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Saving Société Générale

New CEO Frédéric Oudéa remains in control of French bank's destiny.

Never let a crisis go to waste. That saying from Rahm Emanuel, President Barack Obama’s chief of staff, embodies the U.S. administration’s philosophy in addressing today’s financial and economic turmoil. Frédéric Oudéa, the CEO of Société Générale, has taken a similar approach.

In January 2008 the French bank was jolted by the disclosure that a rogue trader, Jérôme Kerviel, had run up a massive loss of €4.9 billion ($6.6 billion). The size of Kerviel’s allegedly unauthorized trading position in European stock index futures stunned the banking community, sent global markets into a free fall and fueled speculation about the possible demise of the 145-year-old institution. But Oudéa, a former CFO who was promoted to deputy CEO and then chief executive to lead the bank’s response to the crisis, moved smartly to bolster its capital and tighten controls. One month after the loss was revealed, Oudéa organized a rights issue that raised €5.5 billion. He also implemented a 25 percent reduction in risk exposures at Société Générale’s corporate and investment banking unit, where Kerviel had worked.

Those moves, which many outsiders doubted would be enough to preserve Société Générale’s independence, ended up positioning the bank well to ride out the even bigger storms to come. Just five days after the rights issue, Bear Stearns Cos. collapsed, triggering a global liquidity scare. Six months later, Lehman Brothers Holdings failed, causing markets around the world to seize up and governments to arrange unprecedented bailouts of major banks. But throughout this turmoil, Société Générale, France’s third-largest bank by assets, with €1.2 trillion, has stayed in the black and avoided the massive write-downs that have crippled many larger competitors.

“What we have managed to do is actively fashion a business that will do well in a banking environment of lower growth, lower transaction volumes and less appetite for risk,” Oudéa, 45, told Institutional Investor during a recent interview in his wood-paneled office on the 35th floor of Société Générale’s headquarters in the La Défense district on the western edge of Paris. “Our aim is to survive in today’s tough times, take market share in highly focused areas and emerge from the crisis stronger than our rivals.”

To be sure, Oudéa still faces plenty of challenges. The economic downturn in Western Europe is starting to cut into revenues and profits in the bank’s core retail and investment banking businesses. Severe recessions in Central and Eastern Europe pose a major threat to Société Générale’s big banking network in the region, a major growth driver in recent years. Although the bank was one of the few big European lenders to turn a profit in the fourth quarter of 2008, it did so only by taking advantage of a change in European mark-to-market accounting rules to avoid €1.5 billion in asset write-downs. The group did take a €300 million goodwill write-down on Rosbank, a major Russian retail bank in which it holds a 57.6 percent stake.

Caveats aside, though, Société Générale is outperforming many of its rivals, and Oudéa remains in control of its destiny. The bank posted net income of €2 billion last year, more than double the €947 million earned in 2007, the year that included the Kerviel loss; revenues slipped just 0.3 percent, to €21.9 billion. By contrast, French market leader BNP Paribas reported a 58.5 percent drop in earnings in 2008, to €3.5 billion, as revenues fell 11.8 percent, to €27.4 billion. Société Générale’s shares have performed somewhat better than average over the past year, even with investor concerns about the impact of Eastern Europe’s recession on the bank’s business there. At €37.80 late last month, the stock was down 48 percent over the past 12 months. By contrast, brokerage firm Keefe, Bruyette & Woods’s index of large-cap European bank stocks fell by 57 percent in the same period; BNP Paribas shares declined 43.9 percent.

“Clearly, no one is immune to the global economic crisis, but the bank’s fourth-quarter performance is proof of an exceptionally solid franchise,” asserts Helmut Hipper, a fund manager at €145 billion-in-assets Union Investment in Frankfurt, which has an undisclosed position in Société Générale. “You could say Kerviel created a highly capitalized and disciplined bank, better positioned than its peers when it comes to surviving and even thriving.”

With the bank trading at 5.3 times 2008 earnings, versus a European average of 9.1 times, many analysts and investors regard it as undervalued. KBW London-based analyst Jean-Pierre Lambert rates Société Générale outperform. “I’ve gone from thinking that Kerviel could irredeemably destroy Société Générale’s reputation, and its independence, to seeing the trading scandal as an electroshock that’s forced the bank to adapt earlier and more coherently to the crisis than its rivals,” explains Lambert. “Now Société Générale could be one of the consolidators of European banking as soon as some clarity and stability return to the global economy.”

