Bank of the Year
Climbing Mount Improbable: Changing an investment bank’s culture can be a slow, painful and fraught endeavour. Driving fundamental change in the midst of a cataclysmic market dislocation and in the absence of a transformational merger is no mean feat. One bank did just that without sacrificing business execution, at the same time as pre-empting regulatory outcomes on compensation and generating one of the highest ROEs in the business. Credit Suisse is IFR’s Bank of the Year for 2009.
Let’s start with a thought experiment. Imagine that a market observer had been asked which global investment bank was most likely to get into trouble in the event of a major market downturn. There would have been a few candidates, but the chances are that many would have picked Credit Suisse First Boston.
If there was ever a bank that could get itself in trouble it was the old CSFB. To say the firm was regularly in the headlines for the wrong reasons is an understatement. “Let’s be honest, it wasn’t very long ago that this firm had more than its fair share of pirates,” said one senior CS banker. And yet, in reality, what is now simply the Credit Suisse Group can plausibly claim to have come through the biggest downturn in 80 years not just intact, but even with its reputation and its business enhanced.
What is perhaps most striking about this transformation is how fundamental it is. Those in charge of CS in the last few years have, in fact, done something pretty remarkable: they’ve changed the entire culture of the institution. That change came firmly paid dividends in 2009.
No longer is the bank all about star bankers looking out for themselves, whether that was Allen Wheat in his CSFP days, real estate head Andy Stone in the late 1990s, internet wideboy Frank Quattrone a few years later, or even John Mack, for whom his time as CSFB CEO in the early part of this decade was more about Morgan Stanley – and its power struggles – than it was about CS.
CS no longer has the feel of a firm run for the benefit of its staff at the expense of clients and shareholders. Look, for instance, at the slashing of the cost-income ratio. At the end of 2004, for instance, CSFB's institutional securities division was running a ratio in excess of 90% – way above the industry average. Over and above the high operational costs of running that business, CSFB’s bankers paid a hefty chunk of the bank’s profits to themselves. Now it is much more sensible. For the first three quarters of this year the investment bank’s cost-income ratio averaged 70% and the comp to revenue ratio was 44%, around 10 points lower in three or four years.
Brady’s bunch
Some of that change in culture began under Mack and was built upon by Ossie Gruebel, who took over as CEO on his own in 2004. But it really took hold during current CEO Brady Dougan’s tenure in the top job, which began in May 2007. The culmination of those changes was evident in 2009.
Partly as a result of those changes, CS had done into the crisis in a relatively strong position. Like JP Morgan, it had been nervous about the apparently free money to be made from sub-prime CDOs so had pulled back from the business – where it had built a market leading presence – to the extent that Chris Ricciardi, global head of structured credit and CDO evangelist, quit the firm for Merrill Lynch where he proceeded to Merrill’s CDO platform to the top of the league tables, with ruinous consequences.
When the financial crisis hit, CS had no shortage horribly mispriced assets, especially top-of-the-market LBO debt and CMBS. Unlike many of its rivals, though, it marked those assets accurately to market when prices tanked and took decisive action to deal with them. Unlike many competitors, that action did not involve moving assets to accrual books – but actually selling them.
Even then, though, CS is at the lower end of the industry when it comes to write-downs, marking down just US$20bn, less than half the figures at JP Morgan, HSBC and UBS, and under a sixth of that at Citigroup.
“No-one was as disciplined at risk reduction as Credit Suisse,” said Paul Calello, head of the firm’s investment bank. “We had over US$100bn of risky assets at the beginning of 2007 and we’ve reduced that by 95%. We’re down now in those illiquid asset categories to a few billion dollars.”
That decisiveness – which was also on display in the way in which the bank dropped certain business areas at the outset of the crisis and cut its cost base by around 10% – is all the more impressive when set against the background of what was happening elsewhere in the industry.
And just as the bank’s risk-weighted assets were slashed, so were its value-at-risk numbers. In the third quarter of 2009, VaR declined to US$89m – down 21% versus the previous quarter and 44% relative to the third quarter in 2008.
