Credit Suisse Group AG (CS) 2013 Q2 法說會逐字稿

Good morning. This is the conference operator. Welcome and thank you for attending the Credit Suisse Group second quarter 2013 results conference call. As a reminder, all participants are in a listen-only mode and the conference is recorded. You will have the opportunity to ask questions directly after the presentation. (Operator Instructions). At this time I would like to turn the conference over to Mr. Brady Dougan, Chief Executive Officer of Credit Suisse Group. Please go ahead Mr. Dougan.

Welcome everybody. Thanks for joining us for our second quarter earnings call. I'm joined by David Mathers, our CFO, who will deliver the results portion of today's discussion. Before I begin, please take note of the cautionary statement.

Moving to slide four, we delivered solid results in the second quarter and for the first half of the year. Our business model is performing well, and we continue to make progress against our costs, capital and balance sheet targets. With an underlying after-tax return on equity of 13% for the first six months of the year and 10% for the quarter, we are currently generating one of the highest after-tax returns on equity in our peer group, with a very strong capital base and fully operating under Basel 3. Our results demonstrate consistency and resilience, even in the face of the more volatile market environment that we saw in the latter part of the quarter. This resilience further validates the effectiveness of our repositioned Basel-3-compliant business model.

As I mentioned on the first quarter call, and I think it's worth highlighting again, Switzerland was an early mover in defining its regulatory framework and rules, which required us to accelerate the transformation of our business. As a result we were one of the first global banks to reach full Basel 3 compliance. We are now able to spend the majority of our time and effort focused on advancing our client franchise rather than implementing changes to our business model. By contrast, many industry players continue to face numerous regulatory debates and are only now forced to make hard strategic decisions based on proposals that continue to evolve.

Before turning it over to David, I'll briefly review our financial performance and update you on the substantial progress we've made towards strategic targets. On all measures we're delivering ahead of where we planned to be at this stage.

First, on a reported basis, Credit Suisse Group delivered net income of CHF2.3b for the first six months of 2013 and CHF1b for the second quarter. On an underlying basis we reported an after tax return on equity of 13% for the first half of the year and 10% for the quarter, all while operating under the Basel 3 framework.

Turning to our divisional performance, in Private Banking & Wealth Management we achieved solid profitability in the second quarter with pre-tax income of CHF1b, excluding the UK withholding tax charge. Year over year we saw higher revenues in the second quarter driven by improved client activity and a pick-up in transaction fees. We also continue to show progress on the transformation of the division, and we are delivering on our previously announced expense initiatives. Excluding the UK withholding tax charge, our underlying operating expenses are down both year over year and sequentially, primarily driven by lower compensation expenses, resulting in an improved cost to income ratio of 69% for the second quarter.

Looking at gross margin, despite a continue low rate interest environment and further growth in the ultra-high-net-worth client segment, our gross margin in the Wealth Management clients business improved to 111 basis points from 109 basis points last quarter. This improvement was primarily driven by higher client activity and fee-based revenues. Wealth Management clients delivered net new assets of CHF7.5b, with solid inflows driven by strength in emerging markets.

Investment Banking also delivered a solid result in the second quarter, with reported revenues of CHF3.4b and pre-tax income of CHF754m. We achieved an 18% return on Basel 3 allocated capital for the first half of the year, which is double the 9% we reported in the first half of 2012, supporting our Group through the cycle ROE target of above 15%. These improved returns reflect continued market share momentum, a reduced cost base and lower capital usage. The results also reflected a balanced contribution across fixed income, equities and underwriting and advisory.

The second quarter environment was characterized by a strong April and May, followed by more challenging conditions in the latter part of the quarter due to market volatility resulting from rising interest rates. The resilient performance of the Investment Bank in this environment demonstrates the strength of our diversified business model and our significantly improved capital and operating efficiency.

Second, we continued to over-deliver on our cost, capital and balance sheet targets. We further executed on our expense initiatives in the second quarter, achieving CHF2.7b of annualized run rate cost savings versus the first half of 2011. Given our progress, we are on track to achieve our previously announced targets of CHF3.2b of expense reductions by year end 2013 and CHF4.4b by the end of 2015.

Next is balance sheet and leverage. Since the third quarter of 2012 we reduced our Swiss total exposure by CHF147b, and we expect to reduce by a further CHF70b by the end of the year. With these reductions we are on track to achieve our Swiss total exposure target, with a projected Swiss phase-in leverage ratio of around 4.5% by the end of the year, which is based on consensus net income and assumes the agreed upon exchange of Tier 1 hybrids into BCNs in October 2013.

And finally, capital. We further strengthened our capital base, improving our pro forma look-through Swiss core capital ratio from 9.8% at the end of the first quarter to 10.6% at the end of the second quarter, exceeding our 10% target for the middle of the year. Note that this ratio includes an accrual for a resumed cash dividend for 2013, assumed to be paid in 2014.

In summary, we achieved solid second quarter results, which demonstrate the continued performance and resilience of our business model and the significant progress we've made delivering on our cost, capital and balance sheet targets. Further, we achieved these results in spite of the more volatile market environment in June.

The transition to higher interest rates led in the latter part of the second quarter to increased market volatility and reduced client activity. And this market volatility continued in July, although more recently we've seen signs of stabilization in our major markets. In the longer term the transition to higher rates will benefit our business, both our Global Private Banking & Wealth Management franchise and our client-focused capital-efficient Investment Bank.

And with that I'll turn it over to David, who will review the results in more detail. David.

Thank you, Brady. Good morning. I'll start on slide six with an overview of the financial results.

In the second quarter we achieved revenues of CHF6.9b, pre-tax income of CHF1.5b and net income of CHF1b. Diluted earnings per share were CHF0.52, the cost to income ratio 77%, and the after-tax return on equity 10%. Net new asset inflows stood at CHF7.6b for the quarter and improved significantly compared to the CHF4.4b that we achieved in the second quarter of 2012. For the six month period, underlying pre-tax income was CHF3.6b, equivalent to an after-tax return on equity of 13%.

Let's turn to slide seven. The Private Banking & Wealth Management division reported solid profitability in the second quarter, driven by improved revenues and stable operating expenses. Adjusting for the UK withholding tax charge that we've previously disclosed, the division achieved pre-tax income of just over CHF1b with a cost to income ratio of 69%. Note that in the comparable quarter in 2012 the reported pre-tax income benefited from gains of CHF107m from business disposals that we completed in that quarter.

This pre-tax income of CHF1b compares to an underlying pre-tax income of CHF870m in the second quarter of last year. And this improved performance is primarily driven by a rise in revenues to CHF3.4b, reflecting improved client activity and consequently higher transaction- and performance-based revenues.

So let's turn to slide eight to discuss net new assets. We saw strong inflows of CHF12b in the second quarter, but against this we had outflows of CHF2.2b from Western Europe and CHF1b from certain asset management businesses that we've decided to exit. After eliminating CHF1.2b to adjust for double counting of assets managed by asset management on behalf of wealth management clients, we reported net new assets of CHF7.6b.

Our asset inflows in wealth management clients were driven by our operations in emerging markets, where we saw over 10% annualized growth from across all our major regions. We also saw continued strong momentum in Switzerland, with CHF3.4b inflows in the quarter. And we continue to grow the ultra-high-net-worth client segment, which delivered CHF4.2b of inflows in the second quarter. In the Americas strong inflows in Latin America were offset by outflows in the United States, reflecting both seasonal weakness and outflows from a small number of large customers.

Within asset management we achieved solid inflows of CHF2.5b driven by growth in alternative investments. And finally I'll note we saw modest outflows in corporate and institutional clients, and this primarily related to certain clients rebalancing their asset allocation away from indexed products and into cash, and therefore into custody deposits in this division.

