Can Cabannes save SocGen's investment bank?
Disastrous fourth-quarter results cast a long shadow over Société Générale’s business, especially its corporate and investment bank. Deputy chief executive Séverin Cabannes has given up on fixed income. But is his plan to refocus on core strengths enough to reverse its fortunes?
Séverin Cabannes, the man tasked with turning around Société Générale’s investment bank, is not a markets man by background.
An affable person to meet, with a passion for classical music, the formative part of his career was not even in banking, but in a large French chemicals company. Now Cabannes says the automated production lines of industrial firms, such as chemical manufacturers – and those factories’ absence of a human touch, except for control – is precisely the approach banks need for the future, including in their capital markets businesses.
“The processes of the bank have to be considered as an industrial practice nowadays,” he says. Computers, in other words, are replacing not just cashiers, but staff in banks’ sales and trading arms too, the latter being akin to the artisans of the past. This is killing banking as it used to be – what Cabannes says was a manual and a craft industry.
At SocGen, appropriately, a renewed push to automate processes through digital means is a central part of a plan Cabannes and his team unveiled in February: including an additional $500 million in cost cuts in the global markets and investor solutions division (GBIS), which he heads. This comes on top of what was already a hard task, set out in the bank’s 2018 to 2020 strategic plan: to grow revenues in the division by 2.4% annually, without increases in expenses.
The announcement in February was much more than another starting shot for more negotiations with employees over job losses, however. Much more important is the sign that France’s second biggest wholesale bank is finally conceding defeat, and admitting it lacks the scale to compete globally on the markets side in fixed income. It seems that digitalizing that business and making it more like an automated industrial unit has its limits – certainly for SocGen.
For much of this decade, despite earlier cost-saving programmes, the French bank has sought growth in fixed income as a means to diversify from its core strengths in equity derivatives. Now, a large part of Cabannes’ planned cost cuts will come from fixed income, currencies and commodities (FICC).
By 2020, Cabannes plans to cut risk-weighted assets within the GBIS division by €10 billion, including €8 billion in global markets – more than 10% of the latter’s total, and mostly from FICC.
These measures constitute an abrupt and, some say, belated about-turn. It ends years of insistence that the bank could grow in fixed income, even as it was forced to cut other businesses and generally refocus after the eurozone crisis. It also shows Cabannes reclaiming control over SocGen’s corporate and investment bank: the part of the wider bank that probably has the greatest scope to swing the group’s performance, at least in the short term.
For almost a decade, between the 2008 global financial crisis and 2017, Cabannes oversaw GBIS, along with the group’s finance, risk and compliance functions. Yet Didier Valet was even more directly associated with the fixed-income strategy, as head of corporate and investment banking between 2013 and 2017. When Valet then became joint deputy chief executive, alongside Cabannes, the latter temporarily lost oversight of GBIS.
But in March last year, Cabannes replaced Valet as part of a wider management shake-up, after the latter resigned in the run up to the bank’s June settlement with French and US authorities over a Libyan bribery case and Libor-rigging. (The bank’s communications at the time, albeit vague, suggested Valet was a sacrificial lamb.)
Now Cabannes’ work will be much more centred around a recognition that the investment bank cannot effectively compete in fixed income, and that it must reduce its capital consumption, or else continue to drag the group below its cost of equity.
His division saw its return on equity drop to 7.7% from 10.6% in 2017, even as the group’s ROE rose from 5% to 7%.
By contrast, SocGen’s international retail banking and car-leasing businesses are thriving. Even its French retail business – the most affected by the crippling eurozone interest-rate environment – posted ROE just above 10% in 2018.
The announcement of Cabannes’ new plan, in fact, coincided with a disastrous fourth-quarter result in GBIS. The division came within a whisker of losing money, halving its overall profit compared with the same period last year. FICC was the worst of all, with revenues down 29%, compared with a 15% drop at BNP Paribas.
