On the Edge at Credit Suisse

Will a radical new strategy save the day for CEO Lukas Mühlemann?

Lukas Mühlemann is a man under siege. On July 2, board members at the Credit Suisse Group gathered in Zurich to discuss his strategy and performance--and decide whether to keep him as chairman and chief executive. The 11-member board was unnerved by the 11% slide in Credit Suisse's stock price on June 24 after the group was forced to pour $1.3 billion of fresh capital into Winterthur, its money-losing insurance division. All told, the group's shares have fallen almost 35% this year, making it the worst-performing big-bank stock in the U.S. or Europe.

As BusinessWeek went to press, it was unclear what action the board would take--whether to order a major restructuring and change of leadership, or stay the course. But whatever happens Mühlemann--or his successor--has a crisis on his hands. Credit Suisse's profits are dismal, its capital ratios are falling, its credit rating is slipping, and staff morale is plunging. In the first quarter, the company made just $237 million on operating income of $5.37 billion, barely a quarter of the profit it reported in the same period last year. Archrival UBS, by contrast, rang up a first-quarter profit of $878 million. For the year, Credit Suisse is expected to earn just $1.22 billion on revenue of $22.48 billion, forecasts Guido Hoymann of Metzler Bank, a private bank in Frankfurt. That's only a slight improvement on last year's lackluster performance. "Mühlemann's strategy just isn't working," says Hoymann. Indeed, when word started circulating on July 1 that he might be forced out, the group's stock rose more than 3%, only to fall back by more than 4% the following day.

The former McKinsey & Co. consultant, who is 52, is trying to convince his board members that, given time and a market upturn, he can turn the group around and successfully merge banking, insurance, and investment banking in one group. But nervousness over his stewardship persists. And two possible successors are said to be waiting in the wings. One is Walter B. Kielholz, 51, the chief executive of Swiss Re, a reinsurance company and Mühlemann's alma mater. Kielholz is also a member of the Credit Suisse board. The other potential replacement is Oswald J. Grübel, 59, the former head of Credit Suisse's successful private-banking operation.

Reviving Credit Suisse will not be easy. But supporters say Mühlemann, who became CEO in 1997 and chairman in 2000, has already made a start at Credit Suisse First Boston, the group's money-losing investment-banking operation. There, John J. Mack, the CEO Mühlemann hired last July, has wrung $1.5 billion out of its bloated costs. As a result, CSFB narrowed its loss from $939 million in the final quarter of 2001 to $19 million in this year's first quarter. It also captured top place in the global mergers-and-acquisitions league tables for the first half of the year. "CSFB is on a good track again, and we think it has all it takes to be one of the top global players," Mühlemann told BusinessWeek in a June 26 interview.

But the problems at Credit Suisse, the world's 11th-largest banking company, go far beyond CSFB. First and foremost, there's Winterthur, the life-and-casualty insurer that Mühlemann bought. Winterthur surprised analysts by reporting a $140 million loss in the first quarter after its investment income plunged by more than 80%. Falling equity markets in May and June might have cost Winterthur Insurance an additional $1.1 billion to $1.5 billion in lost returns, according to Schroder Salomon Smith Barney. That's a double hit because Swiss insurers must guarantee 4% returns to life-insurance policyholders. So on June 20, Mühlemann injected $1.3 billion of capital into the insurer to bolster its reserves. "They bought Winterthur to balance CSFB and diversify their risk, but it has ended up intensifying it," says Derek Chambers, an analyst who follows the group for HSBC Securities Inc.

Meanwhile, some investors are fretting over the group's shrinking capital base. The group's ratio of equity to total assets had slipped from 12% in 1998 to 9% in the first quarter of this year. That could drop an additional 50 basis points because of the problems at Winterthur. This level would still be above the 4% legal minimum, but such a slip in a blue-chip institution leaves investors rattled. The shareholder's equity in the $713-billion-in-assets group has fallen by more than 11%, to $26 billion, since March of last year.

As if that's not enough, ratings agency Standard & Poor's downgraded the group's long-term debt from AA- to A+ in May, making it more expensive for Credit Suisse to raise money. "We doubt they'll be able to earn decent profits and strengthen their balance sheet in the near term," says Peter Dutton, who follows the bank for S&P.

To be sure, parts of Credit Suisse are doing well. The private-banking business is thriving. So are the corporate and retail operations in Switzerland. And while total assets under management dipped slightly, to $940 billion, in the first quarter, the group is outperforming most rivals on the money-management front. Mühlemann is sure that even Winterthur can be put right. "The underlying performance of the insurance business is good," he insists. "Everyone has problems with their investment portfolio. Ours are just more noticeable because we're the only Swiss insurer that publishes quarterly figures."

There's no denying that Mühlemann has a track record of meeting challenges. Before joining Credit Suisse, he transformed Swiss Re into one of the world's most dynamic financial companies. He steered the group through the Russian crisis of 1998 when CSFB and its clients were the largest holders of Russian Treasury bills and government bonds. And Mühlemann is continuing to cut costs. In Switzerland, for example, he announced plans on June 12 to trim 500 staff by reorganizing the private- and retail-banking operations. "He's capable of putting out these fires," says a board member from a rival bank.

The larger question is whether Mühlemann's strategy will survive. Observers say Credit Suisse seems increasingly likely to dump Winterthur, ending Mühlemann's fling with bancassurance--a single institution selling insurance and banking products. This rarely works in practice. Besides, Winterthur isn't big enough to compete effectively with rival insurers, the critics say. "I'm not convinced that Winterthur belongs to their core business," says Christoph Ritschard, a banking analyst at Zürchner Kantonalbank. Mühlemann doesn't agree. "But no strategy is ever unshakable," he says.

Whatever happens, a speedy recovery for the group looks unlikely. Schroder Salomon Smith Barney analyst Ronit Ghose thinks Credit Suisse was lucky if it made any profit at all in the second quarter, largely because of the deteriorating situation at Winterthur. Unless things improve and fast, institutional investors, which include corporate gadfly Martin Ebner, whose BZ Group Holding has a 7.2% stake, will take their revenge. Swiss banking used to be a dull and predictable business. Investors would love to have some of that boredom back.

By David Fairlamb in Zurich

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