So let's turn to the next slide. Slide nine looks at the total expenses for the Private Banking & Wealth Management division and outlines the progress we've made on our efficiency targets. During the second quarter we continued to deliver on our cost targets, and compared with the second quarter of 2012 we achieved CHF106m of run rate savings. This was primarily driven by the continued rationalization of front office and support areas as well as streamlining our offshore affluent client coverage model.

I'd note that our expense savings are partly offset by incremental costs directly linked to the high level of client activity and transactions, as well as incremental costs associated with a number of recent regulatory initiatives, including FATCA, the costs relating to the US issue and certain other cross-border issues. After taking these into consideration and again excluding the UK withholding tax charge, our operating expenses declined by CHF20m compared with the second quarter of last year.

Overall we remain on track to achieve an additional CHF750m of run rate savings by year end 2015. And looking to the second half of this year, we expect to generate an additional CHF150m through the impact of the previously announced divestitures within asset management as well as exits from a few small wealth management businesses; the continued streamlining of the Swiss client coverage model that we announced earlier this year; and not least, our exit from a number of small non-core markets within the wealth management client area.

Let's look now at the financial results in more detail, starting with wealth management clients on slide 10. The business delivered improved profitability compared to the second quarter of 2012, albeit this was offset by the CHF100m charge relating to the UK withholding tax agreement. Adjusting for this charge, pre-tax income was CHF629m compared to CHF551m in the same period last year. And this improvement was driven by higher transactional- and fee-based revenues with broadly stable operating expenses. And as a result the cost to income ratio improved to 72%.

Now let's look at the wealth management revenue trends in more detail on slide 11. If you look at this chart you can see that our gross margin of 111 basis points in the second quarter was an improvement from 109 basis points last quarter. And if we look at the three factors driving the improvement in gross margin compared to the first quarter, first, we have seen a pick-up in transaction based revenues, both in absolute terms and as a percentage of average assets under management. This reflects improving market conditions and increased client activity.

Second, we've also seen a pick-up in our absolute recurring revenues, reflecting the increase in average assets under management. But the gross margin on these assets at the recurring level remains stable.

Third, our net interest income has stabilized at higher level compared to the first quarter -- although, as we warned three months ago, net interest income is still lower compared to the same quarter last year. We did achieve some success in offsetting the adverse impact from low interest rates by a number of measures to protect that margin, including increasing loan volumes. If we look forward at our net interest income we would expect the second half to be roughly stable with that in the first half, which cumulatively is in line with the guidance we gave for 2013 against 2012.

Let's now turn to corporate and institutional clients on slide 12. We continued to see a strong contribution from corporate and institutional clients in the second quarter. Despite the low interest rate environment, pre-tax income was stable at CHF244m in the quarter compared to the second quarter of 2012. Both revenues and operating expenses were down year on year, and the cost to income ratio improved modestly to 49%. We posted higher provisions for credit losses during the second quarter. That was driven by a small number of isolated cases. Overall, however, our provisions remain low and reflect strong risk management and the continued high quality of the loan portfolio in this business.

Let's turn now to asset management on slide 13. The business posted underlying revenues of CHF556m, up 11% from the second quarter of last year. And this increase is primarily driven by higher carried interest on private equity realizations as well as higher asset management fees. Now please note that on a reported basis, revenues in the second quarter of last year, 2012, included gains of CHF66m from the sale of part of our stake in Aberdeen Asset Management. As a result of stronger underlying revenues in the second quarter, asset management's pre-tax income increased to CHF143m, up 93% from the second quarter of last year.

The business reported net new assets of CHF1.5b in the second quarter, and that included CHF2.7b of inflows, primarily from our alternatives business, offset by CHF1b of outflows from businesses that we've decided to exit.

Let's turn to slide 14. I'd like to take a brief moment just to provide an overview of the transformation of our Private Banking & Wealth Management division. Our initiatives are divided into three groups. First, we've brought focus to the division. We've integrated Clariden Leu. We've exited a significant number of small, non-core and loss-making markets, and we've divested a number of businesses no longer relevant to our strategy.

Second, we're optimizing the business. We've simplified the product offer to better align with client needs, we've streamlined the value chain by which we source and maintain the products and we've realigned our operations to adapt to changed requirements. Now these optimization efforts are underpinned by significant cost reduction and efficiency measures across the entire division.

Third, we're driving profitable revenue growth. And to do this we need to continue to leverage our market-leading business in Switzerland; to further grow our share of the ultra-high-net-worth segment, which is of increasing importance to us in emerging markets and as a source of revenues across the bank. And, not least, we see significant potential in developing our corporate and institutional client business, where it's highly aligned with our ultra high net worth business -- for example, the expansion of our financing efforts in the Asia Pacific region.

So let's now turn to the Investment Bank on slide 15. We delivered a solid second quarter result in the Investment Bank, with pre-tax income of CHF754m, more than double the profit achieved in the second quarter of last year. Year over year the increase in profitability was driven by a 24% increase in revenues, while simultaneously we reduced risk-weighted asset usage by $25b. The revenue contribution was balanced across all three businesses. We saw strong equities and underwriting performance, reflecting improved market conditions and the continued strength of our franchises. In fixed income we delivered resilient results, notwithstanding a decrease in client activity and higher volatility towards the end of the second quarter.

We also remain focused on cost efficiency, and our total reported expenses were stable compared to the first quarter. I'd note that as in the first quarter, our cost reductions were offset by certain litigation provisions, at a broadly similar level. Going forward we continue to expect additional cost savings, both from the direct cost base and from the savings we're looking to achieve and have achieved within the related infrastructure functions.

I'd note that in the first half of the year, we achieved an 18% after-tax return on Basel 3 allocated capital in this division, double the 9% we achieved in the first half of 2012.

Let's now turn to fixed income results on slide 16. We delivered resilient fixed income results in the second quarter with higher revenues, notwithstanding significantly lower risk-weighted assets as well as a reduction in the balance sheet employed by the business. Specifically, our fixed income revenues increased by 13% year on year, whilst RWAs declined by 18%.

The second quarter was characterized by strong trading results in April and May followed by more challenging conditions in the latter part of the quarter, reflecting the increase in market volatility resulting from the rise in interest rates. And this volatility had an adverse impact on client activity towards the end of the quarter.

Despite the market environment, we saw continued strength in our leading franchises. Within securitized products and credit, and I'd particularly highlight leverage finance, we delivered solid profitability and generated returns above the average for the Investment Bank. We also saw an improvement in FX and commodities, driven by higher volumes. This though was somewhat offset by emerging markets, which was adversely influenced by reduced financing activity and market volatility, and by continued low revenues in our rates business.

With that, let's turn to equities on slide 17. We achieved strong results in equities in the second quarter, with revenues increasing by nearly 25% year on year, notwithstanding the significant cost measures that we've taken in the business. And this combination of higher revenues and reduced costs drove higher profitability in the quarter.

Now if you look at our equities results in more detail, compared to second quarter of last year we delivered higher results in derivatives, driven by improved client activity and stronger trading results, particularly in Asia and in the United States. We also benefited from strong volumes in our market-leading cash equities business, both electronic and secondary. Lastly, we posted lower prime service results with continued strong revenues from prime brokerage, offset by reduced results in our equities financing business.

Let's now turn to underwriting and advisory on slide 18. We achieved strong second quarter results in our underwriting and advisory businesses. Year-on-year revenues increased by 45%, and again on a significantly lower cost base; and again, that drove improved profitability, particularly in Europe and Asia. Advisory fees were somewhat lower in the second quarter, reflecting reduced industry wide M&A volumes and some reduction in our market share. Overall, it was a strong quarter in debt underwriting, primarily due to the strong performance of our leveraged finance franchise. In equity underwriting, revenues doubled year over year, driven by substantially improved performance in the Americas.