The change in culture can be seen as a reclaiming of CS’s “Swissness”. This is an important point. After all, Credit Suisse’s heritage as an investment bank-cum-broker dealer has been distinctly Swiss-American, from the very profitable First Boston association in the 1970s and later through the more questionable acquisition of DLJ. “Swiss banks should stand for stability and a thoughtful, conservative approach. We believe our strategy is consistent with these Swiss values,” said David Mathers, chief operating officer of the investment bank.
That more careful attitude combined with the decisiveness with which the bank reacted to the onset of the crisis had one vital effect: CS has not taken any government investment, nor did it need to issue any government-supported debt.
“We benefited from the fact that we’ve had an extraordinarily conservative liquidity profile, both in terms of the private bank and thanks to our reliance on the long-term unsecured debt that backs the investment bank,” said Calello.
CS did not scrape by without government involvement by the skin of its teeth, as some firms did. Rather, it has emerged from the financial crisis with just about the best financial ratios in the industry. Its Tier 1 ratio as of the end of the third quarter 2009, for example, was 16.4%, while its core capital number at the same point was 11.3%.
Of course, reducing risk and exiting businesses is easy if no thought is paid to the financial consequences. The real trick is to do both without also slashing profitability. That CS has been able to do that – while also maintaining potentially profit-sapping capital ratios – is perhaps its most impressive achievement. At 21.8% for the first three quarters of this year, the bank’s return on equity puts it near the top of the league.
The other danger of hunkering down in risk-reduction mode is that doing so affects the service that clients receive. CS managed to do the right thing while maintaining – even enhancing – its interface with clients. Certainly, the bank has developed its relationships across the board and it is very much at the top table when it comes to dealing with key clients.
Clients who have been won over to CS include the British government, which will have paid the bank some £15.4m for advice from September 2007 through to March 2010, according to figures released by the UK’s National Audit Office.
Some of these enhanced relationships have come about because CS has solidified its reputation as a solid counterparty, but they are also the result of a strategic decision taken in the second quarter of 2007 – just before the crisis hit – to adopt what a client-focused, capital-efficient strategy. That might seem like a platitude (it is certainly the kind of thing that every bank CEO trots out) but CS management has put it into practice and moved from an institution that purely chased deals to one that focuses on building relationships.
“It has been accepted wisdom in the industry for the past 10 years that the easiest way to make money has been proprietary trading and deploying your own capital, with the client-side of the business considered more challenging in terms of trying to make a decent return,” said Brady Dougan, chief executive of Credit Suisse. “But we believe that if we can run a business that is extremely client-focused and which provides value for our clients then that will create superior returns and lower volatility in our returns. It will also differentiate us from the rest of the industry.”
The result has been a strong upward trajectory across a host of client-facing businesses. Take equities: CS now boasts an unquestioned top-tier status in that space. The various surveys put it at – or very near – the top in the US, Europe and Asia. It has also made considerable progress in Latin America. From a trading point of view, it is a leader when it comes to market share on the world’s most important exchanges.
Thanks to aggressive expenditure on IT, the bank’s electronic trading expertise is top-notch unrivalled and it is a clear number one in algorithmic trading in many geographies. The prime brokerage operation is another that has gone from strength to strength as others have gone backwards, and the equity derivatives business has also put a significant hiccup behind it in the shape of a mis-marking scandal uncovered in 2008 to become IFR’s Equity Derivatives House of the Year (see p178).
The story is much the same in fixed-income. The trading alliance with Glencore International has borne considerable fruit in the commodities area, and CS has grabbed market share in rates and structured products. Just as with equities, the willingness to invest in IT has given the firm an edge when it comes to foreign exchange and the Merlin FX derivatives platform has proved a great success.
Cash machine
When it comes to capital markets, the bank can not claim to be all things to all people. It makes a respectable showing in the various league tables, but does not dominate. Nonetheless, the bank accumulated a deal roster that was the envy of many competitors in 2009 – and it made good money.
In ECM, for example, CS may not have been on the most deals or at the top of the league tables, but its wallet share was markedly higher than its league table position. Issuers rank the firm highly and so it was more often able to secure lead-left positions or sole book mandates.
The most impressive of these were the two sole-led Barclays blocks. The first was a record-breaking £3.44bn accelerated bookbuild in June for Abu Dhabi state fund IPIC, followed in October by a £1.37bn accelerated trade on behalf of the Qatari government. Both resulted from the Barclays £7bn fundraising package put together in late 2008, where Credit Suisse was just one of three bookrunners.
