Friday, 22 June 2018

Wounded giants

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If the worst banking crisis in recent memory and the biggest trading scandal in France’s history were not enough to force consolidation among the country’s investment banks, then it is hard to imagine what will, writes David Rothnie.

Market leaders BNP Paribas and Societe Generale, along with smaller rivals Natixis and Calyon, have enjoyed differing fortunes since the credit crisis began. It appeared SG might be first to fall in January, when it uncovered a €4.9bn trading scandal and lay the blame at the door of Jerome Kerviel. In the days that followed, most observers expected SG to be acquired, with arch-rival BNP Paribas named as the frontrunner.

In the event, SG was probably saved by adverse market conditions and a French President unwilling to sanction the inevitable job losses that would have resulted from an all-French tie-up. Banks appeared to have had their fill of acquisitions. The bid battle for Dutch bank ABN Amro had only just finished, and the perception was that the winning bidder, Royal Bank of Scotland, had scored a pyrrhic victory with its massive cash bid in the middle of the credit crisis. No bank had the stomach and few the resources, to launch a bid and besides, chief executives were more interested in assessing the damage in their own trading books than carrying out due diligence on others. One of the few banks with the firepower was BNP Paribas, SG’s bitter rival. Despite weeks of speculation, no bid materialised, and SG set about repairing its reputation following a successful emergency rights issue.

SG’s smaller rivals Calyon and Natixis have failed to exploit its weakness because of problems of their own, with both recording massive losses. Calyon’s CEO Marc Litzler – one of the derivatives wizards who shot to fame at SG – resigned in May, as his division lost €795m (US$1.2bn) in the first three months of the year. The French bank said it was forced to take a further €646m of writedowns against its credit holdings. Both Calyon and Natixis have taken further losses.

Litzler was soon joined by former colleague Jean-Pierre Mustier, who stepped down as head of corporate and investment banking. France has an unrivalled reputation for producing top equity derivatives bankers, and the departures of Mustier and Litzler represent a blow to its pride.

Before the credit crisis took hold, the biggest challenge facing the four French banks was the continuation of their international expansion. Calyon and Natixis have since retrenched and will spend the rest of the year cutting costs and implementing new strategies. This leaves the two market leaders, BNP Paribas and SG, fighting to deliver on their strategic promise of further international expansion and cross-selling.

Your loss, my gain

BNP Paribas, France’s biggest bank by market value, fell under the spotlight when the credit crisis reached Europe last summer, after suspending valuations of three investment funds it managed, citing the impossibility of valuing the underlying assets with the ABS market closed. Since then, BNP Paribas has proved one of the banks least affected by the crisis. Along with Goldman Sachs, BNP Paribas is the only investment bank not to have made a quarterly loss since the crisis began. Jacques D’Estais, head of corporate and investment banking at BNP Paribas said: “A year ago, we held an investor day where we outlined our strategy and our aims have not changed. We have not had to re-think our business model.” However, the bank abandoned targets set this year for its investment banking business, saying “visibility” was too low given challenging financial market conditions. The bank said during the first quarter that its CIB business would surpass the record €8.3bn revenues of 2007.

The CIB business rebounded in the second quarter, when revenues of €1.9bn were down 24.5% compared to the record level in the second quarter 2007, but up 41.3% compared to the first quarter 2008.

The bank took a €542m hit to cover counterparty risk to monoline insurers, which sent revenues in the fixed income business spiralling to €389m, although the bank said it posted record revenues in interest rates, foreign exchange and commodities.

The financing business posted record revenues of €713m, after falls in leveraged finance had been offset by gains in its acquisition finance, commodities and energy finance businesses. The bank was involved on the year’s biggest contested takeover, providing financing to Belgian brewer Inbev on its $53bn acquisition of Anheuser Busch. The bank’s equity and advisory unit saw revenues fall 9% to €750m following the bank’s move into the flow business.