Let's turn to slide 19 to review the capital allocation in the Investment Bank. So we include here our usual chart showing the market share in our major businesses compared to their return on capital. And as you may recall, the size of the bubble illustrates the amount of capital we have employed in each business area. Compared to the previous quarter you can see that the capital allocated to each business is consistent with that in the first quarter.

But we have significantly improved the return in cash equities, in derivatives and in banking products, reflecting both increased activity as well as the benefit of the cost measures we've implemented and I've referred to. Securitized products and credit continue to benefit from our strong market position and from a positive trading environment. We have seen some dilution in returns in prime services, reflecting the reduction in the equity financing business I mentioned before. And in addition, the environment for the emerging market business has been less favorable than in prior quarters. Lastly, as you can see, returns in our rates business remain low, and we intend to take further action to reduce the capital allocated to this business.

Let's now turn to slide 20 to review our progress to date in the Investment Bank. So since late 2011 we've made significant changes to our strategy and business in the Investment Bank. From a capital perspective, compared to peak levels in the third quarter of 2011 we've reduced risk-weighted assets in the investment bank by $112b. At the end of the second quarter, RWAs stood at $177b for the Investment Bank, within striking distance of our target of $175b by the end of the year.

Secondly, if you look at our balance sheet, year on year we've reduced total assets by nearly $100b and reduced total Swiss leverage exposure, so that's including the Basel 3 add-ons, by $150b. We've achieved our internal target to get our on balance sheet assets to under $600b, and we've made substantial progress towards our goal to reduce our Swiss leverage exposure to $840b by the end of 2013.

Third, on expenses we've substantially reduced our cost base, and we've already achieved the bulk of our CHF1.8b direct expense reduction target for the Investment Bank. Our cost to income ratio was 72% in the first half of 2013, improved from 82% in the first half of 2012. And obviously, we remain committed to achieving our target cost to income ratio of 70% through this cycle.

Not least, we continue to optimize our regional performance. Our Investment Banking operations in both APAC and EMEA have delivered significantly improved profits in the first half of 2013 compared to last year. And we now have a more balanced regional revenue contribution from a lower cost base.

Slide 21. This slide looks at the first half of 2013 and shows the improvement in our Basel 3 returns. Our overall return improved to 18%, double the 9% we achieved in the first half of 2012. The primary drivers of this increase include a 4% improvement from higher revenues coupled with a 3% improvement from lower RWA usage compared to 2012.

So let's turn now to the next section just to discuss our capital, funding, liquidity and progress on the expense initiatives. So, as you can see on slide 23, we achieved our year-end 2013 Group target to be under CHF285b of Basel 3 risk-weighted assets two quarters earlier than planned. Basel 3 RWA stood at CHF281b, down nearly 24% compared to the third quarter of 2011.

So let's move now to our capital ratios on slide 24. This slide shows the continued strength of our capital position and the progress we've made delivering on our capital targets. And we're pleased to report that our Swiss core capital ratio reached 10.4% at the end of the second quarter, an 80 basis point improvement from the level in the first quarter and exceeding the goal that we set out to achieve 10% by the middle of 2013.

Furthermore, on a pro forma basis we have an additional 20 basis points to come from the residual capital measures that we announced last July, lifting our ratio to 10.6%. And just to be specific on this point, I'd note that the CHF1.1b capital benefit that we had targeted last year to achieve through divestments, CHF0.6b has already been closed and is reported in these numbers in our reported capital. CHF0.4b has been announced but not yet closed, and clearly the largest contribution for that is the ETF business, the transaction which closed on July 1. And the remainder is on track for completion during 2013. And I think given where we currently stand, it seems increasingly likely that we'll exceed our original target.

Finally, as Brady mentioned, the 10.4% ratio and, for that matter, the 10.6% pro forma ratio, is after a deduction for a six months accrual towards a cash dividend for 2013, assumed to be payable in 2014.

So let me turn now to the balance sheet and the Swiss capital leverage ratio on slide 25. Let's start with the Swiss capital leverage requirement, which is based on the proposed Basel 3 rules. Now we've discussed this in detail in the last couple of quarters. However, just to summarize, the denominator of this ratio includes both on- and off-balance-sheet exposures. The numerator includes Basel 3 CET 1, Tier 1 preference shares otherwise known as Claudius, and high and low strike BCNs.

To start with the denominator, since the third quarter of 2012 we have reduced our total on and off balance sheet exposure by nearly CHF150b. Based on this progress to date, we reported a leverage ratio on a phase-in basis at 3.9% at the end of the second quarter. We remain confident we will achieve the additional CHF70b reduction in total exposure that we've targeted for the second half. And on that basis we project a phase-in leverage ratio increasing to around 4.5% at the end of the year. And that's based on consensus net income and factoring in the already agreed exchange of Tier 1 hybrids into BCNs this October.

Now on a look-through basis, so that reflects the full impact to the end 2019 requirements, our leverage ratio stood at 2.7% at the end of the second quarter. And that includes both high-trigger BCNs and the Tier 1 preference shares in the numerator. Now factoring in consensus net income again, as well as the agreed exchange of the hybrids into BCNs in October, we project this to increase to around 3.2% by the end of 2013.

Finally, just to be clear, the Swiss rules require the major banks to have a further low-trigger buffer capital layer in order to the high-strike CoCos. The amount depends on the FINMA's judgment of the resolvability of the bank and its importance and relevance to the Swiss economy, and that level is currently set at 4.4% of RWAs for Credit Suisse. You may recall the 6% number. The 4.4% is our current assessment from the FINMA on that basis. That implies a low trigger requirement of around CHF12b, and we intend to raise sufficient low-trigger buffer capital to meet this requirement well ahead of 2019, which will clearly lift our leverage ratio to over 4% on a look-through basis.

So let's turn to slide 26. We continued to make progress on our expense program in the quarter. As you know, we compare our operating expenses to the run rate cost base for the first half of 2011, which is when we initiated the program. In the second quarter of 2013, our annualized savings increased to CHF2.7b, up from CHF2.5b at the end of the first quarter. We remain focused on these initiatives, and we're on track to deliver our previously announced target of CHF3.2b of annualized savings by the end of 2013 and CHF4.4b by the end of 2015.

As you can see from this chart, quarter on quarter, we've reduced the expenses across infrastructure and shared services by a further CHF200m. And we're committed to delivering another CHF850m of cost reductions by 2015, largely through the continued consolidation of duplicate services as well as driving efficiencies through all of shared services and the other infrastructure functions.

Within the Private Banking & Wealth Management division our expense savings are partly offset by the incremental costs linked to the high level of client activity and transactions. But again, as we've outlined already, we're committed to delivering a further CHF150m of savings in the second [quarter] of 2013 within this division. We've made continued progress in the Investment Bank, albeit that again this was slightly offset by increased revenue expenses due to higher flow volumes in the second quarter. And we remain on track to meet or exceed the total targeted savings of CHF1.8b in the Investment Bank.

Let's now turn to funding and liquidity on slide 27. We continue to have one of the strongest funding and liquidity positions in the industry. At the end of the second quarter, our Basel 3 net stable funding ratio exceeded 100%, and we remain in excess of the short-term liquidity requirement under Swiss regulation, which uses a similar approach to the proposed Basel 3 liquidity coverage ratio or LCR.

So with that I'd like to conclude the results portion of today's presentation and hand back to Brady.

Yes, with that basically we will be ready to open up to questions now. So operator, you want to open up the line?

