The Curious Case Of Credit Agricole - Part I

Dec. 04, 2012 12:20 PM ET
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Sahil Alvi is a management consultant, economist, intra-preneur, and writer. Sahil lives and works in Dubai. He is strategy consultant with a global consulting firm where he leads the firm’s strategic and business development initiatives including origination of strategies and opportunities for the firm and its clients. Sahil started his career with the Advisory practice of Ernst & Young in Atlanta. Along the way, he helped build a startup into a high-growth enterprise in Miami. Sahil has also held a management consulting position with PricewaterhouseCoopers in Los Angeles. Over the course of his career, he has advised several Fortune 500 clients and startups on strategic, financial and operational issues. His functional experience includes a variety of disciplines such as: Commercial Due Diligence / Investment Analysis, Growth Strategy, Business Transformation, and Risk Management. Sahil's industry experience spans: - Financial Services (Insurance, Private Equity, Venture Capital & Hedge Funds) - Real Estate & Hospitality - Healthcare (Payors and Providers) - Distribution & Logistics - Consumer Internet/Web 2.0 - Energy & Natural Resources - Special Economic Zones. He has had the opportunity to live or work across: US, India, UAE (Dubai / Abu Dhabi), Canada, Netherlands, Germany, France, Saudi Arabia, Oman, Qatar, Bahrain. Sahil holds an MBA (Entrepreneurship) from Wake Forest University in North Carolina, USA and a BA (Economics) from University of Bombay in Bombay, India. Sahil's avocations include: Tennis, Product & Furniture Design, Abstract Expressionistic Painting, Photography, Biking, Blogging, and Reading Literary Classics, Poetry, Management Thinking, and Economic Policy tomes. He can be reached at:

Part I


Every once in a while a trade comes along that defies all macro-economic logic, market fundamentals, valuation metrics, technical analyses, and good old common sense.

Everything you ever held sacred, sensible, and proper about - admittedly somewhat "inefficient" markets - is left thoroughly violated.

The third-largest French bank by market capitalization, Credit Agricole Group (EPA: ACA) (PINK: CRARY) is just such a study where laws of financial gravity don't seem to matter.

Could Credit Agricole be an extraordinarily profitable "Short" trade?

You decide based on the facts discussed below:

Context: Treating a cocaine habit with more cocaine

Over the last few years, while their US and British counter-parts have continued to undertake drastic measures to restructure their operational and financial foot-prints, Eurozone banks have levered up even further by buying hundreds of billions of Eurozone periphery sovereign, corporate and consumer debt. This disastrous move actually gathered momentum in late 2011 on the back of the 1 trillion+ Euro LTRO facility offered by the ECB to these very Eurozone banks who, by Q4, 2011, had lost credibility in international money markets and were asphyxiating from a lack of dollar funding. Like all government interventions, what LTRO injections generated as an unintended consequence was it discouraged the technically insolvent Eurozone banks from de-leveraging their balance sheets off the hundreds of billions in bad assets that should have been sold, restructured, written down, or written off several years ago. Cut to the present, an already untenable situation of bank illiquidity has definitively (and perhaps irreversibly) morphed into an insolvency problem for banks feeding on their own region's debt.

To quote an Octo 3, 2012 Bloomberg article on French banks:

"The investment-banking units of BNP Paribas SA (BNP), Societe Generale SA, Credit Agricole SA (ACA) and Natixis (KN) SA have 2.05 trillion euros ($2.64 trillion) in trading assets, including bonds, equities and derivatives, data compiled from the banks show. That's a 21 percent jump in the 12 months to June and a two-year high, just shy of France's $2.77 trillion gross domestic product.

Trading in derivatives for BNP Paribas increased 48 percent to 446.1 billion euros in the 12 months through the end of June. For Societe Generale, it rose 38 percent to 242.8 billion euros."

Through the LTRO (Long-term Refinancing Operations: a real liquidity injection program) and now OMT ((Outright Monetary Transactions: essentially, a liquidity injection announcement to buy unlimited sovereign periphery bonds), what ECB has done is take in a cocaine addict into rehab and provided the patient with even higher doses of cocaine so it doesn't go into withdrawals.

While the remedy for this patient was a combination of medicines that were bitter and painful and would have included:

a) restructuring irredeemable sovereign and corporate debt by letting errant financial institutions take the losses, i.e. debt forgiveness;

b) consolidating, closing and re-capitalizing insolvent financial intermediaries;

c) bring about gradual but strict fiscal discipline including change in policies as well as governance;

d) reforming inflexible labor markets to boost competitiveness;

e) privatizing inefficient and high-potential government assets,

f) and most importantly, letting the debtor nations exit the Eurozone to regain competitiveness through issuance of their own currencies.

By doubling down, however, a patient who could've been rehabilitated by Eurozone governments and the ECB is now terminally ill - and is about to die from off-the-charts toxicity levels (debt) that kept the patient even more high on cocaine than it was before coming into rehab.


Because it was politically unpalatable to let the Eurozone banks pay for their sins. The banks waved their considerable clout by pulling out the "systemically important" card.

And the troika (IMF, European Commission, and ECB) buckled.

Now, against this back-drop, let's drill down to Credit Agricole's health.

Fundamentals & Valuation: Heavy Things Don't (and Shouldn't) Defy Gravity

First, there's the minor issue of solvency and leverage.

Despite being a heavily leveraged, highly unprofitable banking enterprise with subsidiaries and strategic investments in the choicest, most "eventful" of high-risk Eurozone markets such as Greece (Emporiki Bank), Spain (Bankinter), Italy (Intesa SanPaolo), and of course its home territory of France, this retail banking-focused group's stock price has perversely undertaken a parabolic rise -up 80% since the lows of this year and 66% in the past six months alone.

Credit Agricole belongs to that rarefied top layer of a huge pyramid of financial services sector "Eurozone sinners," i.e. French banks, that together account for the largest private sector balance sheet exposure to the so-called "Club Med" European periphery sovereign, public and private sector debt.

As early as the spring of 2010, The Economist estimated that French and German banks owned as much as 40% of all Eurozone peripheral debt that is estimated to run between 2 to 3 trillion Euro.

As per the 2011 Eurozone bank stress tests, exposures to just Greek debt among four French banks were:

  • 1.7 billion Euro for BPCE,
  • 6.6 billion Euro for Societe Generale,
  • 8.5 billion Euro for BNP Paribas, and
  • 27 billion Euro for Credit Agricole (roughly 150% of the other three French banks combined).

To quote Bloomberg on French banks' total exposure to Greece vis-a-vis its German and