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23 octobre 2009

Credit Suisse : significant smoothing of fair value losses issued from the tightening of credit spreads on CS debt. Thanks to ?

The 2009 third quarter financial results show that quarter losses related to the evolution of Credit Suisse debt, ensuing from the tightening of credit spreads are almost completely offset by gains registered in the past quarters. These past gains, from the diminution of Credit Suisse debt, have resulted from the increase of credit spreads.

Indeed, a special off-balance transaction allows Credit Suisse to offset the losses incurred by the tightening of credit spreads for 553 millions CHF before tax for 3Q 2009.

The 22nd of October 2009, Credit Suisse announced a net income better than expected of 2,4 billion CHF for the third quarter of 2009, much better than expected.

Many press articles seem to comment on those results positively, attributing them partly to strong net asset inflows of 17 billion CHF in 3Q09.

In opposition to many comments in the press, Credit Suisse stock price fell the day these results were announced.

After some experience in studying the impact of credit spreads on bank's debts, I quickly noticed that figures both in the media release and the slides presentations were astonishingly low.

Historically, those pre tax impacts on Credit Suisse debt were, according to my calculations, the following : 2007 (+ 1,1 billion CHF), 2008 (+5,0 billion CHF), first quarter of 2009 (+0,7 billion CHF), second quarter of 2009 (-1,1 billion CHF).

As I foresaw (see my article of 29th July, in French though), I was expecting a substantial negative impact on third quarter results, in relation to what had occurred with the main US banks.

We have to read page 12 of the 116 page Financial Report carefully, to be made aware of some surprising information.

During the second quarter (indeed the second quarter !) of 2009, Credit Suisse entered into a secret transaction (if we consider the media release both Q2 and Q3 2009 and the slides presentation Q3 2009) named FVOD with a conduit named Alpine Securitization Corp.

I listened to the 1 hour and 40 minutes conference call, held on October 22 2009 by CEO Brady Dougan and CFO Renato Fassbind and no questions were asked relating to the transaction either during the presentation or during the questions answers session with the analysts. Surprising, when you know that a loss of 1,1 billion CHF was registered in the second quarter of 2009 while lower figures were disclosed in the third quarter results. How can this not be a major point for understanding progress between Q2 and Q3 ?

So what was the transaction for ? To reduce a significant portion of the volatility in credit spread movements on Credit Suisse vanilla debt.

Alpine is a multi-seller commercial paper conduit, which means Credit Suisse originated and structured the conduit. Besides, Credit Suisse administrates the entity. It is even rated triple A, or AAA by DBRS http://www.dbrs.com/research/230296/alpine-securitization-corp/dbrs-confirms-ratings-of-alpine-securitization-corp.html.

Losses before tax of 646 millions CHF should have been registered in 3rd quarter of 2009. These losses were in relation to the increase in value of Credit Suisse debt, resulting from the tightening of credit spreads which have however been offset by gains of 553 millions CHF, thanks to the FVOD transaction.

This transaction allows Credit Suisse to announce good income results that are not impacted by the increase of the valuation of its debt, in a period of better normalized market conditions.

A few hours after having published this article, I realized that the FVOD transaction had already had a significant impact on Q2 2009 financial statements : 3 744 M CHF of fair value losses were mostly offset by gains of 2 690 M CHF, resulting in a net charge from tightening of spreads on CS debt of 1,1 billion swiss francs. We are talking about pre tax impacts. Without Alpine (-2,7 billion CHF pre tax), net income of 1,6 billion CHF of Q2 2009 would have probably been a loss !

The second quarter impact went unnoticed first because I should have paid more attention, second because the negative impact in the second quarter of 2009 from tightening of spreads was still of size, with more than a billion CHF. Still I wrote in my 29th of July article that I did expect more losses on that relating to the credit spreads.

Credit Suisse report indicates that cumulated gains at the end of first quarter of 2009 (6,8 billion CHF according to my calculations, less the portion of debt that has been sold since) will be reversed and charged to the business segments on a straight-line amortization basis, and the difference between this amortization and the net impact on valuation adjustments on this CS debt, from changes in credit spreads, will be included in the Corporate Center.

The Q2 2009 press release remained mute on the Alpine and FVOD subject, whereas slide 7 of the presentation provides interesting information. The slide confirms the total of 6,9 billion CHF to be amortized, with approximately 300 million CHF of quarterly charges. Which makes a duration of almost 6 years of amortization.

To sum it up, Credit Suisse accounted the big gains at the peak of the financial crises (2008) and now smoothes the losses in almost 6 years of time !

If the mechanism were perfect, then the quarterly impact of tightening of spreads would be a 300 million CHF pre tax loss, which is not what we see, since Credit Suisse accounted a -1,1 billion CHF loss for Q2 2009 and -0,1 billion CHF loss for Q3 2009.

Comparisons between second and third quarters of 2009 cannot be relevant without paying close attention to the FVOD transaction, which is not really done in the presentations and press release.

Compared to Q2 2009, Q3 2009 benefits from a less negative impact on pre tax income of 1 billion CHF (-0,1 minus -1,1) from the tightening of credit spreads if smoothing had been perfect.

Without the FVOD transaction, pre tax income would have been lowered by 2,7 billion CHF for Q2 2009 and 0,6 billion CHF for Q3 2009, which in fact shows better results by 1,9 billion CHF in Q2 2009 compared to Q3 2009.

Which would not have been the same story.

Are Credit Suisse second and third quarter 2009 results really sincere that way ?

Finance is full of tricks !

Such conduits are frequently used and disclosed in the financial statements of the main US banks. Credit Suisse accounts are in US GAAP.

Off-balance is a well-known concept, maybe it would be time to talk about Off-income, in order to be clearer on what it does.

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