We will now begin the question and answer. (Operator Instructions). Your first question comes from the line of Matt Spick of Deutsche Bank.

Good morning. Just had a couple of questions on the Investment Bank. The first was on the fixed income result, which was maybe a little light versus some peers; and you did comment that your rates revenues stayed low, and I guess some peers maybe took advantage of the increase in rates volatility. And if you cut capital-type business on your slide 19, do you expect that bubble to move downwards as well as leftwards?

And I was also wondering, as you perhaps cut back on capital in the rates business, whether that would be a part of the reduced add-ons under your leverage ratio -- for example, rates derivatives under the current exposure methodology?

And I had a second leverage-ratio-related question to credit protection written. Could you make a general comment about credit protection written and how you hedge that? Is it mostly on a portfolio basis, or is it mostly by foreclosed [outer] positions? And do you think there's scope to change that over the next few years? Thanks.

Thanks for that. Maybe let me take the first part of your question, and maybe David can pick up the second. You know, I think in general we're actually very happy with the results in the second quarter in the Investment Bank. I think particularly, as you know, we're very focused on the return profile; and particularly, given the fairly full transition to Basel 3 that we've made, a 12% return in Investment Bank overall, we think that's actually a very strong return, particularly given conditions in the quarter. So, and obviously the majority of our capital is still in the fixed income business, so I think that indicates that the business is actually doing pretty well.

I think that, as you said, David, I think, went through a little bit of the detail in terms of the performance of the different businesses. Structured products and credit, we're quite strong. We saw more of an impact on the emerging markets business. FX and commodities were pretty good. Certainly the rates business was impacted for us; I think also we saw that across the industry.

I think, as you said, I think what's developing is that the rates business actually is increasingly being impacted by a lot of the regulatory changes that are coming through with a lot of the focus on leverage, etc. And I think there is -- I think it's actually something we're going to see in the industry as a whole is you're going to see more of an impact on the rates business. I think, as you mentioned, we certainly see that business, probably -- we see less capital in that business for us. But frankly, we think the industry-wide conditions are going to be such that it doesn't necessarily mean that we will lose market share there. And in fact I think we're going to see a pretty big change in the industry as a whole, which I think ultimately should be of relative benefit to us.

And we continue in various different parts of business in fixed income to be obviously very strong, and including even the rates business. Some of our client franchises are strong there, and there's some recent -- some of the Greenwich data recently showed us it's pretty strong there.

So I'm actually -- I think our view is that we're probably ahead of the curve in terms of having addressed some of the issues on the regulatory side, which probably has differentially impacted the business for now. But we think ultimately that could actually move in our favor. But there is no doubt that, as you said, the impact of -- as we do continue to transform that business, that is going to clearly contribute to the reduction in balance sheet that we are looking to make. So certainly it will have a positive impact on the leverage ratio.

The other thing I would just mention is, as you said, I think actually we stacked up pretty well versus the year ago quarter, not quite as well versus the first quarter. But we had a very strong first quarter, so I think that also contributed to it a little bit. So, David.

Yes, I think you also asked about the relative moves in the bubble. I think clearly as we reduce capital in the rates business -- and you'll see on page 33 that number came down by a couple of billion in the quarter -- we'll also be reducing the expense base there as well. So we would expect that bubble to actually move to the right rather than to the left going forward. And clearly part of that basically will also be the -- we will see some benefit from the move to central clearing, which will enable us to actually use our capital rather more efficiently under Basel 3 rules than in the past.

On the specific point around credit protection written, I think you're probably referring to the -- some of the draft rules which were published by the BCBS under their consultation paper, consultation which is open through September 20. I think we've mostly looked at that. I think clearly what those rules, if they are confirmed in the final document, which they may or may not be, but assuming they are, will require I think a much closer matching of your CDS position in terms of single name and also duration, and which we think is perfectly manageable within our existing targets and plans.

So I wouldn't expect -- I think it will require a slightly more specific management to your hedging approach. And I'm sure we and I'm sure other banks given that this Basel 3 leverage ratio is now going to be applied across the industry in '15, as well as obviously we've been under compliance since the beginning of this year, we'll be making those adjustments.

Thanks very much. That's helpful.

Thanks Matt. Next question.

Thank you. Your next question comes from Kinner Lakhani of Citi. Please go ahead.

Hi. Good morning. Just wanted to start by clarifying the CHF150m on slide nine of the presentation, the CHF150m of savings related to Private Banking & Wealth Management, is this meant to be a quarterly number, or is this an annualized run rate?

Then just wanted to follow up in terms of the pipeline of loans within the wealth management division. You've previously talked about potentially picking up more loans which would help the NII.

And then thirdly, just wanted to ask you on FHFA settlement. Clearly a number of financial institutions have started to settle. I just wanted to get a sense from you guys as to how you're looking at this and to what extent you have already provided for this. Thanks.

Thanks Kinner. Maybe I can start with the third and then David could maybe address the first two.

On the FHFA, as you say, obviously it's an issue that a number of banks have. Obviously, the process has begun, and some banks have announced that there have been some settlements there. I think obviously the specifics for each institution will be quite different, and what we look at is obviously the quality of the portfolio and the quality of performance on the portfolio, which is obviously an important aspect of it. And we feel like in our mortgage business, we actually cut back originations quite substantially in 2006. We feel like we were very rigorous around due diligence processes, etc. So we think that that is reflected actually in better performance of the portfolios.

But obviously these are issues that will be worked through. And clearly in terms of the FHFA and other matters, we clearly obviously review those on a quarterly basis and make sure that we're from an accounting point of view providing what's adequate against that. And we'll see with regard to timing and process around that how it develops. But I think, again I think from our point of view we clearly feel we're adequately positioned, and we'll see how that -- we'll see how the process moves forward in terms of timetable and result. David, you want to --

So just on the PB cost number, what we mean by that is -- obviously, we measure our cost savings against the annualized targets we're making. I think we've said we wanted to be at CHF750m, so I think what you'd expect is by the end of the year that when you look at that table we have later in the deck showing the total savings, that we'll have moved that down from CHF750m to CHF600m. So I guess that's, I think that's how I think about it. I think that means it's an annualized saving.

You may know, incidentally, that the headcount within the Private Banking & Wealth Management division actually did drop I think by about 600 heads in the reported numbers you see in the accounts. So I think that does show some of the progress we're making towards these cost goals.

And then there is the issue of the -- I mean on the --

Just on the pipeline in wealth management.

Yes, loans within the wealth management business, clearly that continues to be a big focus for us. It's an area that we are -- we continue to view as a big opportunity, and one that we are -- where we see a lot of upside in. I would say in the second quarter, I wouldn't say that we saw any significant increase in those numbers. But overall it's certainly an area that we see lot of opportunity in really in our franchise globally.

Great. Thanks.

Okay. Next question.

Thank you. Your next question comes from Kian Abouhossein of JP Morgan. Please go ahead.

Yes, hi. I've got a few questions. The first one is related to Basel 3, to the June document, the consultation document. Assuming that this is the final ruling, let's assume this is what's going to come, how would you get there? Is it more through alternative capital, or do you think you also would have to do additional asset reduction beyond what you announced to get to your Swiss Rules? That's the first question.

The second question is related to dividends. Clearly we have FHFA. We have other regulatory issues which are coming, leverage, etc., securitization, and so on. What is your thinking about dividend considering there is still a lot of uncertainty of how much capital you actually need to have to operate without knowing exactly your final risk-weighted assets, leverage numbers and litigation? Can you talk a little bit about your thinking? Should we think more conservatively about the dividend? Or once you're at the 10%, you will really see a material increase going forward as you go beyond the Basel 3 10% as we know it today under the current regime?

