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Derivative strategy

Calyon imitates its French rivals by targeting derivatives as the key to growth. Can this late-starting investment bank succeed?

When the barons of Crédit Agricole were debating whether to bid for rival French bank Crédit Lyonnais three years ago, one of the more vocal critics of the proposed deal was Edouard Esparbès. As head of Agricole's largest division, Paris-based Crédit Agricole d'Ile de France, Esparbès was the biggest of the barons, or regional chiefs, and enjoyed tremendous independence under the cooperative bank's federal structure. He worried that a merger with the centralized Lyonnais, where investment bankers rather than regional bosses controlled relationships with key corporate clients, would threaten his autonomy, costing him customers and revenues.

Esparbès failed to stop the E16 billion ($18.6 billion) acquisition, but he has prevailed nonetheless. He won a hard-fought internal power struggle to become chief executive of the combined group's investment bank, named Calyon, and deputy CEO of Crédit Agricole to boot.

Now Esparbès has embarked on a major expansion designed to make Calyon a European powerhouse. But he is doing so in an unusual way. Instead of leveraging the parent bank's strengths by focusing on the French corporate market, which could create conflicts with the regional chiefs, Esparbès has chosen to target the lucrative but highly competitive market for equity derivatives, a business dominated by French rivals Société Générale and BNP Paribas. He aims to triple Calyon's modest derivatives business by 2007 and use those revenues to finance expansion in fixed income, asset management and other areas.

"Our ultimate desire is to be a bank of reference in the international markets," the 61-year-old banker says in an interview at Calyon's offices along the Seine in the La Défense district just west of Paris. "Current initiatives like our goals in equity derivatives are just the first steps in that direction."

To lead the derivatives drive, Esparbès has lured out of retirement Marc Litzler, a flamboyant banker who helped build Société Générale's world-leading equity derivatives business in the 1990s. During his two-year break from banking, Litzler used his considerable wealth to buy a Paris restaurant, open an art gallery and collect modern art. What attracted him back to the business was the chance to create the kind of dynamo he had forged at Société Générale.

"An opportunity to build a new investment banking operation at one of the world's top-ranked banks in terms of balance-sheet strength comes around only about once in a decade," says Litzler, who joined Calyon as deputy CEO in December.

The ambition of Esparbès and Litzler is laudable, but rivals and analysts question their prospects of succeeding. Calyon starts far behind its rivals, and it is expanding at a time when other bulge-bracket investment banks, including Goldman, Sachs & Co. and UBS, with deeper pockets and more lustrous pedigrees are also beefing up their equity derivatives businesses.

Even more significant, the two investment bankers must overcome a legacy of failure stemming from the stultifying dominance of the caisses régionales, the regional banking divisions that control Agricole. These units forced cutbacks in Agricole's successful Asian equities and European fixed-income operations over the past decade and prompted the departure of a number of talented bankers, including Dominique Ferrero, the former head of Crédit Lyonnais's investment bank. Rather than challenge the regionals, Esparbès is bowing to them by setting a strategy that largely ignores Agricole's powerful position in the French corporate market. The bank is the euro area's second largest by assets, with E913 billion, and is the leading lender to small and medium-size businesses in France.

"In the past the influence of the regional bank heads has led to the destruction of valuable businesses," says Jean-Pierre Lambert, a banking analyst at Keefe, Bruyette & Woods in London. "Today it is diverting Calyon from building up a domestically focused corporate and investment banking business that leverages off the corporate connections of the regional banks."

Esparbès insists that his expansion strategy makes sense, however. As a former baron himself, he refuses to compete with the regional banks for corporate lending and investment banking business. By focusing on derivatives, he hopes to avoid internal conflicts, penetrate new markets, such as selling structured products to hedge funds, and build up the bank's trading capacity.

"We did not want a strategy that would have put the caisses régionales in an uncomfortable competitive position," Esparbès says. "Today, Crédit Lyonnais has its own business clients, while on the other side, the caisses régionales have theirs. Calyon is at the service of the two networks for capital markets products, rather than competing with them."

Understandably, that approach has the firm support of Agricole's regional bosses. "Putting an emphasis on derivatives and not on expanding in the domestic corporate market may seem like a tough strategy to deliver on, but it makes sense given the structure of our group," reasons Nicolas Renaudin, CEO of Crédit Agricole Brie Picardie, which is based in Meaux, 40 kilometers east of Paris. "We don't want Calyon aggressively expanding its corporate business in France since it would lead to competitive overlap with our own growing corporate loan businesses, but we do want to improve its relatively poor profitability and its ability to expand overseas so that it can serve us better."

