Credit Suisse surprised investors with an unscheduled acceleration of a move to cut trading exposure and costs at its global markets division in late March. The restructuring came just over a month after Credit Suisse had announced far worse than expected fourth quarter 2015 results and made further refinements to a strategic overhaul that was originally announced in October.
The revelation in March of additional trading losses in distressed credit and leveraged finance books at the bank was an embarrassment for Tidjane Thiam, which was compounded when he admitted that he had not fully grasped the scale of the exposure run within the global markets group.
Given that Credit Suisse recently raised SFr6 billion ($6.2 billion) of capital, including a rights offering of SFr4.7 billion that completed in December, this raises a version of Richard Nixon’s Watergate question for Thiam: What didn’t he know, and when didn’t he know it?
Thiam’s version of events is that certain unnamed individuals in the global markets group at Credit Suisse were running higher than expected exposure to distressed credit as a weak fourth quarter for most investment banks turned into an exceptionally poor trading start to 2016.
“Clearly something went wrong. We’ve since then been looking at that very closely,” Thiam told analysts on a call to announce further restructuring and trading losses. “Internally, the scale of those positions was not widely known,” he added. “There have been consequences internally for a number of people, and I’ll stop at that.”
This raised as many questions as it answered about risk-management techniques within both Credit Suisse and the broader industry.
Many banks with substantial investment banking operations trade at a wide discount to the theoretical value of their assets, which is a source of grievance to leading industry executives such as JPMorgan CEO Jamie Dimon.
The sceptical approach by investors becomes more understandable given that the regulatory overhaul that followed the 2008 credit crisis has failed to prevent frequent valuation and trading mishaps at big dealers.
The most recent misadventure at Credit Suisse is not one of the bigger trading upsets in terms of total losses – at least not so far. The two main areas of additional markdowns in the first quarter of 2016 were in distressed credit dealing and secondary trading of US collateralized loan obligations, or baskets of credit exposure.
The distressed credit book – which typically saddles a bank with unplanned equity exposure when high-yield bonds or loans default – was reduced from $2.9 billion to $2.1 billion, with a resulting loss of $99 million in the first quarter up to March 11. The secondary trading book of CLOs was reduced from $800 million to $300 million, at a loss of $64 million. Once related losses in securitized products and leveraged finance underwriting were factored in, Credit Suisse announced a $346 million first-quarter markdown to add to the $633 million of fourth quarter 2015 losses for these business lines.
The bank has accordingly suffered close to $1 billion in losses in the months since Thiam’s October strategy overhaul set a new framework for the bank that initially retained substantial securitized-product and high-yield credit trading exposure on the grounds that these businesses had produced substantial profits in the past.
That is a negligible hit compared to JPMorgan’s self-inflicted trading loss of $6.2 billion from the London Whale credit derivatives debacle of 2012.
It nevertheless undermines the credibility of the current Credit Suisse management team as it attempts to reform the bank.
The new plan in March for the global markets unit (or an acceleration of change, as Credit Suisse dubbed it), coming so soon after the October strategy overhaul and the February announcement of fourth-quarter trading losses, must have given some employees inside the bank the impression that the executive board is making up policy as it goes along. That is certainly how it looks to many outsiders.
Round numbers can offer apparent comfort, without necessarily being convincing. Thiam announced that risk-weighted assets for global markets will be cut from a previous target of $83 billion to $85 billion to a new goal of $60 billion by the end of this year. Some 2,000 jobs will also go.
Global markets head Tim O’Hara elaborated that around $20 billion of the asset total will be allocated to the equities business, where Credit Suisse hopes to remain a leading player, while $40 billion will remain for fixed income markets.
Goals are less clear-cut for fixed income than in equities, especially given that Credit Suisse is scaling back exposure in its traditional strong points of securitized products and leveraged finance. It is also far from clear that the bank will be able to meets its asset-cutting targets while also delivering sales and trading profits, given that global markets is expected to start the year with a first-quarter loss.
A collision between Thiam’s assurances about consequences for underperforming employees and the hard numbers reported for costs at the global markets unit also failed to inspire confidence in the ability of the current management to execute their strategy.
Thiam announced that 2015 bonuses within global markets had fallen by 35% from 2014 levels and disclosed that around a third of employees received no bonuses at all. Thiam also observed that he had requested – and received – a 40% drop in the variable compensation he was otherwise due for 2015.
But overall costs for global markets actually rose slightly in 2015, moving from $6.5 billion in 2014 to $6.8 billion; they have been stuck in a seemingly immovable range around $6.6 billion for each of the last four years.
There are some explanations for this apparent inability to exert any pressure on costs. Credit Suisse is moving to reduce the proportion of bonus payments that is deferred, which will add to its flexibility in future compensation rounds. There was a rise in indirect taxes for the global markets unit, primarily in the form of VAT, though there was no explanation for why this had not been anticipated.
There was also an increase in risk and compliance spending – the main current growth sector for investment banking employment.
The costs of compliance have become the single biggest gripe for senior bank executives in recent years (ranking ahead even of shareholders’ inexplicable failure to value banks appropriately).
There is a danger that this will become a new catch-all excuse for these managers, however.
Investors can surely not complain about increased spending on risk management, the thinking may go, so why not bury unwanted line items or cost over-runs under the broad category of compliance and risk monitoring?
For the hapless analysts and investors who try to estimate realistic earnings prospects and potential downside exposure at banks, there is often a queasy feeling that each cycle brings a new metric that might be fudged.
Recent adventures in assumptions by Thiam and his management team at Credit Suisse will do nothing to ease that queasy feeling.