Société Générale is Europe’s eighth-largest bank in terms of assets and 12th-largest by market capitalization, at €22 billion. It boasts 27 million clients worldwide, a 10 percent share of the French retail market and one of the biggest banking networks in Central and Eastern Europe, with 2,735 branches in 37 countries, including the Czech Republic, Romania and Russia. The CEE region accounts for just under 11.6 percent of the bank’s total loans of €387 billion, suggesting that the risks posed by the economic turmoil in the region are manageable for Société Générale. French retail banking generates roughly one third of the group’s revenues; corporate and investment banking account for another third; and the remainder comes from Central and Eastern Europe, consumer credit and leasing subsidiaries, and asset management.

With €2.5 billion in exceptional losses, write-downs and provisions in 2008, and almost no exposure to subprime mortgages, monoline insurers or other hard-hit assets, Société Générale’s balance sheet is relatively solid by the standards of Europe’s battered banking industry. It has €30.4 billion in tier-1 capital, an amount equal to 8.8 percent of its risk-weighted assets, ahead of the European banking average of 8.6 percent and BNP Paribas’s 7.8 percent. The bank took a €1.7 billion subordinated loan from the French government to bolster its capital last October, less than the €5.1 billion in preference shares that BNP Paribas sold to the state.

Having a stable balance sheet gives the bank time to develop and execute a long-term strategy for a more risk-averse world, says Oudéa. “There will be revenue growth in banking, but less than in the past as product innovation is constrained by risk, making operational efficiency and highly focused scale absolutely essential profit drivers going forward.”

Oudéa was raised in Nantes in the western Loire Valley, then moved to Paris at 13 with his mother, a pharmacologist and AIDS researcher, after his father, a gastroenterologist, died. After attending Louis Le Grand, one of the country’s top high schools, Oudéa earned the French equivalent of a master’s degree at the Ecole Nationale d’Administration, the training ground for elite French bureaucrats, in 1987. He joined the civil service and rose to senior aide to then–Budget minister and current French President Nicolas Sarkozy before resigning in 1995 and joining Société Générale as deputy head of corporate banking in London. Tapped to lead the division less than a year later, Oudéa helped increase sales of the bank’s flagship equity derivatives products by forging closer cooperation between the structured finance and corporate banking teams. He returned to Paris in 1998 as deputy to the head of equity trading, Marc Litzler, and helped focus the division more strongly on equity derivatives after the collapse of technology stocks in 2000.

Oudéa was appointed deputy chief financial officer in 2002 and then CFO the following year. Over the next five years, a period in which Société Générale’s assets virtually doubled and operations became much more complex, Oudéa “made the bank’s accounts more transparent and improved communications with investors,” says Pierre Flabbée, an analyst at Kepler Capital Markets in Paris.

A collegial, low-key executive who remains calm under pressure, Oudéa took charge in the stressful aftermath of the Kerviel affair, putting in three days of virtually uninterrupted work tracing the financial damage of the trader’s positions before the bank publicly announced the loss and then spearheading the rights issue. His success with that crucial capital raising won him quick promotion, first to deputy CEO, in March 2008, and then the following month to CEO, replacing longtime chief executive Daniel Bouton, who ceded the post to take responsibility for the Kerviel affair but stayed on as chairman.

Late last month, Bouton suddenly announced his intention to resign in May after a wave of criticism, including from President Sarkozy, forced him to renounce a grant of 70,000 stock options. Both Bouton and Oudéa have said that, in today’s high-risk environment, they favor keeping the responsibilities of chairman and chief executive separate.

Oudéa readily acknowledges that he has never been in charge of an operating division and leans heavily on a handful of senior executives. “For me it is a major priority to build a team where I have real complementary expertise,” he says. “It is difficult for any one man to know all our businesses, products and geographies.”

One of Oudéa’s first moves as CEO was to overhaul Société Générale’s approach to risk. In May 2008 he appointed the bank’s head of information technology, real estate and purchasing, Séverin Cabannes, to the newly created post of deputy chief executive in charge of risk and productivity. “Going forward our potential for growth will be determined much more than in the past by a profound and in-depth analysis of risk,” says Cabannes, 50.

In January, in consultation with Oudéa, Cabannes created a 400-person product control group for corporate and investment banking. Separate from traditional back-office settlement and clearing, the group conducts daily audits of profit and loss and monitors capital allocation based on risk trends. “It will improve both risk control and efficiency,” asserts Cabannes. He also set up an operations security unit called “Safe” that aims to guard against fraud and flag any excessive concentration with counterparties or buildups in illiquid or complex securities. The moves are likely to decrease leverage and increase caution at the investment bank, which should reduce risk but could also lower profit margins.

Oudéa has brought in new blood at the top of the investment banking arm as well by appointing Michel Péretié, who headed Bear Stearns’ European business before the bank’s collapse, as CEO. Péretié, 54, replaces Jean-Pierre Mustier, who had been seen as a potential successor to Bouton before the Kerviel affair and now heads asset management.