“It is not often you see a client act like that and trust just one firm with US$6bn of stock,” said Nick Williams, head of EMEA ECM, of the IPIC deal. “As sole bookrunner it is absolutely clear who is accountable, but it also meant we had that deal under control, could make the risk decision and be completely honest with the client.”
IPIC was richly rewarded for its faith, as the largest ever ABB in EMEA was launched after the US close and was still priced and allocated by noon in London the next day. Rival syndicate desks could not help but praise the execution and it was hard for Qatar to look elsewhere when planning its own sell-down.
Other significant wins saw CS secure leading roles on two of the world’s most high-profile IPOs in 2009 – lead co-global coordinator and stabilisation agent slots on the R$13.2bn (US$7.5bn) IPO of Banco Santander Brasil and joint global co-ordinator on the US$3.3bn listing of Malaysia’s Maxis. It also acted as joint bookrunner for Rio Tinto’s concurrent US$15.2bn Anglo-Australian rights issue.
Few trades were natural wins, with the ECM group acknowledging the contribution of the equities business to origination efforts. “A lot of ECM progress comes from the growth of the equity platform,” said Tom Ahearne, head of EMEA syndicate. “There are countless examples this year where our seat at the table was a direct result of our flow in a stock and the informed advice and market insight coming from the equity platform.”
CS also has an enviable convertibles business and has won IFR’s Structured Equity House of the Year (see p162).
Changed circumstances
In the DCM arena, the bank helped reopen the markets and re-established issuer benchmarks to take into account changed circumstances. It was, for instance, at the forefront of the mega M&A financings that got done through the bond markets in the US, with roles on Roche (US$33bn), Pfizer (US$24bn) and Verizon (US$14bn). .
Other notable highlights included reopening the-then dormant 10-year euro sector with the World Bank, a transaction for Rabobank (a US$2.25bn exchange and new issue), the reopening of the retail-targeted Tier 1 market via a US$1.5bn deal for Standard Chartered, and the largest ever placing of a tranche of bank capital in sterling – Barclays’ £1.25bn 14% perp non-call 2019.
The high-yield highlight was the €2.7bn issue for Wind, the largest ever European high-yield note, while the bank can also claim to have reopened the Swiss franc markets for the supranationals, with deals for the World Bank, Inter-American Bank and African Development Bank.
The emerging markets business continued at the cutting edge. In Asia, it structured and sole-managed a US$2bn paired debt exchanged warrants issue for the Philippines. In the CIS, it sole-led the US$2.25bn 10-year put three for Gazprom, which reopened the Russian US dollar market after eight months of inactivity, while in Latin America, it brought a US$1bn trade for supranational Corporacion Andina de Fomento, did the largest ever issue out of Trinidad and Tobago (Petrotrim’s US$850m 10-year) and it arranged the only Swiss franc bond from the region, in the shape of a SFr350m transaction for Mexico’s Pemex.
“We reopened markets with basic blocking and tackling; we proved ourselves equal to changing conditions with our innovations; and we were ahead of the game as the markets stabilised,” said Paul Tregdigo, vice chairman of DCM.
Rebuilding leverage
When it comes to the global loan market, CS has been instrumental in aiding 2009’s slow recovery of the leveraged market. Largely avoiding flow or plain vanilla lending, the bank is positioned firmly in the event-driven lending space.
While many were reading the leveraged market’s last rites, CS was finding solutions to solve borrowers’ existing balance-sheet issues, while also finding ways to source new capital. In particular, the bank was a key mover in helping the US market address the refinancing cliff left over from the boom years through the use of amend-to-extend technology.
CS arranged sizeable transactions that many would have thought impossible just months before. Most notable here was the US$3.2bn financing supporting Warner Chilcott’s leveraged acquisition of P&G’s prescription drug business. The deal, which is which is also IFR’s Leveraged Loan of the Year (see p136), was the largest committed new leveraged acquisition financing since mid-2007.
The firm’s prowess was not limited to the US, with the US$1.4bn loan supporting the LBO of Reynolds Group, a cross-continental placing, key in bringing life back to Europe’s largely moribund market.
