Running a bit late today, but welcome to another issue of Net Interest, where I distil 25 years of experience analysing and investing in financial companies into a weekly email. This one’s about Credit Suisse, which announced a major restructuring this week. I worked there for several years, so if it’s a bit more personal than usual, that’s the reason! If you enjoy the piece please do sign up as a paid subscriber. Thanks.

Long time readers will know that I have a soft spot for Credit Suisse. I joined the firm in 2000 when it was still called Credit Suisse First Boston and rose to become a managing director in 2005. At a glitzy offsite in Orlando, Florida, I was awarded a Tiffany-branded glass star with my name engraved on it – Tina Turner’s Simply the Best blasting from the loudspeakers as I walked across the stage. The glass star turned out to be one of the last of its kind issued by the bank. A few months later, the firm abandoned the name Credit Suisse First Boston that adorns my star and adopted the name Credit Suisse universally across all of its businesses. 

This week, Credit Suisse announced a radical restructuring of its investment banking division including the revival of the First Boston name inside a new, independent entity. As a tactic to fire up nostalgia among a certain cohort of former employees, it’s an exciting development. Whether it’s enough to revitalise the business is a harder challenge. Sadly, the firm’s problems go deeper than its name and they go back a long way.

Plus ça Change

When I joined Credit Suisse, in May 2000, Allen Wheat was in charge of the investment bank. Wheat had grown the business over his years in charge, albeit at the expense of adequate controls. A few months before I arrived, the Flaming Ferraris, a team of five traders, had made headlines over rogue share deals they’d executed on the Stockholm Stock Exchange. The firm was fined by the Swedish authorities and the team was fired but it wasn’t an isolated case. Over the next few years, Credit Suisse would run foul of authorities in multiple other jurisdictions for a series of breaches. “The succession of ‘accidents’ at CSFB was becoming an embarrassment,” wrote one journalist at the time. 

In July 2001, John Mack was brought in to fix the mess. “Brian, I’ve got the biggest, most fucked-up company in the world right here,” he pitched a potential recruit. “Come back to CSFB and help me fix it.” 

Mack didn’t succeed. The firm lost $1 billion in 2001 and $1.2 billion in 2002 and three years after he arrived, Mack was pushed out. In his recently published memoir, John Mack blames cultural differences with the Swiss board. Presciently, though, he recounts some advice he was given before taking the job. “To survive, John, you have two choices,” a former colleague told him. “One is to spin off First Boston and make it an independent company. The other is to move to Zurich. Otherwise, they will kill you.”

John Mack was replaced by Brady Dougan, previously my boss as head of the equities division. Brady went on to run the entire group – and yes, he did move to Zurich – steering it through the financial crisis with fewer knocks than many of its peers. Perhaps because it emerged less bruised than others, the firm failed to adapt to the new post-crisis climate of stricter regulation. As late as 2015, Dougan reiterated his commitment to the old model. “Some argue for a change of tactics,” he told shareholders. “But instead, we have persevered and worked to reshape this business into a streamlined division that is focused on core clients.” 

Investment banking was always a hard business but without the leverage that was available prior to the crisis to boost revenues, it became harder to mask mistakes. Over the years, a series of mistakes rose to the surface at Credit Suisse. In 2015, Tidjane Thiam was brought in as a new CEO. His initial assessment was blunt. “It’s as though you guys have been shitting everywhere,’ he apparently told senior managers shortly after taking over. “I’m going to clean up all that mess. I’m going to put in new toilets – the best, modern Japanese-style toilets with flashing lights and music. And then your job is to make sure people stop defecating on the floor and start using the toilets.”

Thiam found that a fifth of the assets in the investment banking division didn’t earn their cost of capital. His solution was to shrink the business around its more profitable parts, promising that what’s left would deliver a return on capital well into the double digits. 

Those returns never materialised on his watch nor that of his successor, Thomas Gottstein. Between them, they feverishly rolled out restructuring programs at an increasing rate. Geographic regions were stripped out of the investment bank, then they were added back in; trading and advisory activities were cleaved apart before being recombined; and assets were variously assigned as non-core in an attempt to highlight the underlying operating potential of the business.

