Many investors compare this to when UBS announced their restructuring in 2012, and compare the current valuation with that of UBS, 1.1x 16e TNAV for CS compares to 1.5x 16e TNAV for UBS.
Nevertheless this masks fundamental differences
The key ones being (i) the difference in the capital ratio, (ii) where we are in the credit cycle and (iii) the cost of incremental deleveraging for Credit Suisse. CS has already announced a significant reduction in leverage exposure for the group and IB, and has now been deleveraging for several years. UBS benefitted from the improvement in credit markets which made non-core de-risking less expensive. At YE14 the Credit Suisse CET1 ratio was 10.1% compared to UBS at 13.4%.
We expect the incoming management to rebase the capital of the group
If new management ‘upfront’ litigation costs, ‘regulatory inflation’, and target a 12% CET1 ratio, CHF7-10bn of additional capital is needed. Based on our estimates, it is difficult to achieve this organically through IB deleveraging, and it would have a significant impact on profitability in the next few years. Current profitability is effectively ‘overstated’ by the lower CET1 capital base, and reflecting the differences we see CS trading on the same 2018e PE as UBS, despite the execution risk of a change in strategy, that has not yet been announced by a CEO, who is not yet in the role.
Could the group make a significant acquisition?
In the past Julius Baer has been mentioned in the Swiss Press (SonntagsZeitung) as a potential target, and this management change could rekindle such discussion. Strategically this could be an interesting move for the long term, but at this stage we think (i) it could require additional capital, (ii) only happen after Baer has settled with US authorities, and (iii) could lead to significant revenue attrition (offsetting potential cost savings).
One of the key differences between Credit Suisse and UBS is the relative CET1 capital position. At YE2014, Credit Suisse had a capital ratio of 10.1%, compared to 13.4% for UBS. In terms of go to ratios, Credit Suisse is targeting 11% in the medium term, compared to 13% for UBS.
Capital is important
We think a key part of why UBS trades at a higher P/TNAV multiple than CS is the combination of a preferable business mix, and just as significantly a greater capacity to return capital, especially in the current low yield environment.
We see the change in CEO as an opportunity for the group to rebase the capital ratio, and we would expect an incoming CEO to try to ‘upfront’ as much regulatory and legal cost as possible. In this way, the group will be able to invest and focus on growth, with capacity to step up capital return in due course. In particular we could see;
1) A 12% CET1 ratio targeted, up from 11% in the medium term and closer to the levels targeted by a number of peers;
2) RWA inflation from areas such as market risk and securitisation taken upfront (we estimate CHF32bn);
3) The uncovered legal costs of CHF1.8bn covered.
Satisfying these hurdles for 2015e would imply a CET1 leverage ratio of 3.8% post litigation, effectively preparing the group for changes to leverage requirements.
Note that while the group has a significant amount of contingent capital, we think that the benefit of this capital buffer is reducing from a loss absorption perspective as conversion triggers have not moved with increasing capital ratios.
The ‘cost’ of this recapitalisation is that it would impact the return profile of the group until there is capacity to return more capital (which would then in theory be sooner).
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