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Western EuropeAugust 3 2008

Co-operative model stands strong

Unlisted French financial institutions have demonstrated the merits of their conservative strategies, which have made them more resilient than their listed competitors in the face of market pressure. Karina Robinson reports.
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Fashion is a fickle master. During the boom decade and beyond, with banking profits in the listed sector growing at double digits, unlisted French financial institutions such as Groupe Caisse d’Epargne and Groupe Banques Populaire were criticised for being sleepy institutions that piled up capital in an inefficient way.

Revenge is, as the phrase goes, a dish best served cold. For Banque ­Populaire, its Tier 1 capital of more than 9% – in addition, 95% of its capital is of Tier 1 standard – is a tasty dish as other banks repeatedly appeal for more capital from sovereign wealth funds or their existing shareholders.

“The co-operative model is far from being an old or ‘old-fashioned’ model and illustrates its relevance, originality and flexibility,” says Philippe Dupont, chairman of the group. “For instance, in 2007 the Banque Populaire Group displayed its ability to diversify into a recurring revenue business by inte­grating Groupe Foncia, a leader in ­residential property services. This year, our group has recently completed an external growth project to develop its business in the south of France by acquiring HSBC France’s seven regional banks.”

An enhanced network

London-headquartered HSBC was the first of the global banks to admit to a problem with subprime in 2007. Via its HSBC acquisition, Banque Populaire now has 400 additional branches located in the south of France, enhancing its network in regions with high economic potential, while reinforcing its retail banking base. Mr Dupont believes that some of the listed ­commercial banks could learn a few lessons from the savings bank model.

“In the current banking crisis, the first lesson learned is that our co-­operative bank model has proved its robustness in the face of market uncertainties. In comparison with banks that have a short-term approach, our group, created by entrepreneurs, is founded on strong values and medium- and long-term development plans,” he says. “Our group demonstrates its resilience to financial market turbulence. Actually, the development of the Banque Populaire Group is significantly based on the retail banking business, which generates strong recurring revenue, while being less prone to financial ­market pressure.”

Groupe Crédit Mutuel, meanwhile, is sitting pretty with Tier 1 capital of 11%, while niche international trade bank, Union de Banques Arabes et Francaises (UBAF), boasts one of 23%.

Niche position

“We are not affected by the subprime and are taking advantage of it due to our excellent liquidity,” says Patrick Legait, chairman of the management board of UBAF. “What we are targeting is a substantial increase of our ROE [return on equity] through new (sound) additional business” (see box overleaf).

Clear evidence of how that capital can be used came as The Banker went to press. Crédit Mutuel signed an agreement with Citigroup to purchase Citibank Deutschland, the troubled US bank’s German retail operations for €4.9bn. Its first major foreign foray abroad into a low margin, fragmented market, along with the implications of its capital, caused rating agency ­Standard and Poor’s (S&P) to put the French bank’s rating on credit watch negative.

The other French banks, which rarely make the news in the foreign press, share UBAF’s sense of the ­excitement. Their model is one of being close the client – Crédit Mutuel has the second largest branch network in France – with a strong regional bias. Groupe Banque Populaire is made up of a network of regional lenders under a central holding company. Caisses d’Epargne is controlled by 30 ­customer-owned savings banks.

These financial groups allow a great deal of autonomy to their regional banks, while generally co-ordinating marketing, technology and commercial policies, as well as some management. Multi-brand strategies are followed although there is co-ordination at a head office level.

Decentralised model

But this dispersal of power, a less centralised model than prevalent in listed banks, does not mean that all three have slower decision-making processes than BNP Paribas or Société Générale, says Stephane Le Priol, French banking analyst at rating agency Moody’s.

Mr Le Priol argues that they do not differ markedly from the listed banks in France. “We think that the business models of all major banking groups in France have converged to a large extent, whether they are mutualists or not. They tend to offer very similar banking services (including internet-based services), similar types of credits and similar types of deposits, investment funds and insurance products,” he says.

“The main differences today between the large banking groups derive from the extent of their international presence and to the relative importance of their various business lines,” he adds.

For some of these banks, their foreign exposure looks as if it might change as they take advantage of a drop in the prices of financial assets and of their capital strength.

“Today, we are examining all growth opportunities overseas with the fundamental principle of adding value for both parties. The Banque Populaire Group is moving ahead and knows how to seize opportunities and meet challenges in line with its development strategy. And I will inform you voluntarily of our next acquisition when it is complete, as regarding this aspect, discretion is the secret of our success,” says Mr Dupont, coyly.

The banks are, however, not totally immune to the credit crisis and its consequences via their funding, the economy and a foray into investment banking.

First, although on the funding side the savings banks’ reliance on deposits has shielded them from the worst effects, they still need to access the wholesale markets and have had to pay more for this. However, when the capital markets are only responsible for 15% of balance sheet funding, as is the case for Banque ­Populaire, this is not too serious.

Second, the savings banks will be affected by the slowdown in the French economy. Moody’s estimates gross domestic product growth of 1.6% in 2008 and 1.4% next year. S&P in a March report on the French banking industry wrote:

“In 2008, we expect the positive effect of reconstituted margins in mortgage lending to only partly offset decelerating lending volumes. While banking commissions will likely remain resilient, financial commissions will depend on market performance and household appetite for this type of product. Therefore, we expect that revenue growth will remain moderate to low, which will make it difficult to significantly improve profitability in domestic retail banking.”

Feeling the pressure

Additionally, S&P points out that in 2007, despite good commercial indicators, co-operative groups’ earnings ­performance suffered from “higher pressure on interest margins, given the stronger contribution of mortgage lending and more expensive commercial strategies conducted for the past few years, based on enhanced distribution capacity [new branches] and ­multichannel policy”.