Though Calyon is a substantial entity, boasting nearly 11,000 employees and offices in 60 countries, the firm's performance has been second-rate. It ranked tenth among European investment banks last year, according to its own estimates, with revenues of E3.9 billion. That was far behind top-ranked Deutsche Bank's E13.3 billion and trailed domestic rivals BNP Paribas and Société Générale, which had investment banking revenues of E5.7 billion and E4.7 billion, respectively. Calyon also relies more heavily on low-margin, capital-intensive lending than do its domestic rivals, who generate higher returns on capital markets activities like derivatives. The firm devoted E6.9 billion in capital to its investment banking activities last year, virtually double SocGen's E3.5 billion, even though Calyon lagged its rival in revenues by 19 percent.

As a result, the gap in profitability between Calyon and its would-be rivals is wide. The investment bank reported that cost-cutting boosted operating profits to E355 million in the first quarter, the latest figures available, a gain of 24.5 percent from a year earlier. Revenues rose a modest 4.9 percent to E1 billion. Return on equity was 16.9 percent. By contrast, BNP Paribas posted a 21.2 percent increase in operating profits, to E700 million, on a 5 percent gain in revenues, to E1.6 billion. Its ROE was a robust 34 percent. Société Générale rode a blowout performance in derivatives to post a 44.7 percent rise in operating profits, to E754 million, on a 31.6 percent jump in revenues, to E1.6 billion. ROE was an astonishing 54 percent. BNP Paribas's operating profits rose 18 percent in the second quarter from a year earlier, to E714 million, and SocGen's profits edged up just 3.1 percent, to E471 million.

Calyon ranks outside the top 20 in most main investment banking product lines, including debt issuance and merger and acquisition advice, and trails well behind BNP Paribas and Société Générale. The bank's main strengths largely reflect balance-sheet power rather than capital markets expertise. Calyon was the second-largest lender globally in project finance in the first seven months of this year, according to London-based Dealogic, and ranked tenth in syndicated loans.

The bank's equities franchise got a major boost when the French Treasury named Calyon sole book runner on its E4 billion initial public offering of a 22 percent stake in Gaz de France in July. That single deal vaulted Calyon to 12th place in global equity issuance from a position outside the top 40, according to Dealogic. The bank is also joining with Morgan Stanley to handle the expected E11 billion sale of a 30 percent stake in Electricité de France this autumn. Calyon boasts a well-regarded domestic equities sales and research arm, Cheuvreux, which ranked first in France on Institutional Investor's 2005 All-Europe Research Team, but on a pan-European basis, Cheuvreux is small compared with the equities operations of bulge-bracket firms like Merrill Lynch & Co., Goldman Sachs and UBS. Elsewhere, Calyon's only notable business outside of Europe is Asian equity sales and research house CLSA, the third-largest brokerage in Hong Kong by turnover.

Analysts estimate that Calyon generated about E1.1 billion in revenues last year from fixed-income trading and origination (the firm doesn't provide a breakdown). Equity brokerage chipped in an additional E475 million or so. The equity derivatives operations that Esparbès wants to build account for 5 percent of the group's revenues, or slightly less than E200 million -- one of the few figures Calyon has publicly confirmed. Even if Esparbès and Litzler succeed in tripling derivatives revenues, the business would still be less than one third the size of Société Générale's, which is likely to generate more than E2 billion in revenues this year, according to Jacques-Henri Gaulard, an analyst at Merrill Lynch. Esparbès' growth plan aims to increase overall revenues in corporate and investment banking by E1 billion by 2007.

Litzler acknowledges that Calyon lags behind its rivals but insists that focusing on derivatives will drive growth on many fronts. "It will give us the ability to create new structured products in everything from fixed income to money management, and through hedging and market making, it will lead to increased trading competence," he says.

Fixed income is a major growth priority. The bank ranked 23rd globally in the first seven months of this year, according to Dealogic, acting as book runner on 111 offerings worth a total of E27.6 billion. Most mandates were for plain-vanilla deals like a E1.5 billion, three-year bond issue for automaker DaimlerChrysler in March. "The key to growing revenues will be expansion in value-added areas like asset-backed securities, credit derivatives and securitizations," says Yves Perrier, deputy CEO in charge of structured finance and international development and the highest-ranking former Lyonnais executive left at Calyon.

