OREANDA-NEWS. February 16, 2015. Fitch Ratings says that Credit Suisse Group AG (Credit Suisse, A/Stable/A) reported solid underlying profitability in all its business lines in 4Q14. However, earnings pressure will likely persist in 2015 given adverse exchange rate movements and negative Swiss interest rates, which management plans to mitigate with additional cost savings but will make achieving its profitability targets challenging in the short term.

Positively, Credit Suisse improved its fully-loaded common equity Tier 1 (CET1) ratio by 40bps in the quarter to 10.2% at end-2014 despite adverse exchange rate movements affecting risk-weighted assets (RWA). In addition, the bank announced revised leverage ratio targets to be achieved by end-2015 which are more in line with the CET1 leverage ratios of its European peers. The results have no immediate effect on Credit Suisse's ratings.

Credit Suisse reported a core (excluding non-controlling interests without significant economic interest) pre-tax profit of CHF1,178m for 4Q14, down 9% quarter-on-quarter (q-o-q) but notably improved on 4Q13 when significant litigation charges resulted in a CHF529m pre-tax loss. Excluding pre-tax losses booked in its non-strategic units (NSU, CHF271m in 4Q14), Credit Suisse's pre-tax income stood at CHF1,449m in 4Q14, 11% lower than in 3Q14 but broadly unchanged year-on-year (y-o-y).

Reported core pre-tax income for 2014 was unchanged y-o-y at CHF3.5bn with a slight improvement in revenue being offset by 2.7% higher operating expenses largely due to higher litigation charges in 2014.

Credit Suisse's reported return on equity (8% in 4Q14 and 5% in 2014) is significantly below its 15% target with litigation charges and costs relating to winding down its NSU continuing to represent a significant drag on profitability. Its return on equity in its strategic businesses was 11% in 4Q14 (12% in 2014) compared with 11% in 4Q13 and 13% in 2013.

In response to the sharp appreciation of the Swiss franc since mid-January 2015, the bank announced incremental cost savings measures to offset the negative impact from significant currency mismatches between its revenue and cost base, particularly in its private banking and wealth management (PB & WM) division where only 40% of revenue but 55% of operating expenses (excluding litigation) are Swiss franc-denominated.

The bank estimates that had end-January 2015 exchange rates prevailed in 2014, pre-tax income would have been around CHF300m lower (around 6% of 2014 pre-tax income). Credit Suisse expects to more than offset this negative impact by CHF200m incremental cost savings by end-2017, a CHF75m positive effect from lower fair value of future deferred compensation and CHF50m to CHF100m higher client FX hedging revenue. However, costs to achieve this will dent earnings in 2015.

Credit Suisse's investment banking (IB) division reported mixed results in 4Q14, reflecting considerable market volatility, with weak underwriting revenue partly compensated for by resilient sales and trading in both fixed income and equities. Excluding a CHF567m pre-tax loss in its IB NSU but including a first-time recognition of a funding valuation adjustment (FVA; CHF108m booked in its strategic IB division, CHF171m in its IB NSU), Credit Suisse's strategic IB pre-tax profit stood at CHF579m in 4Q14, 20% up y-o-y. Its return on 'regulatory' capital (defined as equity less goodwill and deferred tax assets) in strategic IB also improved (to 10% from 9% in 4Q13) but remained below the return on regulatory capital reported for 2014 as a whole (17%).

In 4Q14, overall strategic fixed income revenue excluding FVA was broadly unchanged y-o-y at CHF1.3bn. However, fixed income underwriting revenue was considerably lower y-o-y as market volatility negatively affected volumes. Fixed income sales and trading revenue benefited from a good performance in Credit Suisse's solid securitised products franchise and improved macro revenue.

Strategic equity revenue excluding FVA improved to CHF1.4bn in 4Q14 (8% higher y-o-y) with strong sales and trading revenue, notably in Asia, compensating for significantly lower underwriting revenue (CHF205m, down 25% y-o-y).

The bank's PB & WM division performed resiliently in 4Q14 (with a strategic pre-tax profit of CHF1bn, 4% lower y-o-y). A 2% drop in revenue was partly offset by ongoing cost savings.

The global wealth management division (accounting for 57% of PB&WM 4Q14 pre-tax profit) performed well with net new asset (NNA) inflows at CHF4.4bn (0.5% of assets under management, AuM). WM's gross AuM margin fell by 5bps y-o-y (9bps if net gains on sales are excluded) almost exclusively reflecting lower net interest income. However, the bank's net margin (excluding net gains on sales) remained stable at 24bps from 23bps in 4Q13. Given the difficult operating environment, any improvements in Credit Suisse's net margin will likely be driven by further reduction in its WM cost base, but further growth of lending to WM clients should also help the margin.

The domestic corporate lending business (corporate and institutional clients) continued to perform well (CHF220m pre-tax profit, 3% up y-o-y) partly driven by higher loan balances as Credit Suisse continues to allocate more capital to its non-IB business lines. Loan impairment charges in this business remained low in 4Q14 but in Fitch's view could be negatively affected in 2015 by the recent Swiss franc appreciation.

Pre-tax profit in Credit Suisse's asset management division dropped by 43% y-o-y in 4Q14 to CHF210m, as markedly smaller transaction and performance fees more than offset a 7% cut in operating expenses. Net asset outflows of CHF10.6bn during the quarter largely reflected a transfer of AuM from Hedging Griffo (in which Credit Suisse is majority shareholder) to Verde Asset Management (where the bank has a significant investment).

A CHF294m pre-tax loss in Credit Suisse's IB NSU was primarily driven by a CHF171m FVA charge, mitigated by lower litigation expenses.

The group's smaller PB&WM non-strategic unit reported a CHF125m pre-tax loss in 4Q14, as a result of higher realignment expenses and notably lower NSU asset management revenue.

Since 2Q14, when Credit Suisse settled its US cross-border matter, the bank has improved its fully-loaded CET1 ratio by around 90bps to 10.2% at end-2014, marginally above its stated target. Its total capital ratio, which includes significant layers of low- and higher trigger contingent convertible capital instruments, improved to 16.5%, only marginally below its current end-2019 total capital requirement of 17.05%.

In line with its target to achieve a balanced allocation of risk-weighted assets (RWA) between IB and non-IB businesses, RWA reductions in 4Q14 exclusively related to IB (both strategic and NSU) which accounted for 56% of RWA at end-2014. Credit Suisse intends to reduce RWA by a further CHF25bn to CHF35bn by end-2016, largely from NSU run-downs.

Fitch expects an increasing focus on regulatory leverage ratios at large Swiss banks reflecting likely revisions to the Swiss capital and leverage requirements following the recommendations of the Brunetti expert commission published in early December 2014. Credit Suisse announced that it now targets a Basel III leverage ratio of 4% (3.3% at end-2014) and a CET1 leverage ratio of around 3%.

Consequently, it lowered its end-2015 leverage exposure target to between CHF930bn and CHF950bn from a previous target of CHF1,050bn. The bulk of the leverage exposure reduction will be achieved in IB, through a combination of trade compressions, NSU reductions, client optimisation and cuts in the less profitable macro businesses.