Credit Suisse (NYSE:CS) is looking to recreate the success of the two Expanded Partner Asset Facility (EPAF) funds it created in 2008 and 2011 once again with the creation of the ‘Plus Bond’ scheme for about 2,000 of its top-level employees.  The move will allow the second largest Swiss bank to move risky assets out of its balance sheet and hand out bonuses to its executives at the same time – a win-win situation for both employer and employee.
While the size of the assets to be transferred to the bonus pool is not clear, we believe it should be at least equal to $5 billion – similar to the 2008 offering which had around the same number of employees enlisted to it. Through its earlier schemes, PAF-1 and PAF-2, Credit Suisse successfully offloaded risky assets worth around $17 billion at a time when stricter capital requirements were being imposed on the industry. No doubt, other investment banks including Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS), Barclays (NYSE:BCS) and UBS (NYSE:UBS) have been keeping a close eye on these bonus funds and will likely come up with similar schemes of their own over the coming years.
We maintain a $25 price estimate for Credit Suisse’s stock, which is around its current market price.
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Here’s How The Scheme Works
The beauty of Credit Suisse’s asset-backed bonus fund lies in the simplicity of the approach. First, the bank earmarks some of its risky, hard-to-value assets (almost always part of its trading assets) for transfer to an investment vehicle which will act as the employee bonus fund. These assets, totaling around $5 billion for PAF-1 and $17 billion for PAF-2, effectively move out of Credit Suisse’s own balance sheet and either appreciate or depreciate in value as part of the fund over a fixed time period. Assets in both the original schemes will be liquidated in 2016.
Then, based on the size of the assets it is transferring, Credit Suisse picks the employees to whom the spoils will go. PAF-1 had 2,000 participants, whereas the bigger PAF-2 had 5,500 participants.  The new scheme for 2012, Plus Bond, is expected to benefit 2,000 investment banking employees at the level of managing director and director.
At the end of the lock-in period, all the assets will be liquidated and the cash raised will be distributed among the participating employees.
And This Is How Everyone Benefits
The benefit for Credit Suisse is two-fold: it can move some of its risky trading assets off its balance sheet, taking it closer to the stringent capital requirement imposed by Swiss regulators, and it also cuts down on employee compensation expenses by making the asset-based bonus part of compensation along with cash and stock. The bank has reportedly saved $1.4 billion on compensation costs through its first two schemes – something that will clearly show as an improvement in operating margins for its investment banking business represented in the chart below.
As for employees, the bonus, although risky, represents a potential to take home more money than they can get through a regular stock based bonus payout. To illustrate this, it would suffice to say that PAF-1 appreciated in value by almost 80% between 2008 and 2012 – all of which will go to the employees. And they obviously expect the newly setup scheme to also bring in similar returns.Notes: