Business Week International Finance: BAD DEBT
A $27 BILLION RESCUE-AND IT MAY NOT BE THE LAST (int'l edition)
It's the first day of spring, and Credit Lyonnais Chairman Jean Peyrelevade is talking rejuvenation. Seated on a sofa at the bank's Paris headquarters, he is mulling the $27 billion rescue plan--the second in a year--that he hammered out for the state-controlled bank. With a balance sheet cleansed of the ill effects of one of the worst-timed expansion drives in banking history, Lyonnais "is ready to leave this humiliation behind and recoup its pride," he states confidently. "We are ready to start up again forcefully on a commercial basis."
But the markets don't seem to share Peyrelevade's spring optimism. In the days following the unveiling of the rescue plan on Mar. 17, the bank's traded shares lost 17% as analysts concluded that the deal could turn the former lion of French banking into a lamb meek enough to need yet another giant rescue.
DEEP POCKETS. Getting back to profitability after three years of losses, including a $12 billion shortfall last year, "is more a hope than an analytical certainty," figures Standard & Poor's Corp. banking analyst R. Scott Bugie. While other ratings agencies left Lyonnais ratings unchanged, Standard & Poor's on Mar. 20 placed the bank's debt on watch.
The warning signs are clear: After operating as a state bank with infinitely deep pockets, Credit Lyonnais will now have to compete on a more equal basis against private French banks as it prepares for privatization down the road. It will be saddled with 65,000 employees and high overhead that raises the bank's operating costs 10% to 20% above those of its competitors. Even if Lyonnais turns a profit this year, as Peyrelevade plans, the bank could be forced to pay back a hefty slice of profits for years to come as part of the bailout plan. And its reserves are virtually nil. So if the economy turns down or more problem loans appear, the bank could easily see its losses mount again.
LOUD PROTESTS. On top of that, Lyonnais will face countless problems rebuilding its reputation as it sells off a chunk of its $400 billion in assets and unwinds the Napoleonic expansion drive launched under ex-Chairman Jean-Yves Haberer. Already, France's generous bailout terms are drawing howls of protest from private banks about unfair subsidies. "Credit Lyonnais and the other French banks are going to be spending a very long time sweating out their problems," observes Robin Monro-Davies, managing director of bond rating agency IBCA Ltd.
The rescue is as massive as the mismanagement that produced it. The package will allow Lyonnais to transfer $27 billion in troubled assets to a special company. Among those assets are $8.5 billion in problem real estate loans, a $4 billion exposure from its ownership of MGM Studios, and $9 billion in equity holdings. Under the agreement, Lyonnais will not only make a concessional loan to the state to finance the purchase of its own assets but will repay to the government between 34% and 60% of its profits--depending on its return on equity--for as long as 20 years.
Peyrelevade also aims to sell an additional $20 billion in assets to boost the bank's efficiency and shed troubled businesses. Among likely candidates: unprofitable retail banking operations in Portugal and Spain. Peyrelevade will rely for growth on remaining retail banking operations in Europe, wholesale banking, and on foreign exchange and equities trading operations.
CUTTING SHORT. French taxpayers could be on the hook for $10 billion or more as the French government tries to dump the $27 billion asset bundle. The cushiness of the deal has already drawn an extraordinary attack from Banque Nationale de Paris Chief Executive Michel Pebereau and Societe Generale chief Marc Vienot. In what has developed into ongoing public scrutiny of Lyonnais' every move, the two on Mar. 21 charged that Lyonnais would benefit from an "operating subsidy" that will distort competition.
They aren't the only ones who see a sweet deal in the rescue plan. Lehman Brothers Inc. London analyst Sheila Garrard even argues that Lyonnais' shares are now a buy because its payments to the government won't exceed what the bank would normally pay in taxes. Moreover, Peyrelevade optimistically plans to privatize the bank in five years. That would end paybacks to the government. And while Lyonnais' rivals continue to put aside reserves against ongoing real estate problems, wiping the slate clean at Lyonnais "is as though the bank came through the recession with a year or two's advance" on its competitors, Garrard notes.
Even that may not be enough to restore Lyonnais to profit. Instead of the complicated package, Lyonnais would have preferred to receive cash up front in the form of a recapitalization from state coffers. Now, with virtually no reserves and a capital ratio that barely meets minimal international standards, even a cleansed Lyonnais will find it tough to stay afloat. It's a far cry from the days the bank talked of becoming the Gallic counterpart to Deutsche Bank. For example, some analysts worry that the loan portfolio left on Lyonnais' books after the rescue remains vulnerable to a deeper slump in French real estate.
Still other factors could hinder the bank's rebound efforts. While Lyonnais once found it simple to use its state backing to win corporate business with lower interest rates and looser surveillance on loan performance, it will now have to live with the crowded French banking sector's razor-thin profit margins. Another key problem, figures IBCA's Monro-Davies, is a monetary policy driven by France's European integration agenda that keeps interest rates high to maintain the French franc's strength against the mighty German mark. That is dampening growth at a time when the banks are desperately in need of it.
And while Lyonnais' competitors complain about its favored treatment, France's entire banking sector is hobbled by other state-supported institutions. Competitors such as the Post Office and other state-lending institutions are governed by more favorable rules than the banks live under. For example, the government is injecting $200 million in new capital into a state-owned lending institution that doesn't take deposits but competes aggressively with banks to lend to small and medium-size businesses.
As Lyonnais fights to get competitive fast, the government's role in French banking will weigh on it in other ways. To reassure shareholders and clients, Peyrelevade could make drastic cuts to Lyonnais' costly global workforce. But that's "legally impossible" under existing labor rules, he says. Instead, he envisions just a 10% reduction over three years. Next year, he plans to eliminate 4,000 jobs, half of them from the bank's 37,000 French employees.
Despite such constraints, Peyrelevade remains upbeat. Investors "ought to take advantage" of a rescue package that could turn France's biggest banking debacle into its proudest privatization moment, he says with a smile. Given the challenges facing the new Credit Lyonnais, however, those investors might worry they haven't seen the last rescue yet.
THE WOES FACING CREDIT LYONNAIS
PROFITS are unlikely to exceed $200 million in 1995, with 34% going to the government
OPERATING COSTS are 10% to 20% higher than at competing private banks
LOAN PORTFOLIO is vulnerable to economic slowdown and new problems in real estate
RESERVES to cover future problem loans are virtually nil
RETAIL CLIENTS are closing accounts because of concerns about the bank's solvency
DATA: BUSINESS WEEKBy Bill Javetski, with Mia Trinephi, in Paris