Undaunted by the rogue trading scandal, Péretié is looking for opportunities to pick up business in a market where many rivals, such as Royal Bank of Scotland and UBS, have had to retrench. “It is difficult in good times to increase market share, but in hard times, especially today, when so many rivals have collapsed or are under financial pressure, it’s not so hard,” he insists.

Société Générale tops most interdealer polls as the world’s top counterparty for standard and customized single-stock derivatives, equity index options and exotic equity derivatives linked to other asset classes like bonds or commodities. The investment banking unit has also gained market share in the revived fixed-income market. The bank ranks seventh so far this year in European debt capital markets, serving as book runner on 101 deals worth $46 billion as of late last month, up from a tenth-place finish for all of 2008, according to London-based financial data provider Dealogic. In European syndicated loans the bank is in fourth place in the league tables this year, acting as lead book runner on 17 transactions worth €7.3 billion, up from fifth place last year, Dealogic reports.

Péretié even sees room to expand into some new areas, notably mergers and acquisitions. “We are a top-tier M&A firm in France and advise clients throughout Europe on asset and liability management as well as on balance-sheet restructuring,” he says. “It is a natural step to add European M&A into the discussions we have with our clients.” The bank is No. 4 in French M&A so far this year, advising on five deals worth €2.9 billion, up from 16th last year. It ranks a lowly 28th in European M&A, down from 18th in 2008.

Cost-cutting is another big part of Oudéa’s agenda. The CEO aims to save €1 billion in operating expenses by the end of 2010 by allocating capital more efficiently, pulling back from subscale businesses and eliminating duplication among business lines.

In one big early move, Oudéa agreed in January to spin off Société Générale’s traditional long-only investment unit, Société Générale Asset Management, into a new joint venture with rival Crédit Agricole. By shedding control of the midsize fund management arm and its €178 billion in assets, the bank expects to generate annual savings of €120 million within three years. Société Générale will retain a 30 percent interest in the as-yet-unnamed business, which, with €638 billion in assets, would be Europe’s sixth-largest fund manager, according to II’s annual ranking of Europe’s top money managers.

The decision to pair up with Crédit Agricole in asset management was inspired by the success of Newedge Group, a 50-50 joint venture that the two banks launched last year to combine their futures brokerage businesses.

Société Générale is also in exclusive negotiations with La Poste to handle the state-owned postal bank’s push into consumer finance following a recent government decision to permit La Poste to offer such products as mortgages and life insurance. The deal would help Société Générale increase its own consumer activity without adding costs.

“Wherever we don’t have the right scale, we are prepared to partner with others,” says Oudéa. “We are particularly interested in deals that allow us to build up where we have market-leading expertise.”

One such area is in alternative investments. The asset management joint venture with Crédit Agricole excludes SGAM’s Alternative Investment unit, which manages €24.5 billion in hedge funds, private equity, real estate and guaranteed funds. The unit is being merged into Lyxor Asset Management, an alternative-investment arm of Société Générale’s corporate and investment bank. Lyxor, which has built up €60.8 billion in assets in just 11 years’ existence, is Europe’s biggest player in funds of hedge funds and its second-largest provider of exchange-traded funds. Although most alternative-asset managers experienced an outflow of funds last year, Lyxor, which provides weekly updates on asset values, saw a net inflow of €3.4 billion.

Lyxor should continue to benefit from an environment in which investors are looking to improve returns, cut costs and ensure the preservation of assets in the wake of the Bernard Madoff scandal, notes Mustier, who has headed asset management since September. “We will see massive rationalization in the alternative-investment industry and in the fund management business generally,” says the 48-year-old executive. “Given that only market leaders with the cheapest, most robust and transparent services will be able to thrive and increase assets under management, merging AI into Lyxor makes perfect sense, as does the spin-off of our more traditional management operations into an entity with true global scale.”

The bank is keeping control of its U.S. asset manager, the $97 billion-in-assets Los Angeles–based TCW Group, which uses its extensive relationships with U.S. banks and investment advisers to attract alternative-investment management talent looking for distribution muscle and Société Générale’s big balance sheet. “Previously, investors were much happier to put their money in small start-ups because the manager had a few interesting ideas and a cool persona that it was fun to identify with,” says Mustier. “In this more risk-conscious world, going that route is a luxury clients can no longer afford.” The deal with Crédit Agricole will give the new joint venture a 30 percent stake in TCW, with Société Générale keeping 70 percent ownership.

Having survived a crisis of its own making, Oudéa avers, Société Générale is prepared to take advantage of the wider troubles in the global industry. “With less-well-run banks struggling to survive today, we expect there will be a huge opportunity to gain market share in everything from mergers and acquisitions to Eastern European retail banking if we use our capital strength and existing expertise judiciously,” he says. That’s more than anyone could have said of the French bank a year ago.

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