Investment banking drives Q1 profits at Credit Suisse

Credit Suisse yesterday released a strong set of results for the first quarter, driven primarily by an impressive turnaround in its investment banking division. The improvement shows that the strategy shift towards client-focused and flow trading businesses that began in early 2008 is working well for the bank -- at least in the current environment.

The Swiss bank reported a net profit of SFr2.01 billion ($1.7 billion) for the first three months this year, compared with a loss of SFr6.02 billion in the fourth quarter last year and a loss of SFr2.15 billion in the first quarter of 2008. This translates into SFr1.60 per diluted share and a return on equity of 22.6%. Net revenues rose to SFr9.56 billion from SFr2.93 billion in the year earlier period. Revenues were negative to the tune of SFr1.83 billion in the fourth quarter last year.

Asia-Pacific contributed 9.3% of the net revenues in the first quarter, down from 19% a year earlier, and only 3.9% of the pretax profit. It remains by far the smallest region with a net revenue of SFr886 million.  

The investment bank, which includes sales and trading and prime brokerage, generated net revenues of SFr6.44 billion, compared with a negative top-line of SFr4.62 billion in the fourth quarter, thanks to strong results from global rates and foreign exchange, secondary trading in US residential mortgage-backed securities, cash equities, prime services, and flow and corporate derivatives. But businesses that have been singled out for repositioning in a way that will make use of the bank's competitive advantage, but reduce risk and volatility, also did well. Emerging markets trading, US leveraged finance, equity trading strategies and convertibles returned to profitability and contributed a combined SFr1.4 billion of revenues in the first quarter -- having lost SFr2.3 billion in the fourth quarter.

Aside from these two categories of businesses, the investment bank has also broken out a set of businesses that it intends to exit altogether as they are deemed to be too risky and volatile for the financial reality that is emerging post subprime. In a conference call with analysts yesterday, Paul Calello, CEO of investment banking, described this category as "businesses that do not meet our clients' needs, that provide low return on balance sheet or capital, are more volatile, more complex or less liquid, or businesses where we feel we don't have any competitive advantage."

They include highly structured derivatives, illiquid principal trading, mortgage origination and collateralised debt obligations (CDOs), leveraged finance trading outside the US, residential mortgage-backed securities (RMBS) outside the US, and power and emissions trading. On the advisory side, it is also scaling back its involvement in slow-to-market, capital-intensive financing transactions. These businesses recorded negative net revenues of SFr1.7 billion in the first quarter, driven by net write-downs of SFr1.4 billion on commercial mortgage-backed securities (CMBS).

However, the bank said it continued to reduce its legacy positions, cutting its holdings of dislocated assets by another 31% since the end of the fourth quarter. These assets have been trimmed by a cumulative 92% since the end of the third quarter 2007 when the bank started to reposition itself amid the first signs of the emerging financial crisis. The average carrying value of the CMBS portfolio - which the bank says is its last legacy area with material exposure - has been marked down to 59% from 72% at the end of the fourth quarter. 

"It is important to note, though, that we are not just cutting our risk, we are rebalancing and reallocating our capital to our key client businesses," Calello said.

All in all, the investment bank posted a pre-tax profit of SFr2.41 billion, compared with a loss of SFr7.46 billion in the fourth quarter -- a turnaround of SFr9.9 billion in just three months -- and a loss of SFr3.42 billion in the first quarter last year. Regional numbers weren't broken out for individual divisions.

The result was well above the average expectation among analysts polled by Reuters of a net profit of SFr948 million and contrasted strongly with preliminary first-quarter numbers announced by UBS last week. Investors showed their appreciation by pushing Credit Suisse's share price 8.8% higher in Zurich trading yesterday.

UBS projected a first-quarter loss of almost SFr2 billion, including approximately SFr3.9 billion of losses on illiquid risk positions, credit loss expenses and valuation adjustments on positions transferred to a fund controlled by the Swiss National Bank. It also noted that the private bank saw an overall outflow of net new money to the tune of approximately SFr23 billion following a settlement with US authorities regarding cross-border services for US private clients.

Credit Suisse estimates that about 20% of its investment banking revenues were due to more "normalised" market conditions, including the narrowing of credit spreads, the reduction in the differential between cash and synthetic instruments, the reduction in market volatility and the stabilisation of the convertible bond market since the fourth quarter last year. The revenues also benefitted from fair value gains of SFr365 million on Credit Suisse's own debt.

Private banking, which includes wealth management as well as corporate and retail banking, also had a solid quarter with the addition of SFr11.4 billion in net new assets, of which SFr9 billion was generated by wealth management. However, net revenues dropped by 14% from the first quarter of last year and by 8% from the fourth quarter to SFr2.88 billion. This was primarily due to a decline in average assets under management and cautious client behaviour in the wealth management division, but a SFr45 million provision for credit losses in the corporate and retail banking division also weighed on the top line. The pre-tax profit for private banking as a whole improved to SFr992 million in the first quarter from Sfr517 million in the fourth quarter, but was down 25% from a year earlier.

The asset management division, which is the smallest of the three, posted net revenues of just SFr6 million and a net loss of SFr490 million -- a slight improvement on the fourth quarter loss of SFfr656 million and on the shortfall of SFr544 million in the first quarter last year. The negative result in the just-ended quarter was mostly due to unrealised investment-related losses of SFr387 million, mainly on private equity positions.

The bank's chief financial officer, Renato Fassbind, acknowledged that the financial performance in the asset management business in the first quarter was disappointing, but said the management is convinced that the bank is "on the right track in asset management strategically to return the business to profitability."

Having already demonstrated its financial strength by rejecting a capital infusion by the Swiss government in the fourth quarter in favour of raising $9.1 billion from private investors, Credit Suisse said yesterday that its capital ratios have continued to improve. As of the end of the first quarter, its tier-1 ratio (based on Basel II) was 14.1% compared with 13.3% at the end of the fourth quarter. The bank also has a continued strong liquidity position and intends to redeem two upper tier-2 bonds with face values of €125 million and £150 million, when they become callable in July.

"Credit Suisse's strengths are increasingly recognised by existing and potential clients and this provides us with a distinct competitive advantage," the bank's CEO, Brady Dougan, said in the analyst call. "Our combination of a differentiated strategy, a strong capital position, an absence of government ownership, strong funding and liquidity, well-positioned businesses, a capital-efficient business model and a significantly lower risk profile makes Credit Suisse a trusted partner for clients and a good place to work."