Societe Generale Undermined by Greek Debt Crisis After Kerviel

Frederic Oudea, chief executive officer of Societe Generale
Frederic Oudea, chief executive officer of Societe Generale SA, pauses during a news conference in Paris on Feb. 16, 2011. Fabrice Dimier/Bloomberg

In a locked room on the 33rd floor of Societe Generale SA’s 36-story headquarters in western Paris, members of the bank’s fraud control team peer at their computers, scrutinizing the trades being executed by dealers in eight trading rooms on the floors below.

They’re searching for clues that Societe Generale might harbor another Jerome Kerviel, the junior dealer who bank officials discovered in January 2008 had amassed some 50 billion euros ($72 billion) of unauthorized trades -- which, when unwound, cost the bank 4.9 billion euros in losses.

The sleuths investigate when a trader triggers one of about 80 different alerts built into the bank’s proprietary security system, Bloomberg Markets reports in its September issue. They include exceeding a euro trading limit, deferring a transaction date or failing to take vacation -- all behavior that Kerviel, now appealing a fraud conviction and a three-year prison sentence, displayed as he frantically tried to cover wrong-way bets on the direction of the stock market.

“We introduced specific controls to guard against what Kerviel did,” says Severin Cabannes, the bank’s deputy chief executive officer with responsibility for fraud and risk control. “We can now say that his kind of fraud is no longer possible.”

With Kerviel in mind, SocGen CEO Frederic Oudea has made “growth with lower risk” his top priority since taking over France’s second-largest bank by market value in 2008, repeating the phrase almost every time he speaks to analysts, investors and the press.

Heavy Greece Exposure

Today, Oudea, 48, faces hazards from a different direction. SocGen and other French banks are heavily exposed to the sovereign-debt crisis enveloping Greece and other euro-zone nations. SocGen owns 88 percent of Athens-based Geniki Bank SA - - whose stock was down 51.9 percent this year as of July 25 -- and held 2.5 billion euros of Greek debt at the end of March, SocGen reported.

“A default by Greece would trigger a catastrophe for Societe Generale,” says Jacques-Pascal Porta, who helps oversee $400 million, including SocGen shares, at Paris-based investment firm Ofi Gestion Privee.

Oudea insists the bank has the resources to weather whatever happens in Greece.

“Given our exposure to Greek sovereign debt, the direct impact of any restructuring scenario would be manageable for the bank,” he said on June 28.

Moody’s Threatens Downgrade

SocGen’s Greek exposure was one reason Moody’s Investors Service announced on June 15 that it was reviewing the lender’s rating and that of two other big French banks in anticipation of a downgrade. France holds more Greek loans than any other European country: $56.7 billion, including $15 billion in sovereign debt, the Basel, Switzerland-based Bank for International Settlements says.

In July, the panic spread from Greece to Italy after Moody’s and Standard & Poor’s said they were reviewing ratings for that country and its banks.

As the Italian crisis unfolded, SocGen’s shares plunged, falling 14.4 percent from July 1 to July 11. The lender’s shares tumbled 5.5 percent more on July 18 following the release of the results of stress tests conducted by the European Banking Authority on 90 banks, including SocGen.

“The tests show that Societe Generale is at the tail end of large European banks, with a capital position that’s more stretched than bigger rivals,” says Francois Chaulet, who helps manage more than 200 million euros, including SocGen shares, at Montsegur Finance, an investment firm in Paris.

New Bailout Plan

European Union officials announced a new rescue package for Greece after markets closed on July 21 in which it would be given 159 billion euros of new aid with lower interest rates and longer repayment terms. Private banks agreed to participate in the rescue by writing down the value of their Greek bonds by 21 percent as part of a bond exchange and debt buyback program.

SocGen and BNP Paribas SA, France’s largest bank, are among banks supporting the plan, according to a statement by the Washington-based Institute of International Finance. SocGen’s shares jumped 6.2 percent on July 21, to 38.23 euros, in anticipation of the agreement. The shares closed yesterday at 36.27.

“It’s excellent news for banks, including SocGen,” Chaulet says.

