Credit Suisse Reports Strong Q2 Results, But Will Face Headwinds In The Future

Credit Suisse (NYSE:CS) shares jumped nearly 6% over trading on Thursday, July 23, after the Swiss banking giant beat investor expectations with its results for the second quarter of the year. ^[1] Investors were particularly happy about the fact that the bank’s revenues soared nearly 5% sequentially – something in sharp contrast with the notable quarter-on-quarter reduction in total revenues reported by all major U.S. banks over recent weeks. Credit Suisse also did well to improve its common equity tier 1 (CET1) capital ratio for Q2 after reporting a marginal reduction in this figure for the first quarter.

However, the optimism investors have demonstrated towards Credit Suisse’s share price may be excessive. The bank posted a decent operating performance for the quarter, and it will also unlock sizable value from its new CEO’s focus on wealth management offerings in Asia Pacific. But it must be remembered that the bank’s revenue figure for the period got a boost from a favorable exchange rate movements – especially its net interest income figure, which jumped 11% compared to Q2 2014 and a whopping 33% compared to the previous quarter. This performance is unlikely to be repeated over subsequent quarters once FX rates stabilize globally. The bank’s operating margins in the near future will also take a hit from higher costs related to additional risk, regulatory and compliance infrastructure. Moreover, Credit Suisse’s capital ratio figure is lower than that for most of its peers. This, coupled with the tighter capital requirement norms being considered by the Swiss National Bank, indicate that the bank will continue to focus on shoring up its balance sheet for several more quarters.

Taking all these factors into account, we stick to our $27 price estimate for Credit Suisse’s, which is about 10% below the current market price.

See our complete analysis of Credit Suisse here

Wealth Management Division Takes The Lead In Driving Q2 Profits

Credit Suisse’s cornerstone wealth management business reported revenues just shy of CHF 2.2 billion ($2.3 billion) for the second quarter of 2015 – the best performance in two years. This figure is a 10% improvement over the figure for the year-ago period, with a bulk of the change coming from higher net interest incomes (CHF 821 million in Q2 2015 compared to CHF 688 million in Q2 2014). However, operating costs for the division only rose 6% year-on-year, resulting in a sharp increase in operating margins for the period. In fact, the pre-tax margin of 30.5% for Credit Suisse’s wealth management division this time around was the best since Q1 2009.

Credit Suisse also gained from notable inflows over the period, which helped its fee-based revenue figure. The wealth management division reported total inflows of CHF 9 billion, with inflows of new cash in Switzerland (CHF 2.6 billion), the EMEA region (CHF 1 billion) as well as the Asia Pacific region (CHF 6.3 billion). There was a marginal outflow of cash from the Americas region. Incidentally, Q2 2015 was the best quarter for the division in terms of total inflows since Q2 2011.

But currency movements hurt the Swiss bank’s total asset base. Total assets under management fell for the second consecutive quarter to end Q2 at below CHF 850 billion from CHF 874.5 billion at the end of Q4 2014. Taking into account changes in asset values from currency-related as well as market-related movements, only the asset base in Asia Pacific saw a sequential improvement in size (CHF 149.2 billion). With Credit Suisse looking to increase its wealth management efforts in this region over coming years, the growth in these assets will be an important driver of value in the future.

Investment Banking Profits Shrink, Likely To Remain Under Pressure 

Credit Suisse’s investment banking division reported total revenues that were largely similar to those seen a year ago. The bank’s advisory and underwriting fees recovered from the dismal figure of CHF 617 million in Q1 2015 – the lowest in three years – to CHF 914 million ($950 million) in Q2 2015 thanks to improvements across the M&A advisory, equity underwriting and debt origination units. While equities trading revenues were only marginally lower than the exceptionally strong results seen for the first quarter, debt trading revenues fell a little more than 25% sequentially. This was largely expected though, as debt trading activity fell drastically over the months of May and June, and nearly all U.S. banks reported a similar trend in trading revenues.

Despite reporting revenues that remained unchanged year-on-year, the division’s pre-tax income figure fell more than 18% because of a marked increase in operating expenses. Operating expenses jumped from under CHF 2.6 billion for Q2 2014 to CHF 2.75 billion ($2.9 billion) in the latest quarter. While negative foreign exchange movements were an important factor behind this change, a bulk of the increase can also be attributed to higher costs from regulatory and compliance activities. And these costs are likely to remain elevated for the foreseeable future.

Although this factor affects the industry as a whole, it must be noted here that Credit Suisse’s pre-tax margin for the investment banking division is substantially lower than nearly all of its peers. To put things in perspective, the bank’s Q2 2015 margin figure was 18.2%, while U.S. banks reported an operating margin between 30-35% for the same period. Credit Suisse has already drawn a lot of criticism from investors over recent years for its decision to maintain a full-fledged investment bank despite its capital-intensive nature. The poor margins will likely force the bank’s new CEO to implement additional steps to get rid of some of its fixed income business in the near future – helping Credit Suisse improve its capital ratio figure in the process.

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1. Second Quarter 2015 Results, Credit Suisse Investor News, July 23 2015 [↩]