The savings banks’ longer-term perspective means that they are not as bothered by slower profit growth as their listed peers because they believe they are investing for the future health of the business and they do not have fund managers and hedge funds pressuring them in the same way.

Overall, S&P expects the retail business to continue to act as a buffer against potential stresses facing other business lines, which will benefit the savings banks compared to their competitors. Their conservative lending policies should shield them from the worst of the crisis as well.

Finally, however, there is a black mark against the savings banks that comes via their corporate and ­investment banking arm, Natixis.

Caisse d’Epargne and Banque ­Populaire merged their investment banking businesses a few years ago in order to create a new listed company. Whe­ther it was because of pressure from other shareholders to deliver hig­her profits or the euphoria that so many bankers got caught up in, Natixis stra­yed far from its savings bank roots.

Net profits plummeted by 48% in 2007 to €1.1bn, on the back of its involvement in subprime and structured products such as collateralised debt obligations. Analysts at Keefe, Bruyette and Woods (KBW) estimate the damage will continue, with a net loss of €300m in the second quarter of 2008 and more to come.

Put into context

That may not seem to be much in the context of other banks – nor has it had a major effect on the profits of both parents. However, it is a major embarrassment, regardless of the words of Mr Dupont.“Basically, you must remember that despite the crisis, Natixis has recorded good performance in its other business lines. For instance, in the asset management division, in the first quarter of 2008, inflows of net new money came to €11bn,” he says.

Natixis is ranked among the top 15 asset managers worldwide, with total assets under management of €575bn at March 31, 2008. Mr Dupont points out that the bank is well capitalised, with a Tier 1 ratio of 8.4%, while both of its main shareholders are willing to support it. Banque Populaire Group and Caisse d’Epargne each announced an injection of €500m into Natixis at the end of June.

KBW says that this transaction takes advances from the parent shareholders to a total of €2.5bn. The advance is expected to be replaced in part by hybrid instruments when the capital markets improve, and by the sale of assets.

“A thorough review of the corporate and investment banking businesses of Natixis and a new strategic plan are in progress,” says Mr Dupont.

UBAF STRENGTHENS FRENCH-ARAB CO-OPERATION

sUnion de Banques Arabes et Francaises (UBAF) is a specialised bank that is riding the wave of expanding global trade and Arab revenues. Founded in 1970 to strengthen co-operation between the Arab world and France, its list of shareholders reads like a Who’s Who of major Arab institutions.

Among them are Banque Extérieure d’Algérie, Libyan Foreign Bank, National Bank of Abu Dhabi, the Central Bank of Egypt, Riyad Bank, and Bank of Bahrain and Kuwait BSC. “The profile of our public shareholders [with some exceptions] does not give us access to any privileged national guarantee or credit support. However, it gives us a unique link to a lot of top country officials who are able to provide excellent business advice,” says Patrick Legait, chairman of the management board of UBAF.

However, he adds that the bank does have unique access through its shareholders to pan-Arab funds and insurance programmes, such as those from the Islamic Development Bank in Jeddah. These are not available to international, non-Arab institutions.

The French shareholder is Calyon, Crédit Agricole’s corporate and investment banking unit, with a 47% stake. It provides advice on compliance, technology and risk management. The latter was especially needed when the bank faced a major upsurge in its non-­performing loans (NPLs) in the early years of the century. These were cleaned up in 2005 and 2006 and Mr Legait, who is seconded from Calyon, says non-provisioned NPLs are now only 0.1% of total assets and he is confident that “some large recoveries will materialise in a not-too-distant future”.

Rating agency Fitch points out, in a 2007 report, that Calyon “is UBAF’s reference shareholder in the eyes of the French regulatory authorities and its commitments to UBAF exceed its 47% stake in the bank. Fitch Ratings believes there is an extremely high probability that UBAF would receive support from Calyon if needed.” It gives the bank a long-term foreign currency ­rating of A- and sees market ­risks mainly arising from interest rate sensitivity on the placement of excess capital.

At 1.08%, UBAF, with assets of $2.995bn, has the third best return on assets of the French banks in The Banker’s list of Top 1000 World Banks, plus the second best capital to assets ratio at 12.86%. Profits last year from the recurrent core business of letters of credit was higher than in 2006, although a couple of extraordinary gains in that year resulted in a 48% drop in pre-tax profits to $32m for 2007. (The 2006 one-off gains came from the recovery of notes obtained under the Iraqi debt rescheduling and a large recovery from an Asian debtor.)

Mr Legait notes a positive and a negative effect from the boom in oil price profits. On the one hand, it has increased the volume of trade from oil-producing countries. On the other, the substantial improvement in the fundamentals of those economies means that the bank is forced to charge less for its services as the risk factor is lessened.

It has had to increase the volume of its business to make up for this. In 2007, it transacted $19.2bn of letters of credit versus $12.6bn in 2006, remarks Mr Legait.

There are also two sides to the currency effect of the dollar’s fall against the euro for the bank, which reports in euros, while most of its business is in dollars, the global trade currency. As a counterpart to the negative currency effect from translating revenues generated from dollar-­denominated instruments into euros, UBAF has a dollar-pegged cost base via its extensive Asian network.

That Asian network is one part of the bank’s two-pronged strategy to increase revenues and return on equity.

“We are the only ‘Arab’ bank with a fully fledged Asian network,” observes Mr Legait.

Its expertise in Islamic trade products – it has been dealing in them for several years – is one that the bank expects will throw up “huge opportunities in the future but always within the scope of its own core business”, says Mr Legait, in what looks like a pointed reference to banks that expanded beyond their areas of competence into subprime and structured ­products.

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