Given its position of relative strength, BNP Paribas should be judged on its ability to win market share across all business lines. But the bank also has a reputation for caution, particularly outside France. Several of its London-based corporate financiers have expressed hope that its strength would lead to greater commitments to non-French clients. They have been disappointed: a conservative attitude reigns in Paris. “The cost of cash has increased massively and that is here to stay,” said D’Estais. “In the credit markets many banks are closed for business but we are still doing business. However, we will only do so at the right price.”

It has maintained its strength in European loans, where it is ranked second. Its market share has risen from 7.2% last year to 8.7% in the first eight months of 2008, according to data from Thomson Reuters. The bank had its best year in European M&A last year, ending in 12th position with a 17% market share. This year, the bank has 6% of the market, falling from 10th to 17th in the European ECM rankings.

The bank has not made massive job cuts: D’Estais said redundancies are in the hundreds rather than the thousands. In July BNP Paribas reorganised its investment banking business, in a move that some thought was a direct response to the credit crisis – something the bank refutes: “This reorganisation has nothing to do with the credit crisis as we decided on it more than a year ago. We have had the same organisational structure since the merger ten years ago,” said D’Estais.

The most important aspect of the reorganisation is the creation of a single coverage unit for its biggest clients, so its bankers can sell multiple products, said D’Estais. At last year’s investor day the bank said it would build up in derivatives, structured finance and emerging markets, namely China, India, the Middle East and Russia.

Earlier this year, it acquired a prime brokerage business from bank of America, while it is also considering buying a brokerage in Russia and setting up a joint venture in China. In India, it has taken an organic approach. D’Estais declined to comment on recent reports that the bank is poised to make a big acquisition in Russia, although with BNP Paribas in relatively good shape, it is one of the few banks that can afford to do deals.

The fight back continues

It is an indication of the torrid times being experienced in Societe Generale’s corporate and investment banking business that last month it found cause for optimism in its €186m second quarter loss. The result beat analysts’ expectations, showing its business is intact despite discovering a €4.9bn trading scandal in January.

The loss was only the division’s second in the last decade, and was less dramatic than the €3.9bn reverse it assigned to Q4 2007, following the detection of an alleged trading fraud by Jerome Kerviel in January.

After returning to profit at the start of this year, the division fell to a loss in the second quarter and was €47m in the red for the first six months, compared with a €1.4bn profit for the first half last year.

The bulk of the €1bn writedowns came from exotic credit derivatives, monoline insurers and European asset-backed securities and hit SG’s fixed income, currencies and commodities unit. These drove net revenues in the business down 92% from Q2 last year to just €48m. Equities revenues fell a third – to €703m – partly due to €68m of valuation cuts. The financing and advisory business slipped to a €88m loss from a €449m profit last year, after a €501m cut in the mark-to-market value of the credit default swap portfolio.

So far, SG has won plaudits for its ‘fighting back’ initiative, which involves investing €100m ($157m) over the next two years in operational and risk management functions, revamping its risk management systems and consulting with all of its clients to repair the damage to its reputation.

While SG strives to move on from the scandal, the probe has deepened. Last month, French prosecutors placed Kerviel’s assistant under formal investigation, deepening the probe into one of Europe's biggest-ever corporate scandals.

The investment bank will come under the spotlight again this month when Jean-Pierre Mustier, who resigned as chief executive of SG CIB in May, formally hands over the reins to Michel Perétié, the former head of Bear Stearns International. Perétié has been at the bank for the last three months, but he will start to stamp his authority on the division once Mustier has left. Perétié is a relative outsider, having previously worked for Banque Paribas, and he will enter a culture that has been founded on the bank promoting from within.

Despite the losses in the second quarter, SG is keen to stress the health of its corporate and investment banking business model. Jean-Francois Mazaud, deputy global head of capital raising and financing, said: "We have maintained our leadership position in French DCM and ECM, and have kept a top five position worldwide, which equates to a 6% market share for all euro-denominated bonds, whatever the issuer and the bond format, despite the fraud and in a very challenging market environment. We take this as a strong sign of confidence of our clients. This shows as well the resilience of our capital markets franchise, whatever weather conditions.”

