SocGen: making the case for European bank champions
EU politicians are warming to cross-border mergers. The French lender wants to be at the forefront
Even by the high standards of the École Polytechnique in Paris, founded to educate the country’s future business and engineering elite, the class of 1984 plays a remarkable role in European banking.
The group contains Tidjane Thiam, Jean Pierre Mustier and Jean-Laurent Bonnafé, who run Credit Suisse, UniCredit and BNP Paribas, respectively. It also includes Frédéric Oudéa, the Société Générale boss who is Europe’s longest-serving major bank chief executive.
Still friends, the men occasionally meet to play golf. “We were very bad, all of us,” recalls Mr Oudéa about a round a few years ago with two of his classmates at the La Baule Club on France’s Atlantic coast. “I think our balls went in the water. It was a disaster, but it was for fun.”
Those friendships could turn out to play an important role as the European banking industry considers a new round of dealmaking to create regional champions to take on the American groups that dominate the industry.
In the decade since the financial crisis, Europe’s biggest banks have largely struggled. Ultra-low interest rates, tougher post-crisis rules and the resurgence of Wall Street have made it all but impossible to generate decent returns.
For the most part, European banking executives have eschewed talk of large mergers, deterred by fragmented national laws, rules and the memory of the calamitous combination of RBS and ABN Amro at the height of the crisis.
But the dam may be about to break. Troubled by the parlous state of the financial system, eurozone politicians and regulators have given the first signal in years they may soon dismantle the remaining barriers to cross-border M&A and achieve a true banking union.
While many of his rivals are still wary of deals, Mr Oudéa is one of the few who openly courts the idea.
“At this moment, which might be the turning point for Europe, I want to be able to seize the opportunity,” he said in an interview at one of SocGen’s trio of mirrored towers in La Défense.
“If this consolidation, which is a logical outcome of a completed banking union, happens, you will have very few combinations. Do not imagine a flurry of deals, but Société Générale should be part of it.”
For the Parisien lender, a merger with a continental rival would make a lot of sense, giving it the firepower to invest in new technology and push back against the supremacy of Wall Street in trading and capital markets.
According to Jérôme Legras, managing partner and head of research at Axiom Alternative Investments, European banking regulators have made it clear that “the best way to fight negative rates is mergers, the solution to unprofitable banks is consolidation, so how long can the French resist?”
Mr Oudéa’s 11-and-a-half years in charge have been bruising. He has presided over a 59 per cent fall in the share price while enduring a succession of misconduct scandals and a deteriorating operating environment.
SocGen has been on a particularly bad run of late, opening the year with a profit warning and making thousands more job cuts, which have sharpened existential questions about its strategy and size.
While his bank has been punching below its weight for most of his term, Mr Oudéa — who in the 1990s worked for Nicolas Sarkozy in government — is in no mood to quit.
“I was appointed CEO at 45. I’m now 56, which is usually the age when you are appointed. So, I’m in great shape, I sleep very well and I must say I’m perfectly fit,” Mr Oudéa said, flexing his biceps for emphasis.
Many obstacles remain to banking union. National regulations still differ on capital and liquidity, not to mention incompatible bankruptcy laws and treatment of mortgages.
Yet after many false dawns, bankers finally had cause for optimism last month when a historically recalcitrant Germany dropped its opposition to a common deposit insurance scheme, perhaps the single biggest hindrance to cross-border deals. Mr Oudéa said he could see the remaining problems being solved within three years.
The chief executive thinks that regulators, worried about “too big to fail” institutions, will prevent any bank from running a balance sheet of more than €3tn. But SocGen’s more modest €1.4tn of assets gives it “a margin of manoeuvre . . . a size which offers some flexibility”.
“The supervisor will be very, very prudent,” he adds. “They will want to avoid a catastrophe like we had in RBS,” referring to the £46bn taxpayer bailout of the UK lender after it bought ABN.
Deal rumours have swirled around SocGen for years. In the summer, Mr Oudéa flirted with UniCredit, run by his friend and former colleague Mr Mustier, who lost his job at SocGen over a rogue trading scandal.
However, the deal never advanced because of the probable credit rating downgrade that would have followed a takeover by a riskier Italian bank, increasing funding costs and effectively killing the margins of the wholesale banking business, people familiar with the discussions told the Financial Times.
After also having a look at Commerzbank this year, Mr Mustier has now sworn off deals — in public at least. “No M&A,” he told the FT in December. “How can I be more precise?”
Undeterred, the top brass at SocGen believe there is political and supervisory support for a new European investment banking champion better able to vie with JPMorgan and Goldman Sachs, who have been steadily poaching business from the retrenching French, Germans and British.
A wide gulf has opened up. JPMorgan’s $436bn market capitalisation makes it six times more valuable than BNP Paribas and 16 times more than SocGen. In the first three months of last year alone, the US giant made $9.2bn of net profit, more than any of continental Europe’s biggest banks earned for the whole of 2018.
“When I speak with clients they don’t want to be in the hands of American banks and I think that the regulators will not want to have such a concentration of risk,” Mr Oudéa says. “The risk of the world in three, four, five balance sheets? I don’t buy that.”
SocGen’s chairman, Lorenzo Bini Smaghi, an Italian former member of the ECB’s executive board, echoes these concerns.
“Not having a European bank committed to the euro is not desirable, politically or economically,” he says. “The fact that Deutsche Bank is refocusing is a loss for Europe. The Germans are starting to realise this, after so many years they are realising that having somebody that is committed long term, not just in an opportunistic way, is important.”