Yet the margin in the business failed to radically improve. Over the six years between 2016 and 2021, the investment banking division made a cumulative pre-tax profit of 1.36 billion Swiss Francs on revenues of 51.1 billion. Employees, whose number grew over the period from 15,590 to 17,750, took out 23.5 billion Swiss Francs of compensation along the way. Shareholders were left with a return on equity averaging just 3%. Their distaste was reflected in a share price that underperformed materially, even as they were promised that the next restructuring would be the one that delivers. 

Indeed, the continual tinkering may have made the situation worse since a lot of good assets got thrown out with the bad. This was highlighted following the firm’s $5.5 billion loss last year from its involvement with Archegos Capital Management. According to an official inquiry, the loss partly stemmed from “injudicious cost-cutting” as headcount reductions led to a less experienced workforce, not least in areas of risk management.

Other scandals, such as the firm’s links to Greensill Capital and the Mozambique “tuna bond” corruption case illustrate the point. Normally, it’s when the tide goes out that these scandals are exposed, but in 2021 markets were riding high. In a year when peers were reporting record profits, Credit Suisse reported a loss of $3.8 billion in its investment bank. 

Back to the Future

Ulrich Körner is the latest CEO to face the challenges of Credit Suisse’s investment bank. “The investment bank has not created value for a long time,” he confessed at his strategy update this week. His proposal to fix it channels the firm’s long history: It wasn’t always the case that Credit Suisse fully owned its own investment banking franchise. 

Credit Suisse first got into investment banking back in 1962. The Swiss bank acquired the Zurich office of US firm White, Weld and Co and the two firms set up a joint venture to collaborate internationally. In 1978, White Weld was taken over by Merrill Lynch and Credit Suisse was left looking for a new partner.

Timing was of the essence. A new banking act was being drawn up in the US to extend the stipulations of the Glass-Steagall Act to foreign banks. Domestically, Glass-Steagall had been in place since 1933 – it required commercial banks and investment banks to operate separately. If Credit Suisse didn’t act soon enough, it would be prevented from setting up an investment banking arm in the US. After a short round of negotiation, Credit Suisse signed a deal with First Boston the day before the new legislation was enacted. First Boston would take over White Weld’s stake in the joint venture, and Credit Suisse would take a 25% stake in First Boston.

For ten years, the various parties operated independently. Credit Suisse looked after the Swiss market; First Boston looked after the American and Australian markets; and the joint venture – which became known as CSFB – was responsible for Europe and the rest of the world. Across the three groups, the franchise became a top three player in M&A and established leading positions in equity and debt underwriting, with market shares of 11-15% and 9-15% respectively. 

However, as markets increasingly globalised, the three groups started treading on each others’ toes. In 1988, they were merged into a single firm headquartered in New York known as Credit Suisse First Boston (albeit with a First Boston unit beneath it to service the American market). Initially, Credit Suisse took a 45% stake, with employees holding onto 25% and institutional investors 30%.

This may be the model Ulrich Körner is trying to replicate. “Imagine a bank rooted in North America,” he extolled at his strategy briefing. “Imagine an owner open to creating a partnership culture to attract the best talent and willing to mobilise third-party capital to grow the franchise… Imagine an owner who is also a leading global bank and a future partner.” 

Yet what happened a year after the merger was consummated is a warning of what can go wrong with such a structure. By 1989, Credit Suisse First Boston had become a leading player in the junk bond market, ranked #2, behind Drexel Burnham Lambert. When the market collapsed, CS First Boston was left holding $1.1 billion of paper it couldn’t shift, issued by companies like Federated Department Stores, Ohio Mattress and Jerrico Inc. Fast-Fish. With the firm’s future in doubt, Credit Suisse was forced to bail it out, taking majority control and slashing its headcount and balance sheet. Leveraged finance write-downs of $120 million in the most recent quarter are a reminder of the cyclicality in that business.

