Credit Suisse Announces Strong Q3 Results, Plans To Shrink Investment Bank Further

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Credit Suisse

Credit Suisse (NYSE:CS) comfortably beat investor expectations from its Q3 results late last week when the second largest Swiss bank reported a marked increase in total revenues year-on-year as well as quarter-on-quarter thanks to an exceptionally strong performance by its fixed-income, currencies and commodities (FICC) trading desk. [1] The revenue improvement, coupled with the bank’s efforts to cut costs over recent years, had a positive impact on the bottom line as employee costs fell almost 8% sequentially. The results for the quarter were also not burdened by heavy litigation-related charges – something that has dragged results into the red in two of the last four quarters (Q4 2013 and Q2 2014). Moreover, the bank revealed plans to boost its leverage ratio to 4.5% by the end of 2015 from the current figure of 3.8% by slashing its leverage exposure by roughly CHF 70 billion ($74 billion) – most of which will come from its trading operations.

Investors, however, did not pay much heed to the strong quarterly results or to the plan to cut trading exposure, with Credit Suisse’s share price remaining largely constant over the latter half of last week. There are two key reasons for this lukewarm response from investors: firstly, the bank’s core (strategic) operations actually saw a sequential decline in revenue as well as pre-tax income – indicating that it was the non-core and for-sale units which boosted results in Q3. Secondly, the focus on reducing leverage exposure is likely to hit trading revenues over subsequent quarters – negatively impacting the top line.

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In view of this, we have revised our price estimate for Credit Suisse’s stock downwards from $33 to $32. The new price estimate is still about 25% ahead of the current market price – something we believe is primarily due to the sell-off in the shares of European banks over recent weeks due to the weak economic outlook for the region as well as due to the poor results of the ECB’s stress tests for banks.

See our complete analysis of Credit Suisse here

Investment Banking Operations Had A Strong Quarter

Credit Suisse’s investment banking operations roped in CHF 3.3 billion ($3.5 billion) in revenues for the quarter – a 29% jump compared to the figure a year ago, but slightly below that for the previous quarter. These operations include the Swiss bank’s M&A advisory, debt origination, equity underwriting, FICC trading as well as equities trading units, and all of them except for the equities trading desk saw a substantial jump in revenues compared to Q3 2013. Notably, the FICC trading desk roped in almost 73% higher revenues this quarter compared to the same quarter last year. In comparison, equities trading revenues were almost flat and fell by more than 5% quarter-on-quarter. The equities underwriting desk reaped the benefits of being involved in Alibaba’s massive IPO in September (see Alibaba Hands Out Generous Fees To Investment Banks Involved In Its IPO) and reported a 66% increase in fee revenues. Coupled with a strong debt origination performance, the bank’s total advisory and underwriting fees increased 28% year-on-year, although it dipped slightly compared to Q2 2014.

Overlook Short-Term Hiccups In View Of Long-Term Operating Efficiency

Over the last few years, Credit Suisse has been chipping away at its operations in order to meet its target of cutting recurring annual costs by CHF 4.5 billion ($4.7 billion) by the end of 2015. The bank has made notable progress in this regard, with annualized cost savings topping CHF 3.6 billion ($3.8 billion) already. While ongoing efforts to wind down or sell off the non-core operating units will easily allow the bank to meet its target, the recently announced plans to shrink the investment bank further should also help cut more costs in the long run.

Credit Suisse expects its overall expenses to be negatively affected by litigation-related costs in the near future, but its efforts to rein in expenses will be an important source of value for the bank. You can understand how an increase in operating margins helps Credit Suisse’s share price by making changes to the chart below.

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Notes:
  1. 3Q14 Earnings Release, Credit Suisse Earnings Releases, Oct 23 2014 []