Are the wheels coming off BNP Paribas’ grand plan?

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By:
Mark Baker
Published on:

Its 2018 results look bad, but the bank insists it is still on track for success.

BNP Paribas bowed to the inevitable on February 6 and revised the targets it had set for corporate and institutional banking (CIB) revenue growth and cost savings in its 2017 to 2020 strategic plan. The move came after a year of decidedly mixed results that saw it underperform peers heavily in equities and fixed income sales and trading.

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Philippe Bordenave,
COO, BNP Paribas

The bank still trumpets its leading position in euro debt capital markets, but the reality is that some of the areas where BNPP continues to rank highest are the ones that are going badly for everyone. After all, total DCM revenues are down 11% year on year at those banks that report it explicitly (BNPP does not).

At the same time, BNPP is showing small but nonetheless worrying signs of slip-ups in sophisticated businesses where it has traditionally been dominant, like equity derivatives, while it is also underperforming peers in big areas like fixed income, currencies and commodities (FICC).

It is no surprise that FICC was a tough year at BNPP – it was for almost everyone – but the bank did worse than those that have reported so far.

Group profits fell 10% on revenues that dropped 1% to €50 billion. CIB profits fell 21% to €3.1 billion – less than the bank clocked up in 2015 – on revenues that dropped 7% to €12.7 billion.

Where does all that leave the bank’s grand plan? Certainly not in tatters, but the bank did adjust its targets.

BNPP says that while its domestic markets and international financial services divisions are performing in line with targets, CIB’s objectives need to reflect the unfavourable environment it was now operating in. And in spite of cutting costs for three years in succession, increasing the number of new clients and reducing its allocated capital, that division needs to intensify its transformation, the bank says.

Profitability of the CIB unit fell 3.2 points year on year, to a return on notional equity of 12.9%.

Three measures

Three measures are to be taken. First, non-strategic, subscale or unprofitable operations are to be reviewed. Examples of activities already exited are the Opera Trading Capital proprietary trading business and commodity derivatives in the US. The bank says it would also rationalize “sub-profitable” clients.

In other words, it is doing what many of its rivals have already done. Exits could account for recurring revenues of between €200 million and €300 million, the bank says, although those come with cost-to-income ratios of above 100% and some €5 billion of risk-weighted assets.

Second, cost-cutting will be increased. The recurring savings target for CIB rises by €350 million a year to €850 million – and these savings exclude business exits. To achieve this will involve an increase in industrialization and electronification, and the increased development of shared platforms.

Third, there will be more effort made to cooperate across businesses, such as the merger last year of the bank’s corporate banking and global markets platforms. FX and equity derivatives will also be targeted for improvement.

Shareholders at least seemed to shrug off the earnings disappointments. By late afternoon, the stock had traded up to €41.40, up 0.6% on the day, although it had opened 3.5% down.

Doomed from the start?

Much has been done since the 2020 plan kicked off, even in CIB. The bank has added some 215 corporate clients since 2016, with 90 in 2018 alone. Much of this recent effort has come in its target growth markets of Germany, the Nordics, the Netherlands and the UK. But it has also onboarded 60 in the US and 50 in Asia.

Automation has continued apace. It is true that costs have fallen for three years, but the scale of the challenge is such that this represents a drop of just 3.5% from 2015. The bank notes that over the same period there have been rises in compliance costs, banking taxes and its contribution to the French bank resolution fund.

bnpp graph 300px

At group level, the bank is dropping its target for compound annual revenue growth of 2.5% a year from 2016 to 2020 to just 1.5%. The cost savings target rises from €2.7 billion to €3.3 billion, while the cost-to-income target moves from 63% to 64.5%. Return on equity drops from 10% to 9.5%. All of which is designed to keep the dividend target unchanged, at 50%.

Was the bank’s plan doomed from the start? The inconvenient truth for BNPP is that it launched its revenue and cost plan at a time when global CIB revenues were already looking flat at best. According to Euromoney data, the biggest dozen corporate and investment bank divisions saw revenues fall 2% in 2016, and were then flat in 2017.