Crédit Agricole's mutual ownership structure is a rarity among major European banks and downright unique for those with investment banking pretensions. The bank's 42 caisses régionales are owned by their members, principally local depositors and borrowers. The caisses, in turn, own 53 percent of Crédit Agricole, the publicly listed holding company.

This structure has caused numerous internal power struggles and nearly stymied the acquisition of Crédit Lyonnais. Former Agricole chairman Marc Bué, a key ally of Esparbès, hesitated over making an offer, fearing that Lyonnais's centralized model would threaten Agricole's federal structure. It was only after BNP Paribas bought a 10.9 percent stake in Lyonnais in November 2002 that Bué was replaced by current incumbent René Carron, chairman of Crédit Agricole des Savoie and a firm proponent of the merger.

One of the key conditions demanded by Lyonnais as its price for a friendly acquisition was that its executives, led by Ferrero, should be put in charge of the combined entity's investment bank. It's not difficult to see why. Although modest in size, Lyonnais's Banque de Financement et d'Investissement was integrated and efficient. Ferrero had melded BFI's corporate finance activities with Lyonnais's banking business, putting investment bankers in charge of relationships with key corporate clients. In 2002, its last full year of operations, BFI had an operating profit of E660 million on revenues of E2.3 billion and was increasing its market share in fixed income and credit derivatives.

Agricole, by contrast, had little record of success in investment banking. It had a thriving Asian equities business and acquired a significant fixed-income franchise when it bought Banque Indosuez in 1997, and renamed it Crédit Agricole Indosuez. But Agricole quickly undermined both businesses. It made drastic personnel cuts in Asian equities after the outbreak of the regional financial crisis in 1997. And when Russia's default roiled bond markets the following year, Agricole's chairman at the time, Lucien Douroux, closed down CAI's emerging-markets debt trading operation, contending that the business was akin to gambling.

"Not only have the caisses régionales repeatedly frustrated the investment banking arm's efforts to expand domestically for fear of competition, but as retail bankers they have also never been comfortable with the risk levels that are normal in this profession," says one former Indosuez executive who took early retirement last year.

After the Agricole-Lyonnais merger, Ferrero, who was named deputy chief executive of Crédit Agricole under CEO Jean Laurent as well as head of the investment bank, set out to build an integrated operation. He drew up a restructuring plan that called for putting the group's investment bankers in charge of all corporate relationships, including small and medium-size companies, which had always been controlled by the caisses régionales. Needless to say, the barons, led by Esparbès, put up fierce resistance. "In theory, Crédit Agricole Indosuez already controlled the group's relationships with France's large corporates," says the former Indosuez executive. "But in practice, if we wanted to do a syndicated loan destined for Toulouse-based Airbus or an investment banking operation for any other company, the head of the caisse régionale where the company was located would have to sign off on it. That kind of veto power strangled our domestic development and was something that Dominique was determined to change."

Ferrero also wanted to adopt the kind of streamlined marketing that has swept the industry in recent years, replacing the investment bank's single-product sales teams with a multiproduct sales force that could offer corporate clients everything from equities to loans to asset-backed securities. The aim was to improve productivity and profitability by cross-selling more products in the French market. Esparbès has maintained the old product-oriented sales approach but is beefing up the firm's ranks of high-powered account managers, known as senior bankers, in a bid to improve cross-selling.

A struggle raged within the bank for a year over Ferrero's plan, with Carron and Laurent desperately seeking to hold on to talented Lyonnais bankers loyal to Ferrero while at the same time trying to placate the powerful barons at Agricole's caisses régionales -- including Esparbès -- who strongly opposed the restructuring. Unable to persuade Ferrero to modify his plans, Carron and Laurent effectively forced his resignation in December 2003 and appointed Esparbès to take over the newly named Calyon. Ferrero, who works today as a vice chairman and French adviser at Merrill Lynch International, declined to comment for this article.

"Although Ferrero wanted to make the investment bank dominant, the development of Calyon's corporate finance activities is clearly once again subject to the approval of the caisses régionales," says Agricole Brie Picardie's Renaudin.