The investment bank’s results were so bad that SocGen took the unusual step of bracing investors in mid January, warning its performance would be seriously hurt by IFRS5 accounting of disposals, and an adverse environment in global markets. That triggered a 6% one-day fall in the share price.
“Retail investors are not using their cash, mainly because of geopolitical risks and uncertainties,” explains Cabannes. “The volumes, in terms of demand for structured products, have been very low.”
He thinks the fourth quarter’s difficulties – sharp movements in prices, despite a relatively stable rates environment – should relent.
“The market environment in 2018 was particularly tough and the fourth quarter was extreme,” he says. “This is not a normalised situation.”
Nevertheless, even if the cyclical dynamics had been better, he says he would still have changed the underlying strategy.
In fact, he prepared to do so long before the fourth-quarter results. The results merely underline the necessity of those measures. Their announcement might have softened the accompanying blow to investors’ confidence in the results, although the shares still fell another 7% that day as the bank adjusted its targets downwards.
SocGen must consider the high and rising capital and compliance costs of these businesses, Cabannes insists, as well as the stronger degree of competition, particularly from US banks. “Whatever would have been this quarter, we have to adjust the execution of our plan by adapting our franchise, our set-up and our cost base,” he emphasises.
Some new costs, like the hundreds of millions of euros it must now contribute every year to the eurozone’s Single Resolution Fund, are not specific to the investment bank. Those costs weigh on profitability across groups, so makes it even harder for markets businesses to reach cost of equity, which is a particular challenge for other reasons.
But until the release of the final standards in mid January, Cabannes notes, there were still question marks about the impact on capital requirements of the Basel Committee’s Fundamental Review of the Trading Book.
Moreover, since the resolution of the Libor and Libya litigation, SocGen’s compliance and control costs against corruption, bribery and market manipulation have risen again.
“After the settlements, we have committed to a remediation plan, to further strengthen our framework,” Cabannes says.
None of this, including the litigation issue, is unique to SocGen. Across Europe, markets businesses are struggling to cover their cost of equity. Indeed, close peer BNP Paribas had to announce similar efficiency measures in February, as well as lower revenue and profitability targets for 2020, as poor performances in global markets also weighed on its fourth-quarter results.
For both banks, it was a sorry way to end the first year of their respective three-year strategic plans, particularly as these announcements came amid new signs of another eurozone economic slowdown.
This does not just impact their markets businesses. SocGen flagged a €500 million hit to revenues in 2020 as a result of what it now expects to be a one-year delay to ECB interest rate rises. Its French retail franchise will account for most of that hit.
However, BNPP seems more optimistic about the prospects for its investment bank. Unlike its smaller rival, BNPP did not pinpoint cuts in fixed income, where scale is particularly important during its readjusted targets.
At SocGen, however, Cabannes is lumped with the entirety of the €500 million additional cost cuts it announced to 2020. Of the €600 million additional cost cuts BNPP announced for the same period, by contrast, the corporate and institutional bank will only contribute €350 million.
There is, unfortunately, a clear rationale behind this. Unlike at SocGen, BNPP’s ROE in CIB is still comfortably above its cost of equity, at 12.9%. Although the gap between the two narrowed slightly last year, BNPP’s CIB remained about four percentage points higher than the equivalent measure in SocGen, even as both divisions’ ROE fell about three percentage points in 2018.
Cabannes now plans to cut costs by exiting businesses, taking out layers of management, and by better integration within his division. This could imply mergers between his nine sub-divisions, which range from Lyxor (exchange-traded funds) to private banking and securities services, as well as the markets and financing arms.
One of the businesses it could close is Descartes, its proprietary trading arm. In this case, SocGen would be following BNPP, who has already made the decision to close its equivalent, Opera Trading Capital. SocGen has already closed Descartes’ Hong Kong unit.
Prop trading survived longer in France than the US and UK, where post-2008 regulation in the US and UK has forced their Anglo-Saxon peers out of it. In France, a new law forced banks in 2015 to separate prop trading from trading involving clients’ money, which led them to carry it out in ringfenced funds. The idea of exiting prop trading in 2015 seemed a waste of the bank’s capability in this area, according to Cabannes.