BNPP’s own flat revenues in 2016 and 2% rise in 2017 represent a slight outperformance against the entire group, therefore, but its 7% fall in 2018 looks bad against the US firms that have been reporting mostly single-digit increases.

Those rivals have been helped by some of the same factors that have hindered BNPP, most notably the rates environment, which has risen in the US but remains stubbornly flat in Europe. And this doesn’t just translate into net interest income: while US rate rises have been predictable in the sense that markets were sure they would happen, there has been much speculation over the precise timing.

That speculation adds up to client trading activity and therefore revenues for banks – provided they have those clients.

Viewed against that backdrop, the plan arguably always looked to be based on a counterintuitive and overambitious analysis of the potential.

Cautious pessimism

It’s no surprise that Philippe Bordenave, COO of BNP Paribas, disagrees with that assessment. Even with the bank’s natural approach of cautious pessimism, he argues it was difficult to anticipate the extent to which the global CIB revenue pool would suffer a structural decline.

“We believed that we could outperform and we did outperform – not last year, but the year before,” he tells Euromoney. “We can still do so. At the time we launched the plan we were indeed thinking that the CIB revenue pool would be flat, but it is down. We think that 2018 is exceptional, but the trend is still down.”

It is also true that the bank’s plans were always predicated more on its ability to cut costs and grab market share from rivals as they exited business they could no longer afford, rather than relying on a global revenue uptick.

"The essence of the plan has not changed. What we must more is accelerate and streamline."
- Philippe Bordenave, COO, BNP Paribas

Bordenave also notes that a few tweaks aside, the bank’s domestic markets and international financial services divisions have continued to perform against the original plan.

“The essence of the plan has not changed,” says Bordenave. “We keep developing our client relationships, we keep our plans to develop Germany, the Nordic region and the UK. What we must do more is accelerate and streamline.”

In that category come initiatives like the merger of the banking and capital markets teams, with the intention of creating a truly originate-to-distribute model.

Some firms found themselves having to focus much more on that 10 years ago, in the immediate aftermath of the global financial crisis – another way in which BNPP (not uniquely) might be said to have suffered from having had a “good” crisis, by not having been forced earlier into a more radical reshaping of its model.

“We need to accelerate this move to originate-to-distribute, and have brought together our global banking and global markets teams to reinforce collaboration in areas like syndication and securitization, which will immediately save on risk-weighted assets,” adds Bordenave.

It might be later than others to this particular party, but what BNPP wants now is a CIB balance sheet with more velocity.

Equities hiccup

There were a few gremlins in the 2018 numbers. The bank had a shocking fourth quarter in equities that took its year to a 6% decline (the US banks had already posted double-digit increases for the year).

BNPP’s quarterly result was just €145 million, a fall of 70% from the same period in 2017.

A specific loss in index derivative hedging was partly to blame; its size has not been disclosed, but Euromoney understands it was about €70 million. Among other things, BNPP is a market maker in relatively simple flow options on the S&P500, typically for insurance companies and fund managers who are trying to improve returns.

Such products might be simple, but the bank nonetheless ends up with a fairly complex and diversified inventory of positions that it has to manage, trying to retain as much margin as possible while hedging the portfolio. Bankers say that the hedging of such risk has become considerably harder as participants increasingly move in the same direction, pushing banks to hedge using instruments further away from the original source of the risk, with varying degrees of correlation.

The index derivative hedging loss should worry the bank because it demonstrates the sensitivity it has to dislocated markets, partly because of its business mix

BNPP appears to have fallen foul of the sharp market movements that started in November last year and continued through December, with poor hedging that then snowballed. Euromoney understands that at no point were any limits breached, however, and the fact remains that €70 million is a small figure against the €2.4 billion that the equities business generated in revenues over the year.

It should still worry the bank, though, not because of the absolute size of the loss but because of the sensitivity it demonstrates the bank has to dislocated markets, partly because of its business mix.

