Global Economics

Credit Suisse is Halfway There


Credit Suisse (CSR) often disappoints investors, and Aug. 2 was no exception. The Zurich-based bank reported second-quarter net profit of $1.75 billion, up 135% from the year-earlier period, but down 17% from the previous quarter. Investors, disappointed by trading results that were weaker than in the strong first quarter, pushed the stock down 3%. They had already been shocked the day before by a reported loss of around $120 million by Deutsche Bank (DB) in equity proprietary trading.

Credit Suisse trading revenues of $2.5 billion were down 36% from the first quarter, but up 36% year on year. Results were hit by four bad days in the quarter when losses exceeded so-called Value-at-Risk (VaR), the maximum daily loss the bank thinks it could sustain. Credit Suisse says there should be no more than four such days in a year. Credit Suisse blames "equity and foreign exchange market volatility." In the quarter, VaR was increased from $58 million in the first quarter to $75 million.

Chief Executive Oswald J. Grubel, a blunt former trader, is essentially trying to emulate the model of Zurich crosstown rival UBS (UBS). An investor favorite, UBS has struck gold by streamlining and ramping-up its huge private banking operations, and encouraging its investment bankers and private bankers, natural enemies, to cooperate more closely. With Grubel having sold insurance arm Winterthur to France's AXA (AXA) in June for $9.8 billion, Credit Suisse now looks a lot more like UBS.

BETTER MIX. Grubel, however, acknowledges that Credit Suisse still has a distance to go before it's firing on all cylinders. For the second quarter, for instance, private banking operating income was down 14% from the previous period, to about $900 million, due mainly to lower commissions and fees. It did attract a strong $13 billion in new money. Another area that needs work is asset management, which was only marginally profitable thanks largely to a loss-making U.S. business that is being restructured.

Still, analysts think that Grubel is making progress. Certainly he is grinding away at costs. The cost-to-income ratio for the first half of 2006 is 69.1% compared to 80% for 2005. "We consider that with the disposal of the Winterthur insurance unit, the business mix is now substantially the same as that of UBS, and with the benefit of restructuring initiatives, we suggest that the profitability gap between the two should continue to narrow," Matthew Clark, an analyst at Keefe, Bruyette, & Woods in London, commented in a note.

Maybe Grubel should also be reviewing Credit Suisse's trading businesses. On the basis of the recent results, the European banks don't seem to be handling the choppy markets as well as their U.S. counterparts. Most of the major U.S. investment banks depend on trading these days for as much as 23% of their revenues. (They don't disclose what portion of their profits trading represents.)

TOUGH TO SUSTAIN. On average, the trading revenues of major U.S. investment banks such as Goldman Sachs (GS), Morgan Stanley (MS), and Bear Stearns (BSC) soared 70% in the second quarter, compared with the same period in 2005.

At Goldman Sachs, trading revenues jumped 113% in the second quarter, as the bank put a record $112 million at risk of being lost in trading on any given day. "In many cases, trading creates more earnings for the banks than the headline investment-banking deals that they do," says Anton V. Schutz, who manages the $131 million Burnham Financial Services Fund.

But he notes: "The problem with trading becoming such an important part of the earnings stream for all of these banks is that the sustainability of those results is hard to maintain." Credit Suisse isn't backing away from risk, but it is trying to build core businesses such as private banking that are low-risk and reliable earners.


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