Descartes’ has since barely made any money, partly due to the low returns across the hedge-fund industry, according to Cabannes. His expectation of continued geopolitical risks, even while rates remain low – keeping hedging costs high and arbitrage opportunities thin – is one driver of the idea to close Descartes. But it is also to do with higher capital charges. “There are no synergies with the client business,” he says.
In its results call with analysts, the bank also included cash equities in a list of businesses where it lacks scale, competitive advantages or profitability.
“There is a strategic readjustment on our key strengths. We are not losing market share in those areas where we have leading capabilities”
-Séverin Cabannes, Société Générale
Is SocGen’s retreat from fixed income – and exits from other relatively weak trading businesses such as Descartes – enough to turn around SocGen’s performance as a bank?
There seems little doubt, at least outside SocGen, that it is needed.
Even before the latest results, SocGen’s commitment to such a large investment bank, especially in fixed income, was sorely lacking in credibility. The question now is more to do with the execution risk, analysts say. The damage to SocGen’s revenues and attractiveness as an employer is hard to predict, says Jean-Pierre Lambert, banks analyst at KBW.
Group-wide, investors already regarded SocGen with more suspicion than BNPP, even if the latter’s growth strategy also faces tough questions. Even before its mid January profit warning, SocGen’s shares traded close to a 50% discount to consensus book value, compared with BNPP’s 37% discount, according to Berenberg.
GBIS is perhaps the biggest contributor to this discount, as the largest consumer of SocGen’s capital: it counts €142 billion in risk-weighted assets, compared with €118 billion for international retail banking and financial services (which includes leasing) and €97.5 billion in French retail. Within GBIS, global markets and investor services is also the largest risk-weighted-asset consumer, ahead of financing and advisory (€58 billion) and asset and wealth management (€11 billion).
Other European banks already took an axe earlier this decade to areas such as fixed income trading (for example, UBS) and cash equities (UniCredit, Crédit Agricole).
Outside fixed income and prop trading, though, Cabannes still sees a future worthy of large capital investment, including in equity derivatives. Last year, the bank exited some central and eastern European countries where it lacked scale, which helped free up capital for an acquisition of Commerzbank’s equities markets and commodities unit. This should boost SocGen’s markets franchise in structured products and exchange-traded funds, especially in Germany.
SocGen’s equities unit performed slightly better than BNPP last year, with their revenues down 4% and 6%, respectively. SocGen seems to have better managed its risk during market volatility in December, in particular. An index-hedging loss at BNPP (€70 million, Euromoney understands) contributed to a 70% drop in its equities revenues in the fourth quarter, compared with a 15% drop at SocGen.
On the other hand, SocGen has suffered a string of potentially disruptive management changes of particular relevance to its equity derivatives business. On the day of the results, it announced the departure of head of global markets Frank Drouet, to be replaced by Jean-François Grégoire, previously deputy chief risk officer.
Valet’s departure also coincided with the exit of the exit of Richard Quessette, former head of equities and equity derivatives.
There is, however, no intention of relinquishing SocGen’s traditional advantages in areas like infrastructure and asset-backed financing. It is more than half way towards its aim to raise €100 billion in renewable energy financing between 2016 and 2020, for example.
Cabannes emphasises the 19% revenue growth in financing and advisory in the fourth quarter (up 7% for the full year). That’s partly thanks to a strategy to bring its market share among European multinationals closer in line with its healthier share in big French corporations. Its transaction-banking business suffered from insufficient investment and technology until 18 months ago. With revenues up 15% last year, Cabannes thinks that has changed.
“There is a strategic readjustment on our key strengths,” he says. “We are not losing market share in those areas where we have leading capabilities, such as equity derivatives. The readjustment is meant to take into account the smaller scale we have in other areas, mainly by refocusing the fixed income and currencies franchise.”
This is an important shift from before; for Valet, SocGen’s strengths were the foundations to build other businesses, they were less of a unique end in themselves.