Like BNP Paribas, cross-selling and expansion in emerging markets are the watchwords for SG. It is moving two of its bankers from Europe to Asia to launch a local DCM presence. SG is also keen on the Indian market: last year it established an investment banking joint venture with local broker Ambit.

The bank is also developing its business in the Middle East, where it is taking a steady approach. "We have a small team working on a small number of accounts, which will not exceed 10 corporates and 10-15 financial institutions," said Mazaud.

SG is confident it can make more of an impact in the covered bond rankings. Mazaud said: "We have made strong progress in this field over the last year. We entered the top five and won interesting awards in this field. The investment made both on the primary and on the secondary side should allow us to maintain this leading presence over the long run."

SG has two fight-backs on its hands. The first is to regain the trust of its clients, while the second is to regain ground on BNP Paribas. “Apart from our rankings, our efforts in the months to come will be put at integrating further our debt and equity offer to the benefit of our issuer clients,” said Mazaud. “Volatile market conditions require a stronger fluidity across funding solutions, be it straight bonds, loans, straight equity, equity linked or equity derivatives instruments, and we want to fully reflect that in our advisory approach."

Retrenching amid crisis

In November this year, Natixis will mark the second anniversary of its listing on the Paris bourse. Few banks can have endured such dramatic upheaval in such a short space of time.

With the appointment of a new CEO last august, Natixis, formed from a tie-up between Caisse d’Epargne and Banque Populaire in 2006, shrugged off suggestions it faced big losses and focused instead on the expansion of its derivatives and international businesses. This expansion came to an abrupt halt last month when it announced a €1.3bn loss for the second quarter and a review of its international growth plans.

Natixis, which earlier this month sought shareholder backing for a €3.7bn rights offering to shore up its capital ratios, revealed fresh writedowns on residential mortgage-backed securities, collateralised debt obligations of asset-backed securities and mark-to-market valuation cuts linked to credit enhancement companies.

The writedowns and value cuts totalled €1.5bn in the second quarter – in line with Natixis' projections last month – and followed a €408m hit in the first quarter this year, and a €1.3bn writedown in the final three months last year.

At the same time, the bank announced a blueprint for its business between now and 2010. It includes plans to cut the risk profile of its corporate and investment bank and refocus the unit on key areas and client-driven businesses.

Natixis said it will immediately take steps to achieve “a significant decrease in high-volatility proprietary trading activities and a decrease in or cap on risk exposure to certain sectors or geographic areas”.

Natixis listed on the Paris Bourse in November 2006. Fears that it would be the biggest French casualty of the credit crunch surfaced in autumn last year, based on the size of its US securitisation business. The bank, which said at the time it had reduced exposures and denied any problems, declined to comment.

New strategies

Later this month, Calyon’s new chief executive Patrick Valroff will tell investors about the bank’s new strategy following a year of writedowns and the resignation in May of Valroff’s highly rated predecessor, Marc Litzler.

Valroff has been working on the plan over the summer in which the bank reported a loss of €855m loss in the second quarter, reflecting a deterioration in its monoline bond exposures, where it has now made total writedowns of €2.9bn since the onset of the sub-prime crisis.

The result in investment banking, which was down from net income of €459m in the second quarter of last year, dragged group net income at Crédit Agricole down 94% to €76m in the quarter.

Valroff’s new strategy will focus on areas such as structured finance and brokerage. Its Cheuvreux operation is the leading equities house in France and one of the top firms in Europe for research. The bank will cut its capital allocation, risk taking and staff.

This is all a far cry from the division’s performance prior to the credit crisis, when Litzler led an aggressive growth strategy based on a build-up in equity derivatives and leveraged lending. In Europe, Calyon currently lies third behind BNP Paribas in all loans. One rival said: “They are still a strong competitor, especially with Cheuvreux, but its problem now is that its success was built on large loan underwriting and this is not sustainable anymore.” Calyon declined to comment.

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