And then the third one is on IB cost base. Your IB cost base is flat quarter on quarter, and I'm just wondering if you can talk a little bit about cost flexibility. Why is it not coming down when revenues are coming down. Thanks.

Thanks. Let me -- maybe I can take the second portion first on dividends, and then maybe David can address the other two pieces of that. I think on dividends in general, as you know, so we've been fairly clear about what we've said. We hope to get to the 10% Swiss core capital ratio sometime in the middle of this year. Obviously we were pleased with the result of exceeding that pretty materially as of the end of the second quarter. We think that puts us in a strong place from a capital point of view. We had always said that having reached that, that we would be expecting to make material distributions to shareholders. None of that has changed.

Is there some uncertainty? I guess there is. Actually I think in our business model, there's a lot less uncertainty than you see in the industry as a whole. We basically are operating under Basel 3 now, as you say. Will there be some continuing adjustments? Yes, but I think our general view is that we're in very good shape against that. And no doubt, obviously there are other issues out there, but we do feel in general that we're obviously adequately provisioned against those matters. So I think our view is that we feel -- I think that we remain consistent in our guidance around where we thought we'd get to from a capital point of view and what the implications of that were from a dividend point of view. So I don't see anything really changing in that respect.

So then I think just in terms of the BCBS and leverage ratio documents, I think there's probably a couple of things here really. Firstly there was the BCBS consultation documents referred to before, which actually laid out some of the definition sets, which I think one of the previous questioners raised. And then secondly there's the requirement, the ratio you actually have to be at, which I don't think has really changed. Essentially the Basel rules say you have to be at 3% Tier I on a leverage ratio on that denominator.

Now the Swiss Rules are very much in parallel with that. What they actually require is that you're at 2.4% on a CT 1 ratio in 2019. The Swiss Rules then require that you have a further 0.7% of high-strike BCNs. And then, on top of that, you then have this requirement for the low-trigger buffer beyond that. Now the amount of the low-trigger buffer, as I said during the presentation, depends on FINMA's view of the resolvability of the major bank and its importance to the Swiss domestic economy. At the moment that's set at 4.41% of our RWA. So you may remember this is the infamous 6% you may remember from three years ago when the Rules came out. So the Swiss Rules essentially say 2.4% plus 0.7% then plus the low trigger gets you to about 4.2% at that point.

Now clearly where we are at the moment, and we included obviously both the summary slide in the main deck, but also there's a slide in the appendix which gets into the components of that, by the end of the year with that CHF70b reductions, then we would expect to be at about 2.2% on a CT 1. We then have Claudius, which actually counts as a Tier 1 instrument, and will in the United States for that matter, which actually gets you to about 2.5%. And then you have the high-trigger BCNs.

Now to be clear on that point, you may recall that in February 2011 we entered into a forward exchange agreement with both Olayan and the [QIH] to exchange their Tier 1 hybrids into Tier 1 BCNs. Some of that has converted already, but a remaining CHF3.8b will convert in October of this year, and that's a forward struck agreement. So by the end of October our high-trigger BCN buffer will actually go up to 0.7%. So that puts us at about 3.2% against that requirement under the Swiss Rules to be around the 3.1%. Now just to be very detailed on that, I think you may know that about CHF2.7b of those buffer capital notes were issued in a Tier 2 form. So that's compliant with Swiss rule, but that would basically bring you down to around the 3% plus/minus against the Basel rule.

So hopefully that's answered those questions. I guess the clear takeaway is that, one, we will be at or very close to the Swiss loss-absorbing capital leverage ratio, the 3.1% requirement, by the end of this year. Two, clearly we will look to issue our low-trigger buffer capital notes, up to around CHF12b, to actually meet that additional CHF1b well ahead of the 2019 requirement, which will push our leverage ratio up to about 4%, 4.2% in total. And clearly the third point is that that will obviously enable us to actually meet the Basel 3 requirement as well.

But it assumes Claudius is part of Basel 3.

It does, and it's a Tier 1 instrument; so I think if you look at the US rules, you would see how that's being treated. I think -- we haven't been mentioning Claudius. I think, as Brady talked about in terms of the dividend outlook, I think we are keen, as we've said before, now we've past the 10% Swiss rule capital target we set out a year ago, to make material distributions to our shareholders. So I think paying a cash dividend is important to us.

I think you know that we'd also like to redeem the first tranche of Claudius, which redemption falls due right at the end of this year, so either later this year or the beginning of next year. That clearly doesn't rule out that essentially we may choose to issue some of our buffer capital notes in the Tier 1 format to maintain the Tier 1 balance, but to be honest we're not under any particular pressure in that context.

I think your final question was really around the IB cost numbers. We did make progress in the second quarter, but it was offset by -- we had litigation provisions, again, at a similar level to what we saw in the first quarter, so same again. But we also saw some pick-up in commission expenses because of a, I think, both seasonally but also somewhat stronger equity performance. So that probably ran against the underlying cost measures we'd achieved. We're not that far away at CHF1.7b from the CHF1.8b we've set for the Investment Bank, but that's still a goal we're very much committed to. But clearly in terms of the bulk of the work, it's now shifting on more to the infrastructure and the Private Banking & Wealth Management divisions.

Okay. Thank you.

Thanks Kian. Next question.

Thank you. Your next question comes from Daniele Brupbacher of UBS. Please go ahead.

Good morning. Thank you. A bit of a technical question first. On page 70 and 67, just on the OCI movements, I found it quite interesting to see that it hasn't really changed much, particularly compared to some of the US peers, who saw a drop of anywhere between [$3b/$4b] or so during the quarter, which probably wasn't a surprise given the yield, the rate changes. How should I read this? Did you just trade well, or were you really short-term positioned, because obviously short-term rates haven't moved much? Just how should I look at this?

And then also note six, NII, NII very strong trading, very low rather in the quarter. Should I just add up these two positions? Because obviously trading assets NII was very strong, I guess, in the quarter. Just how I should read this. Is it possibly related to some dividend income in the trading book, or what is the reason behind that?

And then, sorry, just another technical question. IAS 19R, given the performance in the quarter, can you probably quantify the impact of this move on the Tier 1 ratio?

And lastly probably just on cost-cutting, the run rate has increased from CHF2.5b to CHF2.7b. It's probably a bit lower than what some people would have expected. Any specific reasons? You talked about it obviously, but are there any delays somewhere? Just some more color there would be helpful. Thanks.

Okay. Just taking those questions in order, so looking at OCI, yes, there weren't any particularly material moves in the quarter. You can see it was about CHF136m in the second quarter, most of which actually is in respect of the FX moves. There wasn't -- as you know, we run some hedging against our dollar balance sheet, our equity base -- not particularly material, because the currencies didn't actually change too much by quarter end, and that's then. So that's all it really is.

So why didn't you see the big impact you've seen in some of the US banks? Essentially because we have minimal available-for-sale treasury portfolios. We obviously do own substantial portfolios of government bonds, and various scrips and US treasuries as well. And those are nearly all marked at fair value and are hedged, essentially. We don't really have an open AFS-type position, which I think is what you may have seen in some of the US peers. And I think -- and perhaps that's where CS is a little bit different; the number is extremely small, and therefore we saw no material impact from that. Not good trading per se, but hedging on a fair-value basis. So that's how we actually run that portfolio.

Okay. Thank you.

Your next question then I think was around the details on page 80 and 81 of the accounts relating to the accounting disclosures for trading revenues and net interest income, so notes six and eight, is that correct?

Yes, note six, yes.