BNPP’s equity derivatives business fell about 6% compared with 2017, although it had been heading up into the fourth quarter.

The problem for BNPP – unlike its big US rivals, for instance – is that within its broader equities franchise, it doesn’t have the kind of brokerage revenues that can offset the structured business. Those sit within Exane BNP Paribas, a separate entity.

It means that BNPP has more of its equities eggs in the structured basket than others. And in the fourth-quarter market environment, the structured business was lacklustre, to say the least. Liquidity plummeted; by the very last day of the year, markets were so dislocated and correlations so out of kilter that, of the €300 million or so in revenues that the bank failed to post in the fourth quarter compared with previous years, perhaps about €100 million was attributable to mark-to-market.

The good news is that much of that mark-to-market loss ought to be recoverable, bankers reckon.

Cost-cutting

There were a few other notables in the numbers. BNPP’s fixed income business is a slightly messy reporting line compared with peers because it includes all non-corporate DCM revenues. At BNPP, the business saw revenues fall 21% for the year, and while Deutsche Bank posted a fall of 17%, the US banks generally saw better years, with falls in the single digits. Goldman Sachs actually rose by 11% on the back of a poor year in 2017.

DCM revenues are down about 11% among those banks to have reported so far, but Bordenave says that the BNPP’s underperformance in FICC was not primarily due to this and that its DCM franchise remained in good shape. “We continue to be ranked number one for bond issues in euros,” he notes.

Where it did perform poorly was in foreign exchange, particularly in emerging markets, but fundamentally BNPP’s FICC business suffers because of European monetary policy, with its concomitant low rates and low volatility. Bordenave says that staffing had been changed, but that structure was also important in order for the bank to get the most out of what it has to offer.

“In FX, we have better reinforced the links between banking and markets activities,” he says. “We have been growing market share in cash management, but the FX flows linked to that were not well connected with our FX traders, so we have addressed that.”

It’s a common theme with BNPP: a need to join the dots better internally rather than create new product.

Securities services was a bright spot, something that probably helped the trading businesses to perform better than they otherwise might have. Revenues are trending up well, rising 10% year on year.

"We have been growing market share in cash management, but the FX flows linked to that were not well connected with our FX traders, so we have addressed that"
- Philippe Bordenave, COO, BNP Paribas

In corporate banking, a reported corporate deposits number that fell 3.5% to €126 billion is not as bad as it might have been, given that it represents an average for the year. In the fourth quarter, corporate deposits stood at €132 billion, but the variation over the year, after a 2017 that saw average deposits up 11% on 2016, will have been noticed.

Away from the bank’s CIB division, things looked not serene but at least less troubled. Domestic markets (DM) revenues were flat at about €15 billion, with pre-tax profit rising 3.5% as the cost of risk fell. International financial services (IFS) saw revenues rise 3% to €16.4 billion, but profits fell by 9% as expenses rose to support product development and business growth.

Bordenave says: “Roughly speaking in these two divisions we saw organic growth in revenues, despite being slightly impacted by low rates in the case of DM or FX movements in the case of IFS.”

The bank has still been acquiring, and this always brings pressures, says Bordenave. “It is a challenge when you are in an environment where organic revenues are under pressure, and then acquisitions bring additional expenses due to the ongoing integration process. Our focus now is on extracting the synergies from the acquisitions that we have already made and crunching costs perhaps more than we had originally planned.”

Can the costs be cut, not just in these two divisions but across the whole group, to the extent that the bank now wants?

Bordenave says yes. “It is big but achievable. We are going to do it by accelerating our digital transformation and the electronification of our businesses, the reduction of corporate real estate costs, and more use of external cloud computing for our non-sensitive data.”

Until now, while BNPP has been using its own internal cloud to reduce IT costs; it has not moved other operations to external suppliers. A new arrangement with IBM sees it do just that, with the creation of a hybrid cloud that lets BNPP retain its most sensitive customer data in its own private systems but move less sensitive but data-hungry processes like pricing and stress-testing mechanisms to a public cloud.