SocGen: undaunted by cost of market share

When in June the Czech government chose Société Générale as the strategic investor for the country’s second-largest bank, the critics began to scoff. The sceptics – many of them analysts from the French bank’s rivals – slammed SocGen’s decision to pay e1.2 billion ($1.1 billion) for 60% of Prague-based Komercni Banka as overpriced. After all, they said, Komercni had a history of bad loans on the corporate side and only a limited retail business. Despite a generous government bailout, SocGen had been stung, they argued.

Indeed foreign acquirers have every reason to be wary of potential bad debt problems at banks in emerging markets, even in the more developed EU accession candidate countries. As well as the legacy problem assets hanging over from the days of policy lending some banks in the region have fallen prey to other, more recent bad investment decisions.

For example, during the recent boom in issuance of collateralized debt obligations by European and American banks – sometimes clearing up their own balance sheets, sometimes creating synthetic diversified credit portfolios – one of the difficulties for originators has been in offloading the riskiest first-loss tranches, often called the equity tranches. These high-yielding but high-risk securities must be sold for deals to work.

The identity of buyers of these tranches has always been something of a mystery. Certainly some sophisticated insurance companies have bought them and the suspicion remains that originating banks have sometimes had to retain them. As a number of CDOs now hit trouble during the credit downturn stories are circulating that some large central and eastern European banks have been big buyers of these securities and may now be looking at large losses. Rivals suggested SocGen had better watch out.

Envy, evidently, can blunt professional judgement. It’s now pretty clear that SocGen had succeeded in grabbing what every western bank operating in the region hungers for: market share.

“This purchase is part of a strategic initiative in the region,” says Jacques Tournebize, a Paris-based member of SocGen’s regional management team. “We had an opportunity in a market that is important to us and we took it.”

Certainly, there was a hefty premium – above the now buoyant prices that western banks pay for controlling stakes in central and eastern European counterparts. But SocGen’s swoop provides a market share of 15% in a reasonably advanced economy. After a bid for a major Slovak bank was trumped by an Italian competitor earlier in the year, the Komercni Banka deal and a spate of other deals also restores momentum to the French bank’s ambitions for its international retail franchise.

Previous purchases included the Romanian Development Bank and Bulgaria’s Expressbank in 1999 and Slovenia’s SKB in this year. These gave a foothold in Romania and Bulgaria, both well behind the Czech Republic on the road to EU accession and to Slovenia which is considerably smaller. With its Czech acquisition, SocGen can now legitimately claim to be a formidable regional competitor.

Although the 60% premium paid on the bank’s share corresponds to an estimated 2001 price-to-book ratio of 2.6, officials say they were impressed by the suitability of Komercni Banka’s development strategy and the potential offered once there was support from a major bank. The fact that the Czech operation has undertaken a far-reaching reorganization – cutting staff from 13,000 to 10,000 in the past 12 months – was another appealing factor.

The French team has declared the Prague-based bank’s technology infrastructure to be sound, so fresh investment will only need to be modest. SocGen will instead devote resources to retraining workers, deepening management expertise and giving more edge to the customer focus.

“The bank is already quite advanced as far as IT goes,” explains Tournebize. “This certainly was reflected in our bid. We do not foresee having to spend a great deal on IT beyond creating interfaces with our systems.”

Although Komercni Banka’s 1 million customer accounts already amount to 15% of the deposit market, the drive will be for further expansion. The old management had attracted higher-earning clients. The plan under SocGen will be to widen the customer base by marketing both banking and asset-management services to the country’s growing middle class.

In the corporate market, where Komercni Banka has a 30% market share, lending practices will be made more rigorous in order to avoid a repetition of the problems that forced the Czech government’s $2 billion bail-out ahead of the sell-off. The Czech government initially bought out most of the bank’s non-performing assets and injected some $250 million in new equity capital. Then late last year it agreed to $500 million in guarantees for the remaining non-performing loans.

“For us, it is not so much a case of the right way but of the only way,” SocGen’s Tournebize says. “If we are to be successful, we have to have a significant share in the region’s major markets. And since we cannot build it, we have to buy it.”