Yes, there's obviously been some moves there. I think, as ever, I'm afraid, and we've made this caveat before, the strict accounting disclosures about how you actually break down each of the products doesn't really relate that closely to businesses. So, for example, that interest rate product loss there, that's what you're seeing. It is part of the trade, not the full trade, because you're seeing hedging activity come through there. And then, as you say, the net interest income number was actually up from CHF2.4b to CHF3.7b. A lot of these, what you're really seeing is different components of the trade actually broken out in the financial accounts. So it doesn't really reflect a big loss in interest rates per se.

I think you can see from the slide, our revenues actually in the rates business per se were actually stable, but at low levels between the second and the first quarter, which is disappointing, but is stable basically. It's not reflecting any particular one-off losses, I'm afraid. But I think it's the usual problem just in terms of these accounting notes, just in terms of what you're actually seeing here is actually legs of trades and hedges.

Okay.

On IAS 19, now we're a US GAAP reporter. I think IAS 19 refers to the pension fund treatment?

Yes.

Yes, it was quite a good quarter. On our projections it hasn't really made much difference to our pension accounting so far in the year. Clearly if that continues through the year, we'd obviously be reassessing it, but nothing particularly material.

But a small positive impact is a fair assumption.

Yes, but not particularly material, really.

Yes.

Was that all of your points, Dan, or did I miss anything?

I think costs, just the CHF2.5b to CHF2.7b gross cost run rate -- is that any way to read this? Somehow driven by delays or something? You've talked about it, obviously, but is there any specific issues you could highlight? Just some more color there would be helpful.

Not really. We're kind of exactly bang on track. You can see the big move this quarter was really on the infrastructure programs. If you think about this in terms of phasing, clearly the IB moved first, and you saw the steps that were actually taken in the second half of 2011 really coming through into these numbers, and that's now the most advanced component. Still some more to do, still a considerable focus for us, but we've actually done quite a lot to substantially improve the cost/income ratio for that division over the course of the last two years.

Infrastructure then has very much been the second leg of that. The cost programs there are in -- very much in full flight. I think I've talked about those before in terms of what we're actually doing across the different shared service divisions, particularly in terms of actually integrating, at least in the costs, in our operations functions and in some of the technology functions.

And the private banking division -- the program there is still building. As I've referred to before, I think you can see the reduction in headcount in that division this quarter, which was notwithstanding, by the way, a significant number of campus hires that actually came into that number. Progress there, though, was clearly offset by the incremental regulatory costs we referred to, CHF23m; also some of the mix the business did result in an increase in revenue-related expenses, which actually offset it. I think that's why we want to be very clear, we're talking about CHF750m of savings in the private banking division. The extra CHF150m is something you'll see in the second half, Daniele.

Okay. Thank you.

Okay. Thanks. Next question.

Thank you. Your next question comes from the line of Huw van Steenis of Morgan Stanley. Please go ahead.

Good morning. Congrats on a very good set of results. Just two small ones. First, just going back to Kian's question on the costs in the Investment Bank, should we think that now with all the regulatory change we now have a much more fixed-cost model and therefore actually the CHF2.6b, less maybe a little bit of savings, is really the ongoing run rate?

And then number two, you've been very helpful in terms of regulatory development. Any update in terms of the foreign bank organization rules in the States or at least how you're anticipating potential rule changes there? Thanks.

I think in terms of the costs in the IB, clearly in the short term the move to, required by regulators, I think common across all banks, to a greater deferral does result in less comp-related flexibility in any short period. Clearly in the long term then you still have very substantial comp flexibility, but the fact you're actually generally -- deferral amortization is a larger part of your compensation cost does reduce that flexibility. There are though of course other costs which are variable. Litigation provision's relatively high for the last two quarters. Commission expenses will go up and down in terms of flow, though we are actually doing things to actually reduce that. So there's certain things there.

And the other point is of course when we talk about the CHF1.7b or CHF1.8b target for the direct expense of the Investment Bank, we're talking about the direct expenses. Now if you think about that, both the infrastructure number that you see on page 26, the CHF1.7b, the CHF1.65b total we have there, about 55% of those savings actually come through and are allocated to the program -- 45% goes to -- sorry, to the Investment Bank. 55% goes to Investment Bank. 45% goes to private bank. So the reported numbers will benefit from those infrastructure savings in both divisions and you'll see that coming through. So I think therefore hopefully that's answered the question reasonably fully actually Huw.

Yes, that's very helpful.

On the -- sorry.

Yes on the -- sorry. On the just on the issues in the US, obviously the rules continue to be discussed and will be -- and will presumably become closer to finalization. I think in general we feel like we've been in a better position against some of these issues given that we already have a subsidiary structure there. It's already capitalized etc. Obviously there may be some questions around locating some funding there. That could be small incremental costs, but that may be one outcome of it.

It's still obviously hard to know exactly where it's going to land, but I think in general we feel like we are in a manageable position versus that. It's not going to require any major changes, but it somewhat depends upon where it comes out. But based on where we see it going, range of potential outcomes, we feel like we're in pretty good shape against that. But David, I don't know if you want to add anything.

I think that that's definitely the case. We often get asked around liquidity requirements around the [IFC] rules. I think I've given that view over the last quarter in some of the meetings, but at the moment it looks like putting -- reserving more liquidity in the US entities could result in higher interest costs between of 30m and 50m in terms of our funding cost in the United States. So not nothing and clearly undesirable, but not that material in terms of our total interest bill.

Thanks very much.

Thanks Huw. Next question.

Thank you. Your next question comes from Fiona Swaffield of RBC. Please go ahead.

Hi. Good morning. I just had three areas. The first was the compensation ratio in Q2. I know we've talked about costs in the Investment Bank, but specifically that obviously moved up quite significantly and the comp was pretty static in spite of lower revenues, and I wondered if you could talk more about that.

The second issue was the issue of clients in the wealth management division. Are you seeing any increased risk appetite? I know you talked about transactions, but are there more structured products or anything. Is that why the recurring fee is going up? Clients as a percentage of cash or deposits, where are we now on their equity appetite etc? Thank you.

I think on the second question, maybe I'll take that and David can take your first. But, yes, I think in general the private banking client base tends to move more gradually I'd say. But I think certainly during the second quarter, as you can see in the results as well, I think our client base became more opportunistic around --- and that increased the transactional volume, increased, as you say, some of the managed product. We're encouraged by that. Obviously some of the volatility that we saw in June could obviously have an impact on that, but again it doesn't tend to mirror through immediately.

But I think in general cost -- I think cash portions of portfolios are down to around 30% now. And so -- which is down from where it was a year ago. So in general I think we're seeing encouraging signs that clients are becoming more opportunistic, but again how that develops through the rest of the year we'll see. David.

Just in terms of comp to revenue rates, I think, as we've said before, our accounting policy is to accrue relatively evenly through the year, so roughly 25% a quarter. So the ratio is really more a result, not something we actually target to. So in the first quarter, as you say, it was just under 38% and in the second quarter, for the Investment Bank that is, it's around 43%. Clearly if you compare to the same period last year, the ratio was 51% in the second quarter of last year. So it's fallen from 51% in the second quarter '12 to 43% this year. So that's more a mathematical result of how we look at it.

For the Group obviously the comp to revenue ratio was actually around 42% in the second quarter, up from 41%, but again basically it's slightly less than last year as well actually, Fiona.

Sorry could I just add the third question I forgot to ask? And that was the CHF12b you're talking about on the low trigger, how should we look at an incremental interest cost because I'm assuming there's some offset from other instruments you could retire or let mature?

Yes. So difficult to comment on pricing. Clearly it will depend on the exact structure of timing and the curve when we actually issue. So probably leave you to make a view on that one.

