CS: History of Poor Risk Management Drives Discounted Valuation

Business Strategy & Outlook:

Credit Suisse’s true underlying profitability has been masked for the better part of a decade by multiple restructuring charges and the cost of running down a legacy book of unprofitable assets. The new management team at the helm of Credit Suisse hoped that it addressed all issues during 2020, but new problematic exposures continue to crop up. This suggests a deeper risk management malaise at Credit Suisse. Credit Suisse has some very good, profitable, and generally asset-light business with good long-term secular growth prospects–especially in wealth management/private banking and the Swiss universal bank. The discount that the market has imposed on the rating of Credit Suisse relative to UBS and its other peers should, however, remain in place until Credit Suisse can convince investors that it has addressed its risk management deficiencies.

Credit Suisse will have to report several quarters of results free from the large non-recurring items that have historically marred its results. There is a strong long-term secular trend that sees the wealth of high-net-worth individuals and families growing ahead of global nominal GDP. The ultra-high net worth and family office segment, where Credit Suisse has focused most of its attention, is a particularly attractive segment. The threat of digital disintermediation is reduced and the need for bespoke solutions and strong relationship between banker and client remains. The current negative interest rate environment obscures the benefits of Credit Suisse’s very strong deposit franchise that provides it with ample surplus liquidity. Currently, this is damaging to Credit Suisse’s net interest income–it needs to invest its excess liquidity in short-term risk-free assets that currently pays no or negative interest. Credit Suisse has, however, starting passing on these costs to selected clients.

Financial Strengths:

Credit Suisse has a common equity Tier 1 ratio of 14.4% currently, ahead of its own internal capital target of a 14% common equity Tier 1 ratio. This is comfortably ahead of its regulatory minimum capital requirement of 10%. However, Credit Suisse’s leveraged ratio of 4.2% is more of a constraint, with a regulatory minimum requirement of 3.5% and an internal target of 4.5%. Credit Suisse intends to pay out 25% of its earnings as a dividend and it has not announced new share buybacks.

Both Credit Suisse’s liquidity coverage ratio and its net stable funding ratio are comfortably above 100%, which indicates sound liquidity. These ratios, while helpful, do not fully capture the quality of a bank’s funding. One should also consider the structure of a bank’s funding–where the relatively lower importance of wholesale deposits in Credit Suisse’s funding mix is a clear positive. However, private banking/wealth management clients will typically be more sophisticated than the average retail banking client and therefore more likely to withdraw funds in times of stress. The private banking deposits are as sticky as general retail deposits, although they remains stickier than wholesale funding.

Bulls Say:

Credit Suisse looks set to emulate UBS and transform its business model into a wealth manager with a complementary investment bank, which would increase profitability and reduce earnings volatility.
Credit Suisse has run down a massive book of EUR 126 billion to EUR 45 billion over the past four years, incurring pretax losses of EUR 16 billion in the process. This has obscured the performance and profitability of the core business.
Credit Suisse generates the bulk of its earnings in stable and low-risk private banking/wealth management and Swiss commercial banking.

Company Description:

Credit Suisse runs a global wealth management business, a global investment bank and is one of the two dominant Swiss retail and commercial banks. Geographically its business is tilted toward Europe and the Asia-Pacific.

(Source: Morningstar)

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