Early moves to reduce leverage and cut non-core businesses at Credit Suisse have allowed its investment bank co-head to think carefully about the future of the market, and how to adapt to it.
For Credit Suisse, the so-called 'Swiss finish' of higher capital requirements than international norms triggered an early start to the process of rethinking its investment bank. That has involved cutting both risk and leverage, and trying to tease out which business lines can succeed in the new financial and regulatory environment, even when the final details of that environment are unclear.
Return on equity for Credit Suisse as a whole reached about 12% in the first half of 2013, compared with 3.9% for 2012 and 6% for 2011. And that improvement has coincided with an increase in the bank’s total capital base in response to the increased prudential demands from the Swiss National Bank.
Early birds
“There is nothing to gain from not trying to move forward as soon as possible. It has not been an easy transformation for us, but we have worked at it for two years while some are only just starting down that path,” says Gael de Boissard, who effectively assumed the role of co-head of the investment bank at the start of 2013. His focus is on the fixed-income area, while the other co-head Eric Varvel concentrates on equities and mergers and acquisitions (M&A) advisory practices.
Credit Suisse has surpassed Basel III capital requirements, exceeding a 10% capital ratio and complying 100% with the liquidity coverage and net stable funding ratios. But the ground is already shifting, with growing regulatory focus on pure leverage and new proposals from Basel that would restrict netting in calculating the leverage ratio.
“If the rules were not shifting, we would consider our transformation for Basel III to be done. CRD [Capital Requirements Directive] IV is due in Europe in January 2014 and the US Federal Reserve has published its proposed capital rules, but until quite recently other banks had still been talking about timing rather than execution. Banks in the EU are now beginning to make more of the choices that we have already made in terms of their franchise shape. Judging by the strength of their reaction to the Fed proposals, US banks may have to do the same,” says Mr de Boissard.
Complex decisions
Credit Suisse has not undertaken the kind of headline-grabbing measures to close or wind down entire divisions, like the exit from equities at RBS or the reduction in fixed income at UBS. But this should not disguise the scale of its changes – Mr de Boissard says that total business units in the investment bank have shrunk to about 80, from 120.
He emphasises that, when assessing which business lines are likely to prosper in the new environment, capital requirements alone are not the deciding factor. For example, securitisation faces a particularly harsh regulatory treatment – perhaps tripling capital requirements on securitised assets – but the bank believes it still has strong potential. Securitisation has a clear economic imperative as part of the process of raising finance for the real economy without burdening the balance sheets of deleveraging banks.
And Credit Suisse has the opportunity to grow market share and adjust pricing to economic levels because many arrangers have exited the business. In April 2013, Credit Suisse took on and distributed about €9bn in securitised real estate assets to its client base Royal Park Investments (RPI), a vehicle used to wind up Fortis’s real estate finance portfolio. This followed a similar deal in 2012 for a notional $20bn of structured credit assets from the US Federal Reserve’s Maiden Lane, the vehicle created during the 2008 bail-out of insurer AIG.
“The marketplace has acknowledged that banks cannot hold securitised assets as a means of providing liquidity. So some of the business has become almost M&A, with block placing, such as the RPI and Maiden Lane transactions. By the time we announced these deals, we had the bulk of them syndicated. This is testament to clients and investors working in a different way, and the market has repriced accordingly, so one should not take a static view of the economics of the business,” says Mr de Boissard.
Conversely, some areas that seemed resilient to the financial crisis and regulatory initiatives are now under scrutiny. Foreign exchange, built on short-term deals with low capital consumption and real economic need, became a popular priority for most investment banks. But that created a sharp increase in competition, shaving down margins. Mr de Boissard says the rates business, which accounts for about one-third to one-half of fixed-income desks at many investment banks, is likely to change as a result of the attention on pure leverage ratios.
“Discounting tomorrow’s money for today certainly fits the definition of client utility, and most of it was already centrally cleared with low counterparty credit exposure. But the leverage ratio puts pressure on total balance sheet size, and the latest Basel proposals on netting suggest that even centrally cleared transactions will become more expensive on capital,” he says.
Regulatory questions
Although prepared to adapt to regulation, Mr de Boissard is by no means silent on its unintended consequences. In his role as chair of the Association for Financial Markets in Europe, he has overseen a report on the measures necessary to restore adequate financing flows to the European economies. He says Credit Suisse has demonstrated that it is possible to run a profitable investment bank in the new regulatory landscape, but policy-makers also have a role to play.
In particular, he expresses scepticism about the regulatory attack on risk-weighted assets methodology that forms part of the process for calculating capital requirements. Credit Suisse has attracted attention because its proportion of risk-weighted assets to total assets is very low relative to most global banking groups – less than 25% in 2012. But Mr de Boissard dismisses the idea that the bank is operating with some form of unfair advantage.
“There has not been a single year when we have benefited from model changes, we have been making genuine reductions in both the risk and size of our balance sheet, and the distribution of risk into the markets has always been a key part of our business model. Much of that balance sheet reduction came from government repo activity, so it had little client or business impact. In reality, our risk-weighted assets position is mostly accounted for by the composition of our balance sheet, and regulators would be very unlikely to allow unnatural advantages that were simply due to model calibration,” he says.
On the idea that capital ratios based on risk-weighted assets are too complicated, he warns that the leverage ratio is not necessarily a simpler alternative. The definitions used for both the numerator and the denominator in the leverage ratio vary between the EU, Switzerland and the US, so this calculation does not bring about greater international comparability.
“Probably the best outcome for everyone would be convergence to some sort of standardised risk-weighting model 2.0 – using advanced modelling techniques to encourage good risk management, but with some degree of standardisation to avoid the perception of optimisation,” he concludes.
Finding opportunities
While still needing to navigate each new regulatory initiative, Credit Suisse’s early start on transforming the bank is allowing Mr de Boissard and his colleagues more chance to focus on growth opportunities. In addition to his fixed-income focus, Mr de Boissard also manages the Europe, Middle East and Africa region, while Mr Varvel manages Asia. This is part of the management changes that occurred at the start of 2013, which united the product and regional leader roles previously held by separate managers.
“The underlying idea was to ensure a more direct connection between the different product areas and the regions. It also recognises we are in a world where redistribution of resources is very important, not in a world where the focus is only on growth, which a regional construct tends to facilitate. Now we want each business line such as fixed income or equities to be profitable in each of the regions we are in, which forces an extra dimension to the thought process,” explains Mr de Boissard.
It is also designed to mirror the management structure of Credit Suisse’s vital private banking division, enhancing co-operation between the two. That process is already strong in certain markets such as Russia, where Credit Suisse banks many of the country’s billionaires who are also the leading corporate deal-makers.
Emerging market growth rates are expected to exceed those in western Europe for some time. But Mr de Boissard avoids excessive pessimism over the prospects for the investment bank in western Europe, pointing out that the region is still home to about one-third of the world’s financial assets. In fact, Credit Suisse’s long-standing strength in high-yield bonds and leveraged finance is well suited to the transition away from bank lending in Europe.
“Our credit expertise is particularly helpful in the more challenged markets such as Spain or Italy, and in France companies that were traditionally lending relationship clients of the French banks are approaching us because of our reputation as a high-yield arranger. That transition has to happen, not just for Credit Suisse but to help stabilise the European economies,” says Mr de Boissard.