Beyond the sovereign-debt crisis, Oudea says he has addressed the issues that have caused 147-year-old SocGen to lose two-thirds of its market value since 2007.

On the same day that bank executives announced Kerviel’s fraud in January 2008, they disclosed they had taken 2.1 billion euros in writedowns, mostly against U.S. debt securities SocGen held.

Risky Paper

That turned out to be just a small part of about 11 billion euros in credit losses and writedowns the bank has reported since 2007. And SocGen still has 29.5 billion euros of securities in its legacy assets division, which holds risky paper whose market value plummeted during the financial crisis.

Oudea’s fraud controls are part of a larger reorganization. The CEO has combined the once-autonomous equity derivatives unit, where Kerviel worked, with the fixed-income operation, grouping all of the bank’s traders into a single capital-markets division. In addition to strict, monitored trading limits, the bank has imposed a raft of other security measures, including biometric codes and frequent password changes for staff members seeking access to confidential financial data.

Still, Oudea’s overall strategy is little changed from that of his predecessor and mentor, Daniel Bouton, says Chaulet. Bouton resigned as CEO in 2008 in the wake of the Kerviel scandal. The lender relies for about half of its profits on its corporate and investment bank.

Equity Derivatives

That division has only one product in which it’s a world leader: equity derivatives, which are options on stocks and stock indexes that the bank creates for customers and trades for its own account. And Oudea, like Bouton, is looking for future growth in volatile emerging markets, including Russia and the Middle East.

“My aim is to ensure that Societe Generale appears at the end of four years as one of the strongest banks in this landscape,” Oudea says, grabbing a notepad and, with swift pen strokes, drawing a crude diagram showing Europe as the bank’s hub and the Middle East, North Africa and Russia as the spokes.

At least for the short term, that commitment is hurting SocGen’s bottom line. SocGen’s 2004 acquisition of Geniki Bank has never earned it a penny. In 2010, the Greek lender’s losses almost quadrupled to 411 million euros, as steep public-spending cuts slowed the economy. On May 4, Geniki reported a first-quarter loss of 98.6 million euros, double its deficit of a year earlier.

Mideast Turmoil

Operations at SocGen’s network of retail bank branches in the Middle East, including Egypt, Tunisia and four other countries, have been disrupted by the turmoil there. And the bank has a 700-branch retail network in Russia that from 2008 to 2010 cost it about 450 million euros, according to SocGen data.

Partly because of its exposure to the Middle East and Greece, SocGen reported on May 5 that first-quarter profit fell 14 percent from a year earlier, to 916 million euros.

Oudea told shareholders on May 24 that the recent bad news hadn’t knocked the bank off track. Anchored by its profitable French retail bank, which has earned 1 billion euros or more every year since 2005, SocGen was one of a clutch of big European banks to come through the financial crisis without losing money. Net income was 2 billion euros in 2008 and 678 million euros in 2009. Oudea’s goal is to deliver a profit of 6 billion euros in 2012.

M&A Push

One avenue to that goal is the expansion of SocGen’s investment bank in areas such as mergers and acquisitions, Oudea says. Since mid-2010, he has added 15 senior M&A executives around the world, hiring some of them from competitors Credit Suisse Group AG, JPMorgan Chase & Co. and BNP Paribas.

“The big money in investment banking, in a world that requires more and more capital, is advisory, initial public offerings and equity trading,” says Peter Hahn, a professor of finance at London’s Cass Business School and a former managing director at Citigroup Inc. As of July 25, SocGen ranked 17th in global M&A, according to data compiled by Bloomberg.

Meanwhile, SocGen continues to make money via equity derivatives. They contributed more than 25 percent of sales for the group’s corporate-lending and investment-banking division in 2010, according to estimates by Kian Abouhossein, a London-based analyst at JPMorgan.

Beating Goldman Sachs

“Societe Generale has a superb equity derivatives business,” says Abouhossein, who forecasts that in 2011, the French bank’s unit will be No. 1 worldwide, ahead of Goldman Sachs Group Inc.

SocGen will have $3.9 billion of revenue from equity derivatives this year compared with $3.4 billion for Goldman, he calculates. The bank itself doesn’t break out separate numbers for derivatives.

