Credit Suisse’s U.S. Tax Settlement Drags Lukewarm Q2 Results Into The Red

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Credit Suisse (NYSE:CS) reported its largest quarterly loss since the economic downturn of 2008 this quarter, with its recently announced settlement of U.S. tax evasion charges hitting the bottom line for an already soft operating period. [1] The second largest Swiss bank reached a $2.6 billion accord with U.S. regulators in May after pleading guilty to charges that its employees helped U.S. citizens evade taxes (see Credit Suisse Pleads Guilty, Pays $2.6 Billion To Settle U.S. Tax Evasion Charges) – and was consequently forced to take a CHF 1.6 billion (~$1.8 billion) pre-tax charge in Q2. This was Credit Suisse’s third quarterly loss since 2009, with the other two being in Q4 2011 (when the European debt crisis was at its peak) and in Q4 2013 (when the bank settled its mortgage-related misgivings with the FHFA for $885 million).

While Credit Suisse’s investment banking division churned out figures that were similar to those in the previous quarter as well as the same period last year, its cornerstone wealth management division fared relatively poorly, with total revenues falling 6% quarter-on-quarter and 11% year-on-year. But considering the fact that the bank’s portfolio of assets under management actually grew over the quarter by roughly 3%, we can conclude that a significant factor behind this decline is the weakening of the U.S. dollar compared to the Swiss Franc in Q2, which diminished revenues from the bank’s U.S. operations in CHF terms.

As Credit Suisse’s Q2 results do not point to any notable operational weakness in its otherwise stable business model, we maintain our $33 price estimate for its stock, which is about 15% ahead of its current market price.

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Improved Underwriting Fees Make Up For Lower Equity Trading Revenues

Credit Suisse’s investment banking operations roped in CHF 3.3 billion (~$3.7 billion) in revenues for the quarter – marginally lower than the figure seen in Q2 2013 and Q1 2014. It must be remembered here that revenues for the investment banking industry are seasonal, with a noticeable peak in the first quarter of the year. As debt trading activity was fairly depressed over the first two months of this quarter, the overall showing by the investment banking arm is commendable. In fact, the investment banking revenues actually improved year-on-year as well as quarter-on-quarter in dollar terms. The improvement can be traced to the strong debt and equity underwriting fees for the quarter, which were 15% higher in Q2 2014 compared to the previous quarter.

Subpar Performance In Wealth Management

The strength of Credit Suisse’s cornerstone wealth management business is demonstrated by the fact that the operations never reported a quarterly loss in more than ten years – staying profitable even during the economic downturn of 2008. This makes the division’s loss in Q2 2014 stand out, even though the reason is quite clearly the settlement bill. But looking beyond this one-time charge, what also hit profitability this quarter was the marked decline in revenues. The bank reported Private Banking and Wealth Management revenues of just over CHF 3 billion ($3.4 billion) for the quarter, which is the lowest figure since at least mid-2009 (prior period data is not available because Credit Suisse adopted its current reporting structure in Q4 2012). While the weaker dollar was partly responsible for this decline, two other factors emerge from the bank’s reported numbers – marked reduction in net interest income (CHF 970 million in Q2 2014 compared to CHF 1.08 billion in Q2 2013) and an even more drastic fall in transaction- and performance-based fees (CHF 885 million in Q2 2014 compared to CHF 1.06 billion in Q2 2013).

There were some positives for the operations too, though, as the total size of assets under management for the bank touched a record CHF 1.33 trillion ($1.47 trillion) in Q2, with strong inflows from the Asia-Pacific region complementing improved market valuations over the period. The bank also continues to keep a close eye on its costs as the adjusted operating expenses of CHF 2.2 billion ($2.4 billion) for the wealth management business is the lowest for the period over which data is available.

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Notes:
  1. Q2 2014 Earnings Release, Credit Suisse Results Announcement, July 22 2014 []