Yet the bank did not just announce cost and asset cuts with its 2018 results. It also reduced its group ROE target for 2020, in line with BNPP. Both banks target just below 10%. At SocGen, though, the cut in its GBIS target was more extreme, dropping from 14% to between 11.5% and 12.5%, while BNPP is maintaining its 19% target.
This all suggests SocGen’s options are rapidly narrowing.
European retail banks will always be hampered by negative rates. Competition from mutual groups is especially fierce in France. Banks there tend to use mortgages as a loss leader with which to hook sales of more profitable products such as life insurance and asset management. SocGen has leadership in none of these. It exited its former asset management joint venture with Crédit Agricole, Amundi, in 2015.
Unlike BNPP, SocGen’s private bank is not even in the top five in France, let alone Europe, in Euromoney’s 2019 Private Banking Survey.
SocGen’s international retail and leasing franchises are doing far better. It increased its ROE target for that division, which accounted for slightly more than half its net income last year, from 17% to 18%.
However, the biggest parts of its international retail business, and the fastest growing – Russia, and Africa – are hardly a reliable basis on which to build a large international bank based in western Europe, at least for the moment.
Even within Africa, SocGen does not have leading positions in the main markets. Its biggest single profit earner in its international retail franchise is the Czech Republic, which grew revenues by 1.6% last year.
SocGen is well liked in the international banking community. Group chief executive Frédéric Oudéa is president of the European Banking Federation. But there are still industry doubters, who privately wonder whether or not SocGen has sufficiently robust vision behind it.
To some, SocGen even appears as a sick man of French banking, behind a bigger and bolder BNPP and a restructured Natixis. Crédit Agricole’s listed entity, too, trades at a much higher valuation than SocGen or BNPP. Berenberg notes that SocGen is, to its detriment, the most exposed of these stocks to French retail and investment banking.
Oudéa is the longest-serving chief executive of any large European bank, at the top since 2008. He is up for re-election to another four-year term at the annual general meeting in May.
One prominent Paris-based banker at an international firm says the bank needs new blood at the top, even it comes from internal promotions.
Cabannes is “a safe pair of hands”, as one analyst puts it, but he is not a new figure. Now in his early 60s, Cabannes backed the fixed-income push on the markets side, as Valet reported to him until 2017. He rejects the assertion that this was a mistake, but rather says the market has changed as a result of regulation and technology.
According to Cabannes, the readjustments the bank has made to its 2020 profit targets do not imply its returns will remain so low afterwards.
Scope of scale
He is excited by the scope to better market its single-dealer platform, SG Markets, as a marketplace for other banks’ products. Moreover, although the financing and advisory division must cut its risk-weighted assets by €2 billion by 2020, he is confident the investment bank can grow revenues by pursuing more of a capital-light‚ originate-to-distribute financing strategy.
But SocGen has admitted it could not be globally competitive in fixed-income trading because of a lack of scale. Meanwhile, questions about SocGen’s future – including whether or not it should merge, in the longer term, with Italy’s UniCredit – are not going away.
In the kind of big M&A deals that serve as bulwarks of more successful investment banks’ profits, size matters. Firms like SocGen stand little chance of beating the big US lenders on these deals, partly because it cannot compete on bridge financing due to single-exposure limits, relative to capital.
By comparison, BNPP is not just bigger, it is also better capitalised, with 11.8% of common equity tier 1. SocGen’s 10.8% CET1 ratio is unusually low, according to Berenberg. However, for all its effort, BNPP also struggles to compete in investment banking, even in Europe, against the US firms.
BNPP is not in the top five investment banks by European revenues, according to Dealogic; SocGen is not in the top 10.
Even its equity derivatives leadership may not be safe.
“These are capital intensive businesses, and its capital base is constrained,” says a financial institutions banker.
For all Cabannes’ hope for a digital industrial revolution, the banker adds, it could also lose the technological arms race in markets against bigger and better capitalized banks.