French Banks Sound Retreat After Trading Missteps Foil Ambitions

(Bloomberg) -- For the past few years, French banks have avoided the chill that afflicted the rest of Europe’s finance industry. No longer.

BNP Paribas SA and Societe Generale SA, lenders that predicted expansion and profit growth while Deutsche Bank AG and Barclays Plc struggled to gain traction, have reversed course. They’re now retreating in the high-risk businesses that fueled their ambitions. The trouble that emerged this week for both is that their traders flopped in 2018.

“They are into a very bad trip,’’ said David Benamou, chief investment officer at Axiom Alternative Investments, who previously worked for 11 years at SocGen. “2018 showed that they are not as smart as they used to be.”

The two Paris-based lenders, with combined assets of more than 3 trillion euros ($3.4 trillion), want to yank billions of euros of assets from their securities units as they pull back from some businesses and speed cost cuts. Reporting last year’s results, the banks fell into line with European counterparts that are struggling to deal with an era of low interest rates, competition from U.S. rivals and political volatility. An abrupt slowdown in euro-area growth will add more headwinds.

The trend may not stop at BNP and SocGen. Natixis SA, a smaller Paris-based rival that has sought to gain market share in complex derivatives businesses, has already reported losses and provisions of about 260 million euros linked to esoteric Asian equity trades. It reports fourth-quarter results next week.

Rolling Back

BNP Paribas is carrying out a “granular analysis’’ of its investment bank and may cut businesses, locations and customers that don’t generate enough profit, executives said Wednesday. The lender, overseen by Chief Executive Officer Jean-Laurent Bonnafe, may cut 5 billion euros in risk-weighted assets in the process.

SocGen CEO Frederic Oudea is also reviewing “less profitable activities’’ and will “refocus’’ its presence in fixed-income trading, a presentation shows. The bank plans to reduce risk-weighted assets at the global markets unit by 8 billion euros.

The plans are a stark contrast to earlier optimism. In November 2017, SocGen executives talked of investing in fixed-income businesses and becoming a "top player" across more products in Europe. BNP Paribas Chief Financial Officer Lars Machenil expressed confidence a few months later in beating the return on equity target of 10 percent. It now expects ROE of 9.5 percent in 2020.

Cutting Muscle

“Fat cost bases have generally been addressed over the last two years,’’ said Guy de Blonay, a fund manager at Jupiter Asset Management in London. “Now they are cutting in the muscle, which is concerning.’’

Combined trading revenue for the two French lenders slumped 13 percent in 2018 to about 9.2 billion euros, almost as much as the decline posted by Deutsche Bank. The five biggest U.S. banks reported a 5 percent increase by comparison.

All investment banks were whipsawed by a year of volatile markets spurred by geopolitical instability and fears over global economic growth. Yet the French lenders faced their own problems as well, having put so much faith in their vaunted trading operations.

The banks are renowned for their prowess in equity derivatives, lucrative but volatile products linked to shares, which left them more exposed than most to the turmoil that gripped markets last year, analysts said. At BNP, a series of trades in New York went awry around Christmas and lost $80 million, helping to send fourth-quarter stock-trading revenue plunging 70 percent. SocGen also reported one of the worst results among investment banks, partly because of “structured products performance and hedging costs.’’

“They’ve been ramping this stuff up because it’s easy money to make when volatility is low,” said David Hendler, founder of Viola Risk Advisors and an analyst who’s followed the industry for more than three decades. “They have false confidence that they can trade their way out of problems and they didn’t, both of them.”

Problems with equity derivatives compounded issues elsewhere. Revenue at BNP’s fixed-income unit reported one of the worst performances among global banks in 2018 as traders stumbled on everything from currencies in Asia and South America to corporate debt in Turkey. SocGen’s business also struggled more than rivals.

The two banks had also persisted with proprietary trading -- the use of shareholders’ funds for risky market bets -- even after U.S. regulators banned the practice for deposit-taking banks. BNP is now closing its prop-trading arm, Opera Trading Capital, while SocGen is reviewing its Descartes Trading division, the firms said this week.

For De Blonay, the Jupiter fund manager, the retrenching of the biggest French banks is evidence that more European banks need to merge in order to compete.

“European banks are too small to succeed now,’’ said de Blonay. “Pan-European mergers, meaning the merger of cost bases could be the trigger to unlock the value in European banks.’’

©2019 Bloomberg L.P.