44 analysts following Credit Suisse recommend investors buy the shares, compared with 50 percent for UBS, data compiled by Bloomberg show.

‘Too Big’

One of Credit Suisse’s goals is to outperform the average of nine peers on a total return basis, which takes into account stock swings and dividend payments. The bank handed investors a total return of 26 percent in 2013 and 4.8 percent in 2012, compared with averages of 26.7 percent and 49.2 percent posted by its competitors, according to Credit Suisse’s website.

The nine are Bank of America Corp., Barclays Plc, BNP Paribas SA, Citigroup Inc., Deutsche Bank, HSBC Holdings Inc., JPMorgan, Societe Generale SA and UBS.

“Credit Suisse’s investment bank is still too big,” said Rainer Skierka, a senior analyst at J. Safra Sarasin Holding Ltd. “I don’t see why Credit Suisse shouldn’t be competitive as a pure wealth-management player. When the business gets more stable it also becomes more attractive for investors.”

Credit Suisse needs to resolve a U.S. investigation into its alleged role in helping Americans evade taxes to give its wealth-management business a boost, Skierka said. The probe has cost the bank more than $1 billion in provisions and fines.

Even so, the allure of wealth management is evident when comparing the valuations of Credit Suisse and UBS. In October 2012, when UBS said it would shrink debt trading, its shares were valued at 8.3 times analysts’ estimate for the following year’s earnings, less than 8.4 times at Credit Suisse.

‘Great Franchise’

Since then, the ratio climbed to 11.5 times earnings at UBS, compared with 8.9 times at Credit Suisse. Goldman Sachs, which relies more on investment banking than Credit Suisse, trades at 9.2 times estimated 2015 earnings.

“Credit Suisse is a great franchise, it has a great private bank, so why is it trading at a discount to a company like Goldman Sachs (GS:US)?” said Abouhossein. “It’s trading at a discount because there isn’t that belief in the investment-banking strategy.”

Confidence wasn’t always lacking. During the financial crisis, the investment bank outperformed UBS by cutting holdings of securities that later turned illiquid and lost value. It avoided direct state aid, finding private investors such as the Qatar Investment Authority to provide equity instead.

More Cuts

When markets froze after the 2008 bankruptcy of Lehman Brothers Holdings Inc., Credit Suisse said it would cut risk-taking and staffing at the investment bank to achieve “lower volatility and attractive risk returns.” Headcount at the unit was set to fall to 17,500 by the end of 2009.

As markets bounced back, the bank changed tack. It ended 2009 with 19,400 people at the unit, 200 fewer than at the end of 2008. By 2010, Credit Suisse was hiring to expand in credit trading, foreign exchange, emerging markets and rates, a business it’s now shrinking. That expansion was the biggest mistake Credit Suisse made because it didn’t bear fruit, Abouhossein said.

By November 2011, Credit Suisse was cutting again. It announced an effort to reduce risk-weighted assets in fixed-income by almost half by exiting some unsecured trades and commercial mortgage-backed securities origination, as well as by tweaking its strategy in credit, securitized products and emerging markets.

‘It’s Lunacy’

The approach led to an “exceptionally competitive” 17 percent pro-forma return on equity for the investment bank from 2009 through September 2011 at the businesses the bank was keeping, compared with the 10 percent the unit actually posted, Dougan told investors at the time.

Those returns weren’t maintained. The investment bank’s ROE, a measure of profitability, sank to 7.8 percent in 2012 and 7.5 percent in 2013. By October, additional cuts at the debt business were on the way. More is needed, according to analysts and investors.

“When you have a profitable wealth-management unit, it’s lunacy to run an investment bank that swallows personnel compensation and capital,” said Dieter Hein, a banking analyst at Fairesearch GmbH in Kronberg, Germany. He said Dougan’s history running the investment bank before becoming CEO in 2007 may be making him reluctant to cut deep enough.

Abouhossein disagreed. He said Dougan has to take a longer-term view and recognize that earnings at the debt businesses where Credit Suisse is doing well, such as securitized products, will be hurt by regulation in the future.

“I rate Brady very highly,” he said. “He’s one of the smartest guys in the business. He ultimately needs to take a longer-term view on the viability of the business.”

To contact the reporters on this story: Elena Logutenkova in Zurich at elogutenkova@bloomberg.net; Jeffrey Vögeli in Zurich at jvogeli@bloomberg.net

To contact the editors responsible for this story: Frank Connelly at fconnelly@bloomberg.net Robert Friedman


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