At his strategy briefing, Ulrich Körner was coy on how the new structure will work. “The right way to think about CSFB is to think about a journey,” he said. He disclosed that a “highly respected investor” has made a $500 million hard commitment to invest in the firm, but refused to elaborate. The new firm will have $21 billion of risk-weighted assets (versus $90 billion on the current investment bank’s balance sheet) and has capacity to generate over $2.5 billion of revenue on the basis of unspecified “normalised market conditions”. However, how the new firm raises funding, what Credit Suisse’s optimal shareholding is and how costs are allocated to the new unit are all questions that remain unanswered.

Four Legs to the Table

Fortunately, a revitalised Credit Suisse First Boston is just one leg of a comprehensive restructuring plan for the investment bank. There are three other pieces. First, Credit Suisse plans to release a further $22 billion of risk-weighted assets through the transfer of its Securitised Products unit to an investor group led by Apollo Global Management. We’ve discussed Apollo here before, characterising it as a new breed of financial institution taking share from traditional banks. This deal represents another milestone on that particular journey.

Second, the bank plans to jettison a load of assets from non-core businesses. They include what’s left in prime brokerage after most of that was wound down in the aftermath of Archegos, lending in emerging markets, and other assets. There are about $25 billion of risk-weighted assets slated for wind-down here, plus another $10 billion that currently sit outside the investment bank.

Dixit Joshi, Credit Suisse’s new CFO admitted at the strategy briefing that this wasn’t the bank’s first rodeo when it comes to ridding itself of unwanted assets. “Credit Suisse has experience of successfully managing down noncore entities through our Strategic Resolution Unit,” he said at the briefing. To help, he has recruited the expertise of Louise Kitchen, who ran a similar unit at Deutsche Bank where it is known as a Capital Release Unit. At the end of her tenure there she was ahead of her target, having reduced risk-weighted assets to €24 billion from €65 billion in mid-2019. The trouble is that reducing unwanted assets can be an expensive business. Joshi estimates a drag of $2.2 billion this year, shrinking to only $1.3 billion in 2025. Over the next four years, that’s a lot of bleed. 

The final leg of the restructuring is what Credit Suisse retains as part of a stripped down ‘Markets’ business. The bank is looking to retain just $22 billion of risk-weighted assets, which it estimates have the potential to deliver $3 billion of revenues, again, on the basis of unspecified “normalised market conditions”. This is ultimately the business new management feels it needs to retain to feed its core wealth management franchise. Körner estimates that around half of the revenue here is directly linked to wealth management and Swiss private banking clients. ¹

Yet assessing the optimal synergies between investment banking and wealth management has been at the root of much strategic prevarication at Credit Suisse for years. Rainer Gut, the chairman of the group when it embarked on its global investment strategy, thought it was important to have a global reach. “We want to create an organisation…that allows us to be a major player in every area of financing activity around the globe,” he said. Brady Dougan tried to track “collaboration revenues” between the two sides of the group, aiming for 18-20% of group revenues to come from collaboration between the group’s divisions. Tidjane Thiam began his restructuring efforts by putting the investment bank at the service of wealth management.  

What’s clear is that as much as it needs some investment banking resources, a wealth management franchise needs stability. Social media coverage around the bank’s financial position at the beginning of October led to a significant level of deposit and assets under management outflows, according to the bank. A consistent strategy coupled with a sound financial footing should relieve that pressure.

The problem is that the bank is not projecting an especially exciting future for its financials. After all of his restructuring efforts, Körner projects that the group’s return on tangible equity will hit 6% in 2025. Strip out the losses from Louise Kitchen’s Strategic Resolution Unit and the core return on tangible equity is projected to hit 8%. These targets are some of the lowest in Europe. 

For now, though, it’s less about the upside and more about mitigating the downside of continued franchise erosion. And rather than in numbers, that starts in trust. At his strategy briefing, Ulrich Körner was upfront: “Most importantly, it is about trust. And we know we need to work hard on restoring the trust: the trust of our clients; our employees; our investors; and, of course, our regulators.”

In The World Is Not Enough, James Bond says, “If you can’t trust a Swiss banker, then what’s the world come to?” We’re about to find out.