Funding: French banks get that shrinking feeling

	"We are adapting to a new world since the summer and that is not entirely comfortable. Although I believe we start from a sound base" Frédéric Oudéa, Société Générale

Oudéa’s answer to Société Générale’s funding crisis: shrink the bank


Frédéric Oudéa, chairman and chief executive of Société Générale, presented the bank’s answer to worried equity market investors, whose summer selling had destabilized its stock price, at the Barclays Capital Global Financial Services conference in New York in September.

He pointed out that Société Générale’s net banking book sovereign exposure to Ireland, Portugal, Greece, Italy and Spain combined was just €4.3 billion as at September 9 – less than 1% of the group’s balance sheet.

Oudéa asked his audience: "Do you think that is an issue for the P&L of Société Générale? Do you think that is an issue for the capital of Société Générale? Personally I don’t think it is. When I think about the current environment and the potential outcomes, I don’t think it could have a significant impact on our balance sheet."

More troubling for Société Générale – and other French banks – has been loss of access to dollar funding recently. Fitch calculates exposures from the 10 largest US money market funds, together managing $676 billion of assets (45% of the total $1.49 trillion holdings of such funds), and finds that from May to the start of September they had cut exposures to French banks by 34% and shifted increasing amounts of remaining exposure to the very shortest maturities of one to seven days.

Lost

This has hit various activities inside the commercial and investment banking division of Société Générale, including securities businesses, commodities and legacy assets. The bank lost $12 billion of funding from the start of July to the end of August.

Oudéa highlights other benefits of grappling with these bad assets, including a release of regulatory capital from the dismantling of CDOs of MBS, and returning the bank’s exposure to the underlying collateral of the mortgage bonds themselves. He says: "Often the MBS are better rated and more liquid than the CDOs and the dismantling of them will allow us to free up €1.3 billion of Basle III capital."

He is defiant over how the bank has coped with the disappearance of funding from money market funds. "Remember that throughout this period euro funding remained abundant. How did we manage the reduction of US dollar funding? First, the disposal of legacy assets left us less to fund. In addition, we used other sources of dollar funding, including $6 billion of repos beyond six months’ maturity. We used euro resources including euro-dollar swaps in the interbank market. Throughout, we maintained $34 billion of cash at the Fed and we managed our way through this without even touching our liquidity buffer pool of €105 billion of unencumbered assets."

Oudéa points out that the bank has already completed its 2011 long-term funding programme. In 2012, in addition to continuing funding needs, the bank will have €20 billion of term debt maturing. How will it cope, if the senior unsecured debt markets remain hard to access? "First, we will further deleverage," says Oudéa, "and will continue legacy asset disposals at a high pace." But the bank will also have to choose certain business to withdraw from and is likely to pull back from provision of dollar real estate finance, aircraft finance, shipping finance, leveraged finance and asset-based finance. "In the US, we see plenty of banks with large volumes of cash that they don’t know what to do with," Oudéa says. The bank may reduce up to €10 billion of loans with a loss of anywhere from €300 million to €500 million in revenue. "We are adapting to a new world since the summer and that is not entirely comfortable," says "Oudéa. "Although I believe we start from a sound base".

Closed

While the bank delevers and scales back some businesses it will sell others, mainly in global investment management services and specialist financial services, seeking to free up a further €4 billion of capital, equivalent to 100 basis points of Basle III core tier 1 capital by 2013. It’s just as well that the bank sees a way to boost its capital ratios through disposals and retained earnings. For now, given the discount to book at which its shares trade, the equity capital markets are closed to it anyway.

Baudouin Prot, BNP Paribas: puts a brave face on the bank’s exposure to the sovereign debt of the Piigs

Similarly at BNP Paribas, chief executive Baudouin Prot hopes that near-term hysteria over the bank’s exposure to Greece and other euro area sovereigns can be contained. At the end of June, combined sovereign exposure to Greece, Portugal and Ireland was just €5.3 billion. Applying mark-to-market impacts on this as at September 20 might consume just 20bp of the bank’s tier 1 equity. Prot is putting a brave face on this. BNP Paribas also has €20.8 billion of pure sovereign exposure to Italy in its banking book that, if marked to market in late September, would imply a bigger hit to capital than from Portugal, Ireland and Greece combined.