I think as we've said before, what we will see over the course to some extent this year but to a greater extent next year is that the funding costs for the bank will actually drop quite steeply. Now that reflects two factors. The first is a roll-off of a significant portion of senior debt that was actually issued in 2009/2010 at higher spreads than we've indicated today. Secondly, the retirement of a number of instruments we've already retired but now dropping through into a low-interest bill. And, thirdly, clearly if we do redeem half a tranche of Claudius, that's actually seven-eighths of the coupon, it's a relatively expensive Tier 1 instrument, so that would also benefit this as well.

So I think last quarter we were asked whether we think interest costs would actually drop next year. I think notwithstanding likely issuance we would still expect to see the interest costs of the Bank would be significantly down in 2014 compared to 2013.

Great. Thanks Fiona. Next question.

Thank you. Your next question comes from Jeremy Sigee of Barclays. Please go ahead.

Morning. Just a couple of quick follow-ups actually. So firstly did you say that the dividend accrual is CHF0.75 cash or is that a fair assumption?

And then the second question, I just wanted to come back on to the de-leveraging that you're targeting in the Investment Bank, the $909b, coming down to $840b. Could you just be a bit more specific about which areas you're shrinking? Is it all the repo book in the rates business for example? And also on what P&L give-up we should expect with that? Is there any material P&L impact or is it all fairly low-yielding stuff that you're going to shed?

Okay. So on the dividend, I think we can't really add to what we said already. We've not disclosed the accrual rate so far this year. Suffice to say, we do think making material distributions to our shareholders is important when one exceeds the 10%. That's part of our strategy and we therefore accrued for cash dividends in the first two quarters against that.

As for the sizing and dimension, I think all I can really say is obviously for the last couple of years we've paid CHF0.75 in either a cash, cash with scrip alternative, or a scrip and cash mix. So I guess that's history, but I don't think I can really add to our comments beyond that in terms of where we go for the full year. Clearly whatever we do get to has to be agreed with our Board and whether they choose to recommend it to the shareholders next spring basically. But we've not given a specific number beyond what we've said already about this.

I think the next question then was on the impact of the balance sheet reduction. I think it's certainly clear that a substantial portion of the load has actually come from reducing the rates balance sheet and particularly the repo usage within that, but we've also brought down some of the balance sheet usage within the prime service business. And I think it's fair to say, given the importance of both of those businesses to our balance sheet, both on and in total exposure terms, that that's probably not surprising there, the bulk of the balance sheet usage.

So I think we will see further reductions there but I think, to be clear, having reduced the total exposure by $150b, this is a fairly wide-ranging effort. We're looking at low-ROA assets across the entire bank to actually reduce those positions.

Now clearly these are not negative or zero ROA assets so I think there is some revenue impact from those balance sheet reductions. But I think there's certainly scope to optimize our balance sheet, to reallocate it to our more important clients. And I think certainly this program is revealing the scope for better optimization and allocation of the balance sheet between clients to actually mitigate that. But there definitely is some impact, Jeremy, in terms of a balance sheet reduction exercise.

Okay. Thank you.

Thanks Jeremy. Next question?

Thank you. Your next question comes from the line of Michael Helsby of Merrill Lynch. Please go ahead.

Thank you. Morning gentlemen. Two questions from me actually. You note a very strong DCM performance was driven by the leverage loans. Can you just tell us how much of the DCM revenue comes from that area, from high-yield, and can you also comment on the pipeline that you've got in that business? I'm just very conscious that issuance has fallen off a cliff at the back end of the quarter and into July in high-yield and in investment grade actually.

And second question, actually you've just touched on it, but if I look at slide 19 and I'm just looking at your bubble chart in the IB, I think if I was to recast that for total assets on a Basel 3 basis, then I'm assuming that rates and PB or prime services would expand very, very dramatically. Can you just give us a sense of that $909b in percentage terms, how much is actually tied up within the rates and the prime services business?

And if you could give any commentary on how much the rates revenue is. I appreciate you give us a macro split, but given that FX and rates are moving in different directions, if you could split that FX and rates number for us that would be very, very helpful, Thank you.

I'm just on your first question, Michael. Thanks for those questions. Yes, I think, as you said, clearly the fixed income new issue calendar dropped off sharply in June, not surprisingly. But it's also actually come back pretty quickly as well. So we actually have a fairly strong pipeline on the fixed income side and in high-yield as well, so it's actually returned fairly quickly. So again, whether market conditions will allow us to execute all that and on what timetable we'll see, but it's actually been a -- the pipeline has refilled actually fairly quickly there. So that's a positive.

I think your question about how much of the DCM is high-yield, I think we'd estimate probably greater than 75% was high-yield so it's obviously the majority.

In terms of the other question, you want to --

Yes, I think we've not really given a breakdown of the macro into its components before and I don't think we're going to start now in terms of that, so I'm sorry. Clearly our rates business is larger and more important than our FX business although obviously cyclically there's more of FX activity than there is rates, but in the long run you'd expect rates to dominate in terms of the size and resources we have against it.

I think you're asking me a threshold question, which at the moment the bubble chart obviously is based on 10% of RWAs and how would that look differently if we were to actually give that I guess on the basis of some percentage of the total exposure number. Again I don't think we're going to break down the total exposure number by business today, I'm afraid.

I think it's certainly true, if you looked at page 33, that the number probably would go up a little bit in terms of allocated equity from, if you take 10% of the numbers on 33, to some percentage of the rates number. And I think that comes back to the comment that Brady made before about some of the strategic and regulatory challenges to the rates business from the Basel 3 rules, which I think will be clearly partially mitigated as the industry moves towards central clearing and all this risk would actually go off balance sheet at that point.

Prime services, I think that would also be true. If we were to allocate 3%, say, or 2.4% of the total exposure balance sheet, most of it to prime services, that would result in a higher equity content than 10% of 13. However, of course the returns in that business are also very high already so I think it would be -- it's a much less challenged business in an economic sense. So I think that's probably about as far as I can go in terms of our disclosure at the moment.

Okay. Thank you.

Good. Thanks for your question. Next question.

Thank you. Your next question comes from Jon Peace at Nomura. Please go ahead.

Yes, thank you. I had two questions please about some of the guidance you've given in wealth management. So last quarter I think you told us that you expected gross margins to stabilize at around 110 basis points. Given the pick-up in client activity you referenced, would you be a bit more optimistic about that outlook now in the medium term?

And then the second question, also on wealth management, is that you've given us guidance of net new money of 3% to 4% over 2013 to 2015 because of the European outflows and then 6% in the longer term. But as you're creeping towards the higher end of that range this quarter again, do you feel a bit more confidence that you may get to a higher run rate a little bit sooner? Thank you.

I think on the first point in terms of gross margin, just to be clear, I think when we spoke at the end of the first quarter I think I warned that because of the impact of lower net interest income within the wealth management business relating -- for the reduced interest income we get from our [application] portfolio for our surplus deposits, that I would expect that to have an adverse impact on gross margins of, I think, 2 to 3 basis points which, if you work it out, comes out to around about CHF250m in terms of a lower interest receivable for the division.

Now clearly then you would caveat that saying that that would obviously be dependent on how successful we are in terms of building particularly (inaudible) volumes to actually boost our net interest income and, to a lesser extent -- because I think we've done as much as we can to basically protect the actual margins we're get on that.

I think it's certainly true we've been a little bit more successful in the second quarter actually boosting that which is why the net interest income actually went up second quarter against first quarter. But I don't think I want to go beyond that which is why I'm implying that our guess or our view basically for net interest income is probably for the full year roughly in line with twice the first half, give or take basically.

