France's Societe Generale SA plans to sell shares in its most profitable business: car leasing.
An IPO of a minority stake should help unlock value for the bank's shareholders without them having to give up the full benefit of the business's reliably high returns -- assuming the French election doesn't produce a nasty shock. But the company will need to prove it can keep managing risks in a market that's getting increasingly racy.
For SocGen, leasing vehicles to corporate customers and managing other people's fleets has been a more lucrative business than trading derivatives, as Bloomberg News's Fabio Benedetti-Valentini points out.
The bank's ALD unit has hoovered up assets from Deutsche Bank AG, Hertz Corp. and Wendel SA over 15 years, swelling its fleet to 1.3 million cars. Its return on equity has historically been about 20 percent -- about twice the returns most big investment banks expect from their core business. SocGen reckons it will stay at that level in coming years.
But skeptics think the broader auto leasing market, especially in the U.S. and U.K., is starting to look frothy. Cheap credit has helped fuel a seven-year rebound in the autos market. In the U.S., sales of vehicles tied to lease contracts have grown 230 percent since the low of 2009, according to analysts at Exane BNP Paribas.
The risk here is not so much a traditional credit crunch, but more a drop in prices as used cars flood the market, something that has happened before, notably during the financial crisis. My Gadfly colleague Chris Bryant has pointed out that about 1 million more off-lease vehicles will be available in the U.S. this year compared with 2015. That could put pressure on vehicle prices -- and force leasing companies to write down the value of their assets.
ALD has some protection against a correction in the U.S. or Britain. Its top three markets by fleet size are France, Germany and Italy, according to a 2015 presentation -- though Britain is No. 4 and ALD does have a partnership in North America with Wheels.
Gilles Momper, ALD's finance chief, said in 2015 that while residual value was the "main risk" carried for customers, Europe's used-car prices had never quite recovered to their pre-crisis levels. The company has also been careful to point out valuations are set locally, reviewed centrally and benchmarked against competitors.
This is encouraging. But a deep correction in the U.S., where loan losses are already rising, would hardly leave Europe unscathed. And even strong banks have been taken by surprise in the past: Santander SA's subprime auto lending business in the U.S. has been a headache for the Spanish lender, attracting regulatory scrutiny over its accounting methods.
For SocGen, the timing makes sense, considering ALD's strong run of profit growth and the pressure on Europe's banks to shore up their balance sheet. But given the overheating market for auto loans, risk management will need to be a part of the story for investors.
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