(Bloomberg) -- To find Societe Generale SA's most profitable business, don't look to its trading floors or executive suites in Paris or London, but to gritty parking lots in Lyon, Helsinki and Sao Paulo.
France's No. 2 bank, whose mathematical prowess made it a world leader in equity derivatives, generates its best returns from a more prosaic business: leasing fleets of automobiles.
The development of the car-leasing operation and its growing importance to Societe Generale show how some European lenders are looking outside traditional banking as tougher capital requirements and record-low interest rates sap returns. BNP Paribas SA and Banco Santander SA have also increased their leasing businesses -- from cars to farm equipment to computer systems -- to generate profits without tying up capital. While profit is booming, a slump in the market for used vehicles could expose the companies to losses.
“This is currently a plus for banking profits,” said Karim Bertoni, who helps manage 6.9 billion Swiss francs ($7 billion) at Bellevue Asset Management in Switzerland.
Societe Generale's car-leasing unit, ALD, owns and manages 1.3 million cars. It had a return on equity of 34 percent in the first half, more than twice the level of profitability at its global markets and French consumer-banking divisions. ALD accounted for almost 9 percent of the bank's profit in the first half of the year, while using only about 1 percent of its balance sheet at the start of the year.
"That calls to mind pre-crisis equity derivatives returns,” said Jean-Pierre Lambert, a banking analyst at Keefe, Bruyette & Woods Ltd. in London.
Return on equity will remain at more than 20 percent in coming years, according to Didier Hauguel, a member of the bank's executive committee and co-head of international banking and financial services. In the first half, the business's 208 million euros ($228 million) of net income exceeded the profits from advising on mergers and financing large clients.
No. 2 in Europe
The French lender stepped up its expansion into auto leasing in the early 2000s, after losing the takeover battle for Paribas SA to Banque Nationale de Paris SA. Casting about for paths to growth, it bought units of Deutsche Bank AG and Hertz Global Holdings Inc. in Germany, the U.K. and elsewhere. In May, Societe Generale spent 300 million euros to swallow one of France's top-10 fleet managers from private-equity firm Wendel SA.
Most of ALD's revenue comes from the biggest auto markets in Europe, where it's now the No. 2 car lessor for corporate clients after Volkswagen AG. It also has operations in Brazil, China and India. All told, it employs more than 5,000 in over 42 countries, and is open to more “bolt-on” acquisitions, said Hauguel.
“There is still a lot of room for growth as more companies decide to outsource their cars,” Hauguel said in an interview at Societe Generale's headquarters outside Paris on Oct. 11. “When I meet with CFOs, they see very quickly the gains they can make.”
BNP Paribas's auto-leasing unit, Arval, has about 1 million vehicles and saw “good growth in all regions” in the third quarter, the bank reported. BNP acquired General Electric Capital Co.'s European fleet manager for 1.3 billion euros last year. In 2014, Santander began a joint-venture with PSA Group, maker of Peugeot and Citroen, in 11 countries. Profit at the Spanish bank's European consumer-finance business, which includes auto leasing, jumped 20 percent last quarter. Neither bank breaks out the profitability of the car-leasing businesses.
Auto lessors generate revenue from lease payments, service contracts and the resale of the cars after the leases expire, according to analysts. “This is a profit machine as long as you know how to value your stock of cars and there's no shock in the market for used cars,” Lambert said.
The risks can be great if used-car values drop. Amid discounting for new cars about a decade ago, U.S. automakers were hit by billions of dollars in charges stemming from over-optimistic values on their stocks of used cars.
Pricing Power
For now, leasing is helpful at a time when banking is under pressure. On Thursday, Societe Generale will probably report a decline in third-quarter net income to 805 million euros from 1.13 billion euros a year earlier, according to the average estimate of six analysts surveyed by Bloomberg.
The European auto market is still bouncing back after hitting a two-decade low in 2013. Passenger car sales rose by 8 percent in the first nine months of the year and the volume of September registrations hit a record.
ALD sold almost 260,000 used vehicles over the past year, through website auctions and showrooms. Its purchase of more than 300,000 vehicles over that period makes it one of the top five customers for most car manufacturers in Europe. It offers brands including Audi, BMW, Peugeot, Renault, Volkswagen, Fiat, Opel, Toyota, Ford and Mini, though the make and pricing vary by market.
“It's a scale business,” said Hauguel. “ALD's size provides the pricing power to buy and sell cars on the secondary market as well as to optimize rental and maintenance costs.”
--With assistance from Macarena Munoz To contact the reporter on this story: Fabio Benedetti-Valentini in Paris at fabiobv@bloomberg.net. To contact the editors responsible for this story: Simone Meier at smeier@bloomberg.net, James Hertling at jhertling@bloomberg.net, Frank Connelly, Elisa Martinuzzi
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