THE NEW LEADERSHIP TEAM AT CALYON IS A STUDY in contrasts. The beefy, pipe-smoking Esparbès is a native of Toulouse, in southern France, who speaks no English and has no capital markets experience. He wears off-the-rack suits, rarely leaves France and spends his free time gardening at his home in Les Sonnes, 40 kilometers south of Paris, or fishing for tuna and swordfish in the Bay of Biscay off the southwest coast of France.

As flashy as Esparbès is unassuming, Litzler is a soft-spoken, 46-year-old Parisian with long, wavy auburn hair who favors impeccably tailored suits and frequents art auctions in New York and London. His passion is collecting books with original illustrations by 20th-century masters, including Picasso, Matisse and Miró. During a two-year break from investment banking before joining Calyon, Litzler opened the Galerie Malaquais, a tony Left Bank exhibition space that specializes in modern figurative sculpture, and bought a lively neighborhood bistro named La Tête de Goinfre, or the Head of the Glutton, in the 17th arrondissement in northwest Paris. "I was very happy with my lifestyle, and I wasn't about to give it up for just any high-powered job," says Litzler.

Esparbès insists the two men have a common interest that transcends their personality differences. "What unites us is our desire to build something new at Calyon," he says. "More than prestige or money, the ambition to create something substantial is what motivates both of us."

Both men have an impressive record of success. The son of a furniture store owner, Esparbès earned a bachelor's degree in physics and a master's in computer science before going to France's Finance Ministry in 1966. He spent five years there overseeing the automation of administrative processes before joining Caisse Nationale de Crédit Agricole, or CNCA, as the bank was then known, in 1971. After rising rapidly through a series of midlevel positions, Esparbès was named a director of a regional bank, Crédit Agricole de Loiret in central France, in 1974. In that position and subsequently as deputy CEO of Paris-based Crédit Agricole d'Ile de France, he gained experience in retail and wholesale banking. He finally became a regional banking head in 1985 when, at age 41, he was appointed CEO of Crédit Agricole Loire Haute-Loire in central-western France and integrated what had been two separate caisses régionales. Four years later he was made deputy CEO of CNCA, which he helped transform from little more than a central treasury into a holding company for launching new ventures in consumer finance and asset management.

Esparbès came into his own, both as a manager and as a powerful baron, with his appointment in September 1993 as CEO of Crédit Agricole d'Ile de France. In his ten years there, the bank doubled annual revenues, to E700 million, and boosted net profit more than fourfold, to E237 million, 5.9 percent of the group's earnings. He achieved those gains in large measure by building banking relationships with big corporate clients. Today large corporates generate 22 percent of the regional bank's profits, up from about 10 percent when he arrived.

If Esparbès has the political clout within Crédit Agricole to support Calyon's ambitions, Litzler has the requisite technical expertise and flair to develop the capital markets business. Like many French investment bankers, Litzler studied math and engineering at École Polytechnique, France's top engineering school just south of Paris, graduating in 1983. The son of an engineer from Alsace in northeastern France, Litzler briefly worked for turbine maker Alsthom before joining Société Générale's fledgling equity derivatives team in 1989 as a trader, where he quickly demonstrated a knack for pricing volatility. He was made head of equity derivatives trading in 1993 and formed a triumvirate that included the overall equity derivatives head, Jean-Pierre Mustier, who today is chief executive of SocGen's investment bank, and sales chief Christophe Mianné, now global head of equity derivatives. Over the next six years, Litzler and his colleagues developed a range of products that transformed SocGen into a world leader in equity derivatives. Litzler helped pioneer the first derivative based on the performance of equity funds in 1995, the first reverse convertible in 1996 and the first correlation product -- puts and calls on tailor-made baskets of 20 or more stocks -- in 1997. He was promoted to global head of equities in 1999 and then named one of three co-heads of investment banking in 2001. That structure proved unstable, however, and Litzler was passed over when his colleague, Kim Fennebresque, was made sole head of investment banking in June 2002. Litzler resigned six months later.

Before the two men could start building up Calyon, Esparbès had to cut the overlaps created by the merger. In the 11 months between Calyon's formal creation in May 2004 and this March, he laid off nearly 2,500 employees, or 19 percent of the workforce, and unified the group's information technology systems. The moves have produced E490 million in savings, a target that Calyon had originally planned to hit by May 2007.