Those securities include both conventional put and call options and complex structured financial products traded over the counter. The equity derivatives unit includes men and women with advanced degrees in engineering and financial mathematics from prestigious schools such as Ecole Centrale Paris and Ecole Polytechnique.

Oudea’s ambition to expand the investment bank will be hamstrung by the dearth of business it does in the U.S., says Simon Maughan, co-head of European equities at MF Global Ltd. in London.

‘One Bank Everywhere’

“The world’s biggest companies and financial institutions want to deal with one bank everywhere, including the U.S.,” he says. “Why does anyone need a bank that just specializes in Europe?”

Oudea’s shunning of the U.S. is in line with the policy of his predecessor, Bouton, who says he didn’t think SocGen could compete for U.S.-based clients in fixed-income products.

“I didn’t want to go head-to-head with the world leaders in this market, like Goldman Sachs and Morgan Stanley,” says Bouton, 61, who’s now an adviser to private bank Rothschild & Cie.

Oudea says SocGen can achieve a wide international reach while rooted in Europe because the bank still offers clients a full range of services and products denominated in dollars.

Fabrice Remon, who heads the French office of Deminor International SCRL, a Brussels-based advisory firm for minority shareholders, questions whether Oudea is the man to plot the bank’s future. Oudea was SocGen’s chief financial officer from 2003 to 2008. He was a protege of Bouton, who hired him in 1995 to help run SocGen’s U.K. corporate-lending division.

ENA Graduates

Both men are graduates of France’s Ecole Nationale d’Administration, a training college for the country’s highest-ranked civil servants and top executives, and both served as senior government officials before joining SocGen.

“Societe Generale should have put someone at the helm who had no conflict of interest and was sufficiently independent rather than Oudea, who was so implicated in the crisis,” Remon says.

Oudea is lucky he wasn’t ousted along with Bouton, says Anis Bouayad, founder of Strategie Alliance, a business advisory firm in Paris.

“Logic required that no one on the management board should have been spared, starting with Oudea,” he says. “However, it wasn’t in the interest of shareholders to decapitate all of the bank’s senior management.”

Anthony Wyand, SocGen’s senior independent director, defends Oudea’s role, saying he “absolutely was not involved with Kerviel.”

Collective Responsibility

Oudea, striding around SocGen’s 35th-floor CEO suite, which commands a view of the Arc de Triomphe 3 miles (4.8 kilometers) east, says SocGen’s management board in 2008 shared collective responsibility for Kerviel. And he insists that the scandal -- and the bank’s purchase of tens of billions of dollars of toxic debt -- are in the past.

If Kerviel hadn’t happened, both Bouton and Oudea say, SocGen would have received praise for staying profitable during the credit crunch.

“Societe Generale fared well in the global financial crisis of 2008 and 2009 compared with a lot of its peers,” Oudea says.

Still, the damage in 2008 would have been far worse if SocGen hadn’t protected itself against the default of some $11 billion in securities backed by U.S. mortgages with credit-default swaps it bought from insurance giant American International Group Inc. After the U.S. government took over AIG in September 2008, it paid more than 20 banks 100 percent of what AIG owed on the swaps. SocGen was No. 1 on the list.

AIG Payoff

Oudea says SocGen was entitled to be paid in full on the swaps. “We had legal contracts, and all we did was apply the legal contracts,” he says.

SocGen’s bankers give themselves too much credit for their handling of Kerviel and the market meltdown, says Jerome Forneris, who helps manage $11 billion, including SocGen shares, at Banque Martin Maurel in Marseille.

“They told us at the time they had maximum risk controls, and they didn’t see Kerviel,” he says. Forneris now says Oudea has done a good job of turning the bank around.

Dirk Hoffmann-Becking, an analyst who covers European banks at London-based Sanford C. Bernstein Ltd., says SocGen management’s confidence in its strategy is misplaced. He says Oudea should curb his ambitions and stick with what works.

“Societe Generale should just try to be a decent retail-banking player in France, a corporate lender across Europe and do equity derivatives,” Hoffmann-Becking says.

And it should beware of Greeks bearing bonds.

Editors: Michael Serrill, Laura Colby

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