Secondly it's true that it's clear that the high transaction activity has actually boosted gross margins this quarter and clearly that's something we'd very much like to see continue.

I think on net new assets, difficult to add. Very pleased with the 10% growth in emerging markets; that's good. Probably a little bit disappointed that the Western European outflow, the CHF2.2b is bang in the middle of the CHF6b to CHF10b per annum range we actually gave at the end of the fourth quarter.

Okay, thank you.

Thanks Jon. Next question?

Thank you. Your next question comes from Christopher Wheeler of Mediobanca. Please go ahead.

Yes good morning. A couple of questions on wealth management first. Just looking at the obviously performance that was very good, the [26.9%], I think it was, pre-tax margin, excluding the CHF100m charge. Can you perhaps give us a clue as to what that might -- or what the drag on that perhaps is of the business in the US, because that's, what, 21% of your assets and I think the last time we spoke on this, David, it probably wasn't making any money, in a polite way. So can you give us a flavor for that?

And perhaps looking at the 65% cost/income ratio, what exactly do you build into that for what you're trying to do in that US business in trying to get it to perform more strongly or do something else with it.

The other question in wealth management is on the gross margin; again a good performance and I think the impressive thing is it's a good mix of improvement across the gross margin. Could you just talk a little bit about how that performed regionally on your four main reported regions in terms of what occurred in the quarter.

And then finally can we just put to bed the Claudius issue. We've talked about it being allowable in the United States and redeeming parts of it etc, but I just want to clear my mind. I thought everything I'd read in the SNB reports and your reports was that it would not count under Swiss laws for leverage after 2018. Am I missing something there? Thanks very much David -- and Brady.

So just to take them in order, I think we've been clear that we do in fact lose money in the US business, not that much but we do lose money in the US business. So clearly turning that business around would be highly positive to our gross margin. I think if we think about our target of a 55% cost/income ratio -- I'm sorry --

Pre-tax margin.

Pre-tax margin -- think about our target of 65% cost/income ratio that is clearly part of our plan together with the other cost savings we have, the CHF750m total, to make sure we actually achieve that 65% cost/income ratio and it's sustainably achieved.

I think in terms of --

Sorry, so is it fair to say that there's a -- that we can say there's probably at least 5% drag at the moment on what you're producing in terms of pre-tax margin. Is that in the ballpark?

I'm not sure I'd see it that way. The losses (inaudible) are 50m to 60m, let's be clear about that. I don't --

They're quite marginal; they're marginal.

It's marginal. (Inaudible) to turn around, clearly part of our strategy there is to make that business profitable.

Okay.

I think in terms of disclosure by region, I think we've given some numbers historically. Trends haven't really changed. I would merely note that within Asia Pacific we've seen particularly a pick-up in transactions and particularly in one bank activity; so (inaudible) collaboration there, that's been a really strong driver. I think that's been positive. I think Switzerland broadly stable; recurring up a bit. But not -- I can't really add too much. I don' think we've seen any noted deviations from what we've given before in terms of the regional mix,

And then on the Claudius issue it is indeed complicated. I think what we've said essentially is that under the (inaudible) rules Claudius counts until it actually is redeemed which will probably be in 2015 and obviously we've got the first tranche this year. And that is in fact how the Swiss leverage ratio is actually defined. I think we're merely saying that as a Tier 1 instrument this would probably count under the US definitions we've seen so far, not enormously relevant for us but as a contextual measure.

You're right, the SNB FSR report does a CET 1 plus high-strike buffer capital notes and that's where the difference. But Claudius definitely counts for the Swiss core capital requirements and for the leverage ratios until it's redeemed or I think 2017 in terms of its end date.

And I think we've been very clear about this in terms of our priorities, we do want to resume cash dividends, material cash dividends to our shareholders. It would make a lot of sense for us to actually redeem the first tranche of Claudius either late this year or in 2014, given that it does have a [seven-eighths] coupon basically and is not formally a buffer capital note.

Yes, thanks David. That's cleared that up. Thanks very much gentlemen.

Thanks very much. Next question?

Thank you. The next question comes from the line of Jernej Omahen of Goldman Sachs. Please go ahead.

Good morning from my side as well. I just have two questions left please. The first one is on the federal housing issue, so the FHFA. I was just wondering what the notional exposure is, i.e. what the notional value of this instrument that the litigation relates to. The last number we've got is CHF14.1b and I'm wondering whether that's still an accurate figure. I think it's from the end of last year, if I'm not mistaken.

And the second question I have is on page 25 which is again just on the leverage calculations. And there is -- it's probably my fault but I got a little bit lost with all the numbers and the different ratios. Can you just clarify one thing, the CHF1.258b risk capture measure that you show here as the denominator used for Swiss leverage exposure, what is that number. What is the comparable figure for the purposes of Basel 3 leverage calculation as it stands today, because I understand that you suggested that the Swiss leverage ratio is based on proposed Basel 3 rules, but I think obviously there's been substantial alterations since the Swiss leverage calculations were laid out last year.

And maybe just finally a very short question on the disclosure of standardized risk-weighted assets, since the volume is picking up on that front particularly in the US, but also a reminder, I guess, from the Swiss central bank with the national report that they would like banks to disclose this; how do you think about that. Thank you very much.

I think on your first question on the FHFA, yes I think the notional amount of bonds that were sold by us over the entire history was, I think, around the CHF14b number that you mentioned. More than half of those, I think, are completely redeemed and paid off. And I think, as you say, I'm not sure notional is that relevant. I think it's more relevant maybe what the actual loss is. So, for instance, our portfolio the actual losses like to date are around the CHF100m, plus or minus, on that. So I think obviously the quality of the portfolio is also something that's going to be important, but as we say that's obviously got further to play out.

David, on the leverage calculation?

So the leverage calculation, the number you see there of CHF1.258b, CHF920b which is on balance sheet, CHF338b was the various add-ons. The question really is does the BCBS consultation paper make a substantial difference to that and obviously you get that discretion around CDS (inaudible) and how that's actually treated. I think our assessment of that is that it will not materially change the current number on the basis of the consultation documents being proposed today. Clearly we'll see what comes in the final document which, I guess, could be more aggressive or less aggressive when that comes out, I guess, later in the year or early next year.

But I think, to be clear, that FINMA has always wanted a Basel 3 type regime and that's the basis on which they've actually asked the Swiss banks to actually report their leverage ratio numbers so far this year.

Alright. So the 2.7% figure that you mentioned is essentially also, in your view, a Basel 3 leverage ratio figure spot i.e. today?

Yes I think that's pretty fair. What I could just say is that the Swiss leverage def is a relatively close approximation to the Basel rules as they're understood today. And clearly the rules can change.

Yes, thanks a lot.

I think on the standardization of RWA, I think really what I'd say, the concept of standard model is a little less understood. Some standard models are [closed] to risk, some are very outdated. I think what we would like to see is greater standardization and harmonization of models and parameters across the industry. I think that would be a logical step forward in terms of that and we'll see if that's the way this goes.

Operator -- thanks very much for that question. Sorry, operator, I think we're going to have to close the call now. I think we have actually a couple of remaining questions, so I apologize to those of you who were in queue to ask, but we do have to move on to a -- we have a media call that we have to go to. So I greatly apologize for that, but just to quickly summarize.

The results for the second quarter and the first half demonstrate that our transformed business model is performing well. We're making continued progress towards our cost, capital, balance sheet and leverage targets. And, despite a more volatile operating environment, we achieved resilient results across our businesses, delivered against our strategic targets and generated one of the highest ROEs in our peer group. And, finally, over the long term our business model is well-positioned to benefit from a rising interest rate environment and will continue to deliver superior returns to shareholders. So thank you all very much for your time and your attention.