This fear underpinned German finance minister Olaf Scholz’s ultimately unsuccessful attempt to push together Deutsche and Commerzbank earlier this year. Mr Scholz has said publicly that having stable lenders is a question of “national sovereignty”, stung by the memory of how during the crisis, panicked foreign banks restricted the supply of credit and retreated to their home countries.
“French investment banks with local roots and senior management bring a perspective that is valuable,” says Ross McInnes, chairman of Safran, the French engine maker. “We need also to be mindful of American extraterritorial measures, in particular on legal and conformity requirements, and building alternatives to payment systems involving the US dollar requires strong, broadly-based European universal banks.”
Cross-border deals could provide a partial way out of the slump the European industry has suffered. Europeans’ average return on equity declined to 7 per cent last year, less than half the average 16 per cent generated by big American banks, according to data from the European Banking Authority and Citigroup analysts.
Other potential partners known to be looking for scale and synergies include Dutch lender ING, which had an interest in Commerzbank, while Deutsche Bank and Switzerland’s UBS also discussed a tie-up at the same time, it has been reported.
Before SocGen can ink any deal, however, it must get its house in order. In an unimpressive field it languishes near the bottom in most financial metrics and is worth 40 per cent of book value. Of the region’s largest lenders, only Germany’s troubled Deutsche and Commerzbank trade at a lower ratio. Similarly, its RoE has dropped to 6.1 per cent this year, a far cry from its 9 to 10 per cent target.
The shares plunged after February’s shock profit warning and concurrent drop in its vital core capital level, prompting a strategic review that resulted in 1,600 job cuts and €500m of cost savings at the struggling trading unit, once the group’s main profit centre. “SocGen is now one of the cheapest banks in Europe,” says JPMorgan analyst Delphine Lee.
If the lender cannot get itself into shape, executives are concerned they risk either missing out and languishing as others combine and grow, or are simply snapped up and absorbed by a healthier rival.
“To be an active player our valuation has to be much better,” says Mr Bini Smaghi. “So we are working on this. And to be fit, prepared and flexible. Then when the opportunities come, we will look at them.”
Mr Oudéa retains a lot of personal credit from big shareholders, such as BlackRock, Fidelity, Amundi and Capital Group, for steering the bank through various financial and reputational crises after his battlefield promotion in May 2008.
First came the infamous rogue trading scandal that led to Mr Oudéa’s appointment, when Jérôme Kerviel lost the lender €4.9bn on bad bets on stock index futures.
Then a series of legal cases hit — bribery in Libya, Libor manipulation and sanctions violations in countries including Cuba, Iran and Sudan — which led to deputy CEO and leading succession candidate, Didier Valet, also being forced out.
Those legal woes are now mostly behind the bank with the exception of the Libyan case, which lingers in the form of an ongoing lawsuit from an ex-managing director of the bank and a key witness for the US department of justice, Elyes Jebali, who is suing SocGen for unfair dismissal, alleging he was fired after exposing the bribery scheme.
Few think Mr Oudea’s job is at risk, even if the board has accelerated succession planning for an eventual retirement, according to one person involved in the process. Net profit has doubled from the level when he took over in 2008 and shareholders voted to extend his contract for four more years in May.
“This is France, Fred won’t be chased out unless there’s another huge screw-up,” says a school friend of Mr Oudéa, who is now the chief executive of another European bank. “We don’t run CEOs out of town here.”
The most recent quarterly results provided some relief as the bank’s core CET1 capital recovered to 12.5 per cent, back above its target, assuaging shareholders’ fears it might have to raise extra cash. SocGen’s other main divisions have also been more stable and profitable. International retail remains a selling point, while the domestic retail business has been generating an RoE of 11-12 per cent, among the best in France. Both are widely praised by analysts, even as the investment bank fails to convince.
William Kadouch-Chassaing, SocGen’s chief financial officer, says a year ago investors and executives had “conversations [that] were not very friendly, we knew we needed to do something” but that now “we don’t have major pushback on our strategy”. He adds: “We still have a lot of people to convince internally and externally.”
The immediate priority is to fix the investment bank. Traditionally known for hiring engineering and mathematics PhDs, SocGen is still ranked number one in Europe for exotic structured finance products, such as equity derivatives, where the returns on offer are comfortably in the double-digits.
However, it has been suffering badly in stock and fixed-income trading, where margins and volumes are in structural decline. Remedial measures have included shrinking its hedge fund services team, shuttering its proprietary trading unit — named after Descartes, the French mathematician and philosopher — and slashing its cash equity trading operations.
“We were the inventor of equity derivatives, and then we were the inventor of structured finance,” says Séverin Cabannes, one of SocGen’s four deputy chief executives. “We must refocus on our core DNA; Société Générale is a bank of engineers, that is the core legitimacy we have.”
The other option would be more disposals. After selling its Balkans consumer network and its Scandinavian equipment finance and factoring business last year, market chatter suggests that Lyxor, SocGen’s €150bn asset management business, could be on the block.
Mr Oudéa acknowledges the business is under strategic review, but says it “is not on sale today”. The preferred route would be forming a partnership with a continental rival to gain vital scale in an industry dominated by trillion-dollar-plus US institutions.
Whether SocGen continues to forge a path alone, partners up with peers or plays an active role in consolidation, the bank still has its fans even among long-suffering investors.
“Over the last 20 years SocGen has never lost money, even when going through two huge crises, so their business model is very resilient,” says Davide Serra, founder of hedge fund Algebris, which owns the bank’s debt and equity.
“It is the most undervalued company in Europe and, for us, it is a core holding. I don’t need a cross-border merger to make money. If they keep going the way they are then I am sure the shares will reprice.”