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Insight: How Credit Suisse underwent painful bond surgery -and survived

A general view shows the headquarters of Swiss bank Credit Suisse (R) at the Paradeplatz square in Zurich July 25, 2013. REUTERS/Arnd Wiegma
A general view shows the headquarters of Swiss bank Credit Suisse (R) at the Paradeplatz square in Zurich July 25, 2013. REUTERS/Arnd Wiegma

By David Henry and Katharina Bart

NEW YORK/ZURICH (Reuters) - In spring 2009, senior Credit Suisse executive Gaël de Boissard told colleagues at a strategy meeting that as the bank reshaped its bond trading business, they needed to remember the five stages of grief outlined decades ago by psychiatrist Elisabeth Kübler-Ross.

Denial would come first, followed by anger, bargaining, depression and finally acceptance, he said.

"It is hard to be present in every business line in a world where capital is expensive. You have to make some choices," de Boissard, now co-head of the Credit Suisse investment bank, said in an interview.

Credit Suisse has been among the most aggressive banks in paring back its fixed income, currency and commodities trading business after the financial crisis. The Swiss bank winnowed down the 120 product areas it traded in to around 80, through consolidating some businesses and exiting others altogether.

With Credit Suisse's strategy now well set, it could be a template for other European and U.S. banks that are under increasing pressure from regulators to cut risk-taking, bank executives said.

Banks are being squeezed on at least two fronts. Revenues are down by a third since 2009, but funding costs are higher because regulators are forcing banks to rely less on cheap debt to finance themselves, said Philippe Morel, a consultant at the Boston Consulting Group.

The big banks cannot respond by buying one another - the way companies in the steel, auto and pharmaceutical industries have done to reduce excess capacity - because regulators do not want banks to get any bigger, Morel said. The only real option left for most major banks globally is to voluntarily shrink to be sufficiently profitable, he added.

Credit Suisse did not have a choice. The Swiss government, which was shocked by the near-collapse of UBS AG in 2008, moved earlier and more forcefully than other regulators to require banks to rely less on debt funding and more on equity, which can cushion them better against losses.

Even though Credit Suisse navigated the financial crisis relatively well and received no taxpayer bailouts, executives felt they had to face up to new rules and weaker revenue, and start cutting. They focused on slashing areas where their market position was weak and the capital requirements were high, such as commodities trading.

If they did not make changes, Credit Suisse executives determined that the investment bank's return on equity, a measure of the returns they wring from shareholders' money, would have fallen to 10 percent from 19 percent, an unacceptably low level. With the changes, they aim to get returns closer to 17 percent.

So far, the efforts have paid off - Credit Suisse's investment bank posted a return on capital of 18 percent in the first half of the year, as revenue increased 9 percent, helped by businesses including fixed-income trading.

"Credit Suisse moved very quickly, to their credit," said analyst Chris Wheeler of Mediobanca. "They're getting much bigger bang for their buck," he said.

There are risks to Credit Suisse's strategy. Businesses that the bank exits may come roaring back, and businesses that it stays in may produce less profit than expected. What's more, rivals with weak hands may be slow to fold, reducing profitability for everyone else, analysts said.

CUTTING SURGICALLY

UBS AG last year gutted much of its fixed income business and announced it was eliminating some 10,000 jobs. The move included closing its distressed-debt trading desk, which would require a lot more capital under new rules.

UBS is encouraged by the results so far, a company spokeswoman said.

So far, stock investors seem to be as well. Since the day before Credit Suisse announced the acceleration of its contraction plans in 2011, UBS shares have gained 65 percent, more than four times the 14 percent rise in Credit Suisse shares.

But rivals say they are more likely to follow Credit Suisse's strategy, which has been more surgical. In 2009, the bank set its initial course and disposed of businesses that most obviously would do badly in the new environment, such as trading with the bank's own money, and European commercial mortgage securities.

In November 2011, the bank cut deeper. It slashed capital for interest-rate and foreign exchange trading by 60 percent. It rushed out of low-revenue trades that ate up a good deal of capital because they were not backed by collateral and matured in 10 to 15 years, or more.

It looked closely at potential profits in businesses where it was long a laggard. In commodities trading, it ranked in the bottom tier among global banks. Consulting firm McKinsey said then that across Wall Street, the return on equity in commodities was poised to fall from around 20 percent pre-crisis to around 8 percent after new regulations are fully implemented.

Some decisions were particularly hard. De Boissard remembers the grief inside the bank, when his team could not offer a derivative to an Australian company that was looking to borrow in Swiss francs but pay its debt in Aussie dollars.

"You'd miss a big trade with a client and you'd naturally get people questioning whether we were doing the right thing," he said.

Some people in the bank were reluctant to adapt, de Boissard said. "I remember saying to people if you are not good at change, this would be a good time to get off of the platform."

But from the end of September 2011 through the end of September 2012, the company slashed risk-weighted assets, a key indicator of capital needs, by 43 percent in the fixed-income section of the investment bank. The moves, which included distributing some risky assets to employees as part of their compensation (a tactic Credit Suisse had used early in the crisis) almost immediately lifted returns.

In the first half of 2012, the investment banking segment of the company reported a return on regulatory capital, known as Basel 3 capital, of 12 percent compared with 8 percent a year earlier.

Those returns have edged higher since then, as the company continued shifting assets, although gains at this point are more incremental.

FOLLOWERS

Rivals have already shown signs of following Credit Suisse's strategy.

Deutsche Bank AG is in the process of deciding which businesses to continue after concluding that it must purge as much as 250 billion euros of assets, or 16 percent of total assets after adjusting for items like derivatives, to meet new bank safety rules.

JPMorgan Chase & Co is tuning up its business, albeit less radically. It decided in July to sell its physical commodities business after concluding profits were too slight to justify the demands the company would face from regulators to keep it. In September, JPMorgan said it will quit making loans to students.

Morgan Stanley has stepped back from many areas where it was once a big player, including trading secured bonds known as asset-backed securities, in favor of standardized products that trade on exchanges and require the bank to hold much less capital.

Many banks are unsure how many businesses may come roaring back as the economic cycle improves, and how many are permanently impaired.

Industry analyst Brad Hintz of Bernstein Research sees banks fighting "a war of attrition over the next three to five years," in their fixed-income trading businesses, he wrote in a report in September.

Another risk is that too many banks will all concentrate on the same businesses, squeezing out profits.

For example, competition is increasing in processing businesses, which require little capital because they entail moving money around the world for companies, governments and investors.

Outside of fixed-income trading, wealth management could feel its profits squeezed. Credit Suisse plans to commit the same amount of capital to private banking and wealth management as it does to investment banking. Right now, it applies less than two-thirds as much capital to its private wealth business.

The bank's chief financial officer, David Mathers, brushed aside those concerns on a conference call with investors last month. When asked if profit in private wealth management would fall, he said that customers care more about good service than rock-bottom costs, so the business would continue to be attractive.

(This story has been fixed to restore dropped words from quote in the 12th paragraph)

(Reporting by David Henry in New York and Katharina Bart in Zurich; Additional reporting by Edward Taylor in Frankfurt and Lauren Tara LaCapra in New York; Editing by Dan Wilchins and Grant McCool)

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