DBRS Downgrades Credit Suisse AG to A, Trend Stable

DBRS, Inc. (DBRS) has today downgraded the Senior Unsecured Long-Term Debt rating of Credit Suisse Group AG (Credit Suisse of the Group), the top-level holding company, to A (low) from “A”, and the Senior Unsecured Debt & Deposits rating of Credit Suisse AG (the Bank), the main operating subsidiary of the Group, to “A” from A (high). The trend on all ratings is Stable. The Bank’s Intrinsic Assessment was also revised to “A” from A (high). These rating actions follow a detailed review of the Group’s operating results, financial fundamentals and future prospects.

The downgrade takes into account the high level of execution risk associated with the Group’s new strategic initiatives, which will further pressure earnings in a challenging market environment and limit Credit Suisse’s ability to generate capital internally, as well as DBRS’s concerns about the Group’s risk management systems and controls, following the disclosure of sizeable illiquid inventory positions in March 2016. In DBRS’s view, senior management’s acknowledgement that they were previously unaware of holding such levels of illiquid inventories, raises serious questions about the Group’s ability to monitor and manage the risks across its large and complex franchise. The related write-downs have been sizable, contributing to the pressure on Credit Suisse’s earnings.

The Stable trend reflects DBRS’s view that the ratings are now well-placed at the current level. Supporting the current rating level is the overall strength of Credit Suisse’s franchise, which is underpinned by a leading position in private wealth management globally and a domestic Swiss business, with strong market shares, combined with its solid funding and liquidity profile. DBRS expects that management will work to remedy any risk management deficiencies in a timely fashion, while also working to implement a strong risk culture across the organization.

Upward pressure on the rating is unlikely in the medium term, but could arise over the longer-term if Credit Suisse demonstrates progress in successfully executing on its strategic initiatives, by meeting targets related to cost reductions, pre-tax income and increased capitalisation. On the other hand, downward pressure could be driven by Credit Suisse’s inability to achieve targets, or any indication that the restructuring task is negatively impacting the overall strength of the Group’s franchise. Downward pressure could also arise if DBRS perceives that Credit Suisse’s risk profile is being detrimentally impacted by its expansion efforts, particularly in Asia Pacific and other emerging markets, in an effort to meet ambitious profitability targets.

Credit Suisse’s restructuring plan, which was initiated in October 2015, and updated in March 2016, includes an approximate 20% reduction in the Group’s cost base to below CHF 18 billion by 2018. This is to be achieved in part by CHF 4.3 billion of gross cost savings, of which CHF 1.6 billion will come from the accelerated run-down of legacy portfolios in the Special Resolution Unit and disposals and business exits (predominantly in Global Markets and Investment Banking & Capital Markets) with a further CHF 1.9 billion to come from the substantial completion of major programs, including regulatory projects, as well as efficiencies from work-force strategy and London right-sizing. The Group is anticipating restructuring charges of CHF 1.6 billion to carry out all of the cost reductions. With restructuring costs expected to be frontloaded in 2016, along with additional litigation charges relating most notably to the Group’s US residential mortgage-backed securities (RMBS) activities, and the accelerated wind-down of the Group’s legacy portfolios, DBRS anticipates that Credit Suisse’s earnings will remain significantly pressured over the next 12-24 months.

Whilst many areas of Credit Suisse’s risk management have functioned effectively in recent years, deficiencies became evident with the recent disclosure of the build-up of illiquid inventory positions that are outside the Group’s risk appetite. This build-up became evident to senior management with the challenging market environment in the recent months that resulted in sizable write-downs on these positions. DBRS expected that systems and processes would have been improved post-crisis to monitor this kind of build-up and a risk culture implemented that is supportive of conservatively marking to market positions and reducing outsized exposures. Credit Suisse reported CHF 633 million of write-downs for illiquid inventory positions in 4Q15, and CHF 346 million in the year to March 11, 2016. Operational risk also continues to be a challenge, with the Group’s estimate of the aggregate range of reasonable possible losses for operational risk issues that are not covered by existing provisions totaling between zero and CHF 2.2 billion at end-2015.

Credit Suisse maintains a solid funding and liquidity profile, with conservative asset/liability management underpinned by a long-term funding profile that includes a large deposit base. The Group also maintains a highly liquid balance sheet, of which 23% was match funded at end-2015, as well as a sizable liquidity pool that is sized to cover expected outflows in a stressed scenario. However, wholesale markets remain challenged, with wider spreads driving higher funding costs making incremental debt issuances more expensive. Whilst Credit Suisse’s funding and liquidity profile remains solid, DBRS will continue to monitor how current market concerns impact the Group.

Credit Suisse has made good progress in improving both its capital and leverage positions through the completion of its CHF 4.7 billion rights issue, and CHF 1.35 billion private placement in October 2015. Despite this, the fully-loaded regulatory capital and leverage ratios remain towards the low end of the global peer group range, with Credit Suisse reporting a fully-loaded Basel III Common Equity Tier 1 (CET1) ratio of 11.4% at end-2015, and a fully-loaded Basel III leverage ratio of 3.3%. The Group has outlined a number of steps, including asset disposals and leverage exposure reductions, which should support increases in both regulatory capital and leverage ratios. Credit Suisse is also targeting a minority stake IPO of its Swiss banking subsidiary, Credit Suisse (Schweiz) AG, which could result in a further CHF 2-4 billion of capital. Whilst DBRS views this step as ceding a portion of earnings and adding the complexity of external shareholders in an important banking subsidiary, it also recognises that this action, along with other management actions, which could add another CHF 1 billion of capital, should contribute to improved capitalisation. With internal capital generation likely to be challenged over the next two years, achieving these additional steps will be crucial for the Group.

Notes:
All figures are in CHF unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (December 2015). Other methodologies used include the DBRS Criteria: Support Assessment for Banks and Banking Organisations (March 2016), and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2016). These can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is an unsolicited rating. The credit rating was not initiated at the request of the issuer.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Lisa Kwasnowski
Rating Committee Chair: Alan G. Reid
Initial Rating Date: September 13, 2006
Most Recent Rating Update: September 29, 2015

Information regarding DBRS ratings, including definitions, policies and methodologies are available on www.dbrs.com.