The process hasn't been painless. Calyon has hemorrhaged talent since Ferrero's departure, including Alain Papiasse, Calyon's vice chairman and the former head of Crédit Lyonnais's corporate and investment banking division, who now runs BNP Paribas's asset management business; Joel Jeuvell, head of capital markets first at Crédit Lyonnais and then at Calyon, who retired; and Cyrille Liabeuf, the head of equity derivatives at Calyon, who previously held the same post at Crédit Lyonnais. "It was a messy, violent integration, but one that is clearly behind us now," says Ishan Kapur, global head of Calyon's financial institutions group and a Crédit Agricole Indosuez veteran.

The cost cuts, combined with lower provisions for bad loans, helped Calyon boost net income by 20.9 percent in 2004, to E1.1 billion. Revenues tumbled by 15.1 percent, however, thanks in no small part to the staff turmoil, but they show signs of recovering this year. They rose by nearly 5 percent in the first quarter. "It was very important to complete the layoffs as quickly as possible, otherwise we would still be burdened with an unpleasant ambience for many months to come," says Esparbès.

Now comes the hard part -- going beyond cost-cutting to generate sustainable growth across Calyon's businesses. Litzler hopes to duplicate the kind of synergy between derivatives and asset management that Société Générale has achieved with its Lyxor Asset Management subsidiary, which exploits SocGen's derivatives prowess to offer exotic structured products. It may not be original, but the executive insists the new strategy will pay off.

"At almost every bank these operations are run by French," Litzler points out. "There has only been one school in equity derivatives. We will use our French identity and our savoir faire in this area as strong points."

That's easier said than done, analysts say. "Société Générale started Lyxor in 1998, when it had a dominant position in the derivatives market,'' says Lambert of Keefe, Bruyette & Woods. ''It's going to be tough to copy that success at Calyon, where they are starting from scratch.''

This fall, Calyon and Crédit Agricole Asset Management will launch a joint venture to develop structured products to be sold to the institutional clients of CAAM and to Calyon's clients worldwide. Sharing development expenses "should result in lower costs for both CAAM and Calyon while greatly increasing the range of products we can offer," declares Litzler.

Esparbès and Litzler also intend to market aggressively to financial institutions, including banks, insurers, hedge funds, portfolio managers and municipal authorities, a segment where Calyon has traditionally been weak. "Financial institutions are major consumers of market products and in particular equity derivatives," says Esparbès. "Given their strong appetite for all financial instruments, we should see cross-selling rise substantially as we build this particular client segment."

The two executives have hired about 30 new bankers to spearhead their growth plans. They include veterans like Gilles Trancart, 47, a former partner of Paris brokerage Oddo et Cie., who was hired in April to be head of market risk, and Michel Lefort, 46, who developed Citigroup's structured-finance business in France and will head up a new global structured-finance team at Calyon. Outsiders question whether Litzler will be able to afford to build an A-list team, however.

"One problem he will run into is paying the kind of salaries and bonuses necessary to attract the kind of experienced bankers and traders who can immediately boost business," says the head of a rival investment bank in Paris. Litzler recently poached Société Générale's head of equity derivatives trading, Fabien Hajjar, and its deputy head of structured products sales in Europe, Eric Le Brusq, to take up similar posts at Calyon, but most of his hires have been less-experienced bankers. That was his hallmark at SocGen, where he tended to hire young bankers at low salaries whom he could mold personally.

At Calyon he may not have any other choice. The bank has budgeted 10 to 15 percent of expected revenue growth through 2007 for new hires and technology upgrades. That implies spending of just E100 million to E150 million. By contrast, HSBC has plowed $440 million into growing its investment banking business over the past two years, and Bank of America is halfway through a $675 million buildup it announced at the start of this year. Neither of those institutions has come close to fulfilling its ambitions yet.

That disparity in resources casts doubt on Calyon's ability to become a major force in investment banking, rivals and analysts say. Even Esparbès appears to be modifying his goals. He initially told Institutional Investor that his goal of becoming an investment bank of reference meant getting into the top ten globally. But at a subsequent presentation in Paris in June, he said his goal was to "solidly install Calyon among the top ten European-based investment banks" over the next two years. Calyon ranked tenth last year by revenues in that cohort, just ahead of Dresdner Kleinwort Wasserstein.

All of which suggests that after fighting internally to contain the ambitions of investment bankers, Esparbès will struggle to help them grow. i