Credit Suisse To Combat Revenue Headwinds With Plan To Shrink Workforce By At Least 5,500

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Credit Suisse

Earlier this week, Credit Suisse (NYSE:CS) reported a lower-than-expected loss for the fourth quarter of 2016, as year-on-year improvement in revenues for most of its reporting units and a sharp reduction in compensation expenses helped the Swiss banking giant mitigate the impact of its recent mortgage settlement on the bottom line. [1] Credit Suisse agreed to settle its legacy mortgage-related lawsuit with the U.S. Department of Justice (DoJ) last month for $5.28 billion – a figure that includes a penalty of $2.48 billion and $2.8 billion in customer relief. [2] Notably, Credit Suisse expected the settlement to be higher, and had announced plans to spin off its Swiss retail banking operations (Swiss Universal Bank) this year to raise cash to make up for the resulting capital shortfall. But with Credit Suisse’s common equity tier 1 (CET1) capital ratio remaining at a strong 11.6% at the end of the year (down from 12% in Q3 2016) after accounting for the settlement, the bank might not have to go through with the IPO to meet its CET1 target of 13% by year-end 2018.

This is good news for Credit Suisse in the long run, as the Swiss Universal Bank is one of the bank’s most profitable division, and also houses the bank’s cornerstone Swiss wealth management operations. It should be noted that there has been a clear trend of investors pulling out cash stashed in the largest Swiss wealth managers ahead of crackdowns by tax authorities around the globe, and this is likely to weigh on Credit Suisse’s revenues in the near future. But we believe that the bank will be able to maintain its profitability despite near-term headwinds if it carries through with its aggressive cost-cutting plan. The bank’s aim of shrinking its workforce by between 5,500-6,500 this year (representing 12-14% of its current workforce) will be the single biggest contributor to the bank’s goal of shrinking total operating expenses (adjusted) from CHF 19 billion in 2016 to below CHF 17 billion in 2018. Because of this, we stick to our $16 price estimate for Credit Suisse’s shares, which is slightly above the current market price.

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CS_Ear_PBTDiff_16Q4

The table above summarizes the factors that aided Credit Suisse’s pre-tax profit figure for Q4 2016 compared to the figures in Q4 2015 and Q3 2016. Notably, revenues for the Trading & Investment Banking as well as Wealth Management operations (includes Private Banking units reported under Swiss Universal Bank, International Wealth Management and Asia Pacific division) improved year-on-year, although they fell quarter-on-quarter. Wealth management revenues for Q3 2016 include a one-time real estate gain of CHF 346 million, though, and adjusting for this, these revenues actually improved sequentially.

Notably, compensation expenses fell sharply compared to the year-ago period as Credit Suisse reduced its headcount by more than 2% from 48,210 at the end of 2016 to 47,170 by the end of the year. The sequential increase in compensation costs, despite a sharp reduction in headcount, is most likely due to an increase in operating revenues as we pointed out, as this would have increased performance-based incentives. As for other operating expenses, the sharp fluctuations are due to large one-time charges which the bank incurred in Q4 2015 as well as Q4 2016. The results for Q4 2015 included a goodwill impairment of CHF 3.8 billion (most of which was for the investment banking division) and CHF 919 million in restructuring and legal costs, while the figure for Q4 2016 was elevated by a CHF 2.1 billion charge from the mortgage settlement.

Trading Desks Reported A Lukewarm Performance In Q4

Credit Suisse’s new reporting structure spreads out its total investment banking operations among three reporting divisions: Global Markets (which houses the sales & trading operations), Investment Banking & Capital Markets (which encompasses the advisory and underwriting units) and Asia Pacific (which has an investment banking sub-division). Adding up the revenues for all these divisions, the bank’s total investment banking revenues for Q4 2016 were just over CHF 2.3 billion – a 3% reduction compared to Q3 2016, but a 9% increase year-on-year. The table below breaks down the total investment banking revenues by function.

CS_Ear_IBRevDiff_16Q4

As can be seen here, Credit Suisse’s trading desks had a mixed performance when compared to Q4 2015 and Q3 2016. That said, the last quarter of the year is usually a weak period for the seasonal securities trading industry. The strong year-on-year increase in FICC trading revenues is primarily due to increased debt and currencies trading volume over the second half of the year – first due to the unexpected Brexit vote and then from Trump’s victory. As Europe is a key market for Credit Suisse, FICC trading revenues were higher in Q3 in the wake of Brexit. Over Q4, increased volatility in equity capital markets globally over the last two months of the year boosted equity trading revenues. The changes in advisory and underwriting fees were largely in line with the overall trend in the industry for the quarter.

Wealth Management Headwinds Likely To Remain 

Credit Suisse’s cornerstone wealth management business has been under pressure over recent years as Switzerland’s status as a tax haven diminishes among private clients in the wake of the country’s various tax deals with key developed countries. Pressure on the country’s wealth management industry, coupled with the growing uncertainty in Europe from a potential Brexit, resulted in the total wealth management business reporting outflows of CHF 2.4 billion in Q4 2016 – only the second time in the last three years that the bank witnessed net outflows (the other time being Q4 2015 when the outflows were CHF 4.1 billion).

CS_Ear_AUMDiff_16Q4

The table above summarizes the factors that contributed to the change in size of total assets under management (AUM) (consolidated across all operating divisions) for Credit Suisse from the end of Q4 2015 and Q3 2016. Net outflows of CHF 2.4 billion for the wealth management operations include the bank’s Swiss, Asia Pacific and International private banking units. Notably, poor inflows into the bank’s wealth management inflows over the previous 4 quarters had been mitigated considerably by strong inflows from the Asia Pacific region. But inflows from Asia-Pacific also fell to the lowest level in at least 5 years – hurting the asset base. At the same time, the shifting preference of large institutional investors towards low cost ETFs from traditional offerings like mutual funds has also resulted in an industry-wide loss of assets for traditional asset managers – hurting Credit Suisse’s asset management arm. These trends are unlikely to improve in the near future, and are expected to weigh on revenues going forward.

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Notes:
  1. Fourth Quarter 2016 Results, Credit Suisse Investor News, Feb 14 2017 []
  2. Credit Suisse reaches settlement with U.S. Department of Justice regarding legacy Residential Mortgage-Backed Securities matter, Credit Suisse News Releases, Jan 18 2017 []