The pain of Credit Suisse and its holdover peers, such as Deutsche Bank, is incredibly easy to understand. There is no need for penetrating the depths of technical jargon in interest rate swaps, forward warehousing securities or even the whole varied business of investment banking. In its Q1 2014 quarterly report, Credit Suisse spells out everything you need(ed) to know:
In Investment Banking, we will continue to focus on our market-leading and high-returning businesses, including our top three equities franchise, a strong and profitable underwriting and advisory business and a fixed income franchise focused on high returning yield businesses. [emphasis added]
The first highlighted portion relates very much to the second, as high yield was the basis for their “profitable underwriting and advisory business” as much as it was in their trading book. That’s the real point in all of this, as what these banks provide through their investment banking operations (FICC) is a “soup to nuts” platform of financial resources and efforts that turn (bubble) demand for product into not just securities but securities with a “market” behind them. From origination or underwriting to warehousing and distribution and then finally trading itself, FICC is the liquid grease that makes the financial system work.
Given what has transpired over the last nearly two years, it is actually surprising that Credit Suisse has not fared far worse. That may be what is in store down the road, as banks have a lot of pliability in especially these esoteric functions but time will catch up at some point. From that, we can make some pretty reasonable assumptions about those internals:
Credit Suisse Group AG Chief Executive Officer Tidjane Thiam pledged to accelerate a restructuring through deeper cost cuts and by eliminating an additional 2,000 jobs as he forecast a first-quarter loss.
The bank may post a net loss in the first quarter, Thiam said on a conference call with reporters on Wednesday after announcing the second restructuring plan in five months. Trading revenue is seen dropping as much as 45 percent in the first quarter, with the bank looking to cut risk-weighted assets in that business by another 20 percent to about $60 billion this year.
The bank is more interested in being a consultative, advisory business rather than a securities firm. CEO Tidjane Thiam continues to declare that as the strategic intention:
Thiam, 53, has pledged to focus on wealth management to tap growth across Asia while shrinking the securities business, which helped contribute to the bank’s biggest quarterly loss in seven years in the three months through December. [emphasis added]
It makes a stark contrast that nobody in the media wishes to report since it destroys, fundamentally, “the narrative.” Credit Suisse, as Deutsche Bank, went “all in” on the Bernanke/Yellen fairy tale of coordinated monetary policy bringing home the belated prize of sustainable global advance. Under that very scenario, high risk would have been the right choice and strategy. Unfortunately for all of us, Credit Suisse and its peers are proving monetary policy never really held such potential; it was all a good story, and in many ways that was all it was ever meant to be (rational expectations theory).
Just as the chain of various money dealing activities make up the liquid market that these banks hoped would offer high reward, the works the same in total reverse. A bubble on the way down is just what you would expect given a sudden and sharp distaste for it. And just as these banks were open about following Bernanke/Yellen then, they are equally so about giving up on the dream now (they have to be or face another January; though doing so does not preclude a repeat). From Credit Suisse’s Q4 Report:
Regarding our Global Markets activities, the combination of a high and inflexible cost base, exposure to illiquid inventory in fixed income, historically low levels of client activity and challenging market conditions has led to disappointing financial results. In this context, we have taken immediate action to reduce outsized positions in activities not consistent with our new strategy and systematically reduced our exposures.
In other words, the bank is admitting that it messed up in chasing high yield and EM credit and all the activities that surround them, vowing now to leave those areas as quickly as practical. It isn’t so easy, though, as Thain’s most recent ante in more lost investment banking jobs suggests.
Credit Suisse is also joined in that regard by the others that followed this policy success vision. Deutsche Bank, for example, was just put on negative ratings watch by Moody’s. The ratings agency sees the same as Credit Suisse, that the strategy once followed and having been done leaves only further pain to undo it.
Moody’s Investors Service said Monday it is reviewing Deutsche Bank AG’s credit rating for possible downgrade, citing risks to the lender’s profitability and cost-cutting plans in worsening markets.
The ratings firm said weakness in Deutsche Bank’s key securities-trading business helped prompt the move. It said the bank’s struggles in recent months reflect “rising execution hurdles” to slashing expenses and meeting other goals as the German lender tries to “strengthen and stabilize profitability over the next three years.” [emphasis added]
It also undercuts one of my pet peeves in that academic treatment of money dealing (broadly speaking) always assumes neutrality among the dealers. That may be the case but only in very narrowest of understanding what dealers actually do; again, soup to nuts. It is a comprehensive and intentional placement of resources to accomplish a strategy which means axiomatically that the bank will be expressing some position. Any bank might be specifically neutral in its IR book, for instance (and even that is unlikely), but the presence of the IR book itself may be in support of this seemingly unrelated strategy and position expression. That seems to have been the case with Citigroup as noted a little while back, though not specifically in high yield and EM (that we yet know of).
You might not make money in providing liquidity but you might in the end result of what opportunity that liquidity can provide. Thus, if you don’t make money in that opportunity, it makes no more sense to provide it.
This is also why it is sheer folly to suggest that it is regulations that are killing investment banking and money dealing functions. It is profit; it has always been profit. Yellen held out tremendous profit potential in her soothing story of the unemployment rate and banks eschewed whatever complications of Basel III to jump on it; only now do they express interest in capital efficiency and more so as a an excuse. That is because they are left with only as-yet unquantified risk without reward, a circumstance ripe for flight before the hammer truly falls. The problem, systemically, is that the more they exit the more likely that happens (August; January) as eurodollar liquidity is directly impacted (for the worse) becoming only self-reinforcing across the whole thing, soup to nuts.
This is not to say Basel III has no impact at all, as clearly the new environment is not nearly as easy and efficient as the pre-crisis era but that was no deterrent to Credit Suisse, Deutsche Bank and others (JP Morgan and the London Whale) when they very much wanted to believe in the fairy tale ending. No amount of perceived capital inefficiency deterred the chase for “high returning yield businesses” – and that was barely two years ago!
All that is left is to describe how these banks become banks again since the process isn’t at all straightforward. It isn’t even that way for these individual firms, having to navigate all the landmines and traps that they set for themselves not just in trading HY and EM but also past support of them with other efforts up and down their balance sheet. In the long run this is terrific news and a hopeful result, though it wouldn’t have been so messy (and we don’t yet know the full extent of that) had it been intentional. If Ben Bernanke and Janet Yellen had the foresight to stop trying to fool the world via “stimulus” that 2005 could be rebuilt and instead worked on removing the wholesale finance burden in favor of more traditional banking, the prospects for a less violent paradigm shift would have been somewhat better – not completely, as systemic resets are going to be messy even under the best of circumstances, but much more hopeful than a eurodollar that decays into who knows what.