The focus on relationships certainly bore fruit in M&A advisory. CS can point to many significant transactions and a position of five in the global league tables for announced deals (including being number two in Europe and three in Asia) in the first three quarters of 2009. Highlights included acting as adviser to BlackRock on the US$13.5bn acquisition of Barclays Global Investors; to Sun Microsystems on its US$7.4bn acquisition by Oracle; and to Qatar Holding on its €7bn acquisition of a 10% stake in Porsche and options in Volkswagen.
Another factor behind the bank’s ability to win many of these mandates and one that is distinct from the client-focused attitude is the so-called “one bank” model. This was first introduced by Gruebel but has been built on since then. The idea is that each part of the CS business – private banking, investment banking and asset management – cross-fertilises the others. That it has been successful is clear. The sell-downs of Barclays stock for Abu Dhabi and Qatar, for example, emerged out of private banking relationships.
Adding depth to those views is the fact that CS breaks out what it calls collaboration revenues – income that comes from the integration of the firm. In the first nine months of 2009 that number was SFr3.6bn and while the year-end total is likely to be down on the SFr5.2bn of 2008 the bank intends to push it up to as much as SFr10bn a year by 2012.
Like the investment bank, the private bank has gone from strength to strength during the crisis, benefiting both from the troubles at UBS and a wider flight to quality. At the end of 2008, the division was showing an annualised growth rate in net new assets of 5.1%. By the end of the third quarter of 2009, this rate had risen to 5.9%.
The private bank has also avoided the kinds of regulatory problems that have hit rivals such as UBS. One reason for that is CS’s effort to build onshore private banking businesses, which mean that many of the cross-border issues that have afflicted UBS in the US were avoided. The acquisition of a majority of Hedging Griffo, one of Brazil’s leading asset managers in 2007, is an example of CS’s push onshore.
New comp model
As well as seeing to the interests of shareholders and clients, Credit Suisse also focused on dealing with regulators and employees. In the current climate, keeping both happy is particularly difficult. CS has squared that circle.
The fact that it avoided losses that would have forced it to rely on government funding was the best way to please the Swiss regulators and other regulatory bodies around the world. Almost as significantly, though, the bank was among the first to respond properly to the way the wind was blowing on bankers’ compensation.
In December 2008, it introduced a bonus system in which senior investment banking employees received part of their comp for 2008 in toxic assets. Bonus packages were made up of three elements. The first was cash, which was subject to clawback. The second was deferred stock or other instruments whose performance was related to CS stock. The third was the distribution of units that were linked to the market value of illiquid assets stuck on the bank’s balance sheet.
Later in the year, CS became the first firm to change its compensation policies to be genuinely compliant to new G20 rules. The 2009 scheme applies more stringent tests to the payment of deferred comp while also increasing the proportion of comp paid as base salary.
When the bank pays bonuses in January, staff will receive a cash component; an equity-related component that vests over four years and is linked to the share price and return on equity over that period; and a deferred cash component based on the performance of the bank and the relevant division. “What we’ve done is put in place systems that are more long-term, more aligned with shareholder interests,” said Dougan.
There are those that predicted that the combined effect of both new pay schemes would be a series of CS bankers heading for the door to take up more lucrative offers elsewhere. Although it is too early to be certain and attitudes so far are likely to be swayed by how well the toxic assets contained within the 2008 scheme have performed, those suggestions seem to be wide of the mark. Indeed, many CS rank-and-file bankers insist they are proud of the way management has responded to the skewed incentives that are held to have exacerbated the financial crisis.
And there is one final, telling, data-point. Just about every bank on the street has been forced to sell more equity as a result of the crisis, or in the run-up to it. At one end of the scale sits RBS, which by the end of the second half of 2009 had 1,600% more shares outstanding than it did at the beginning of 2006. In the middle are the likes of Citigroup (321% up), Bank of America (116%) and Barclays (70%), while at the lower end are Goldman Sachs (31%) JP Morgan (23%) and Deutsche Bank (12%).
The number for CS? A 5% decline in stock outstanding. Clearly, some of those numbers are distorted by mergers, but one thing is clear: Credit Suisse’s outperformance has been impressive. Take into account where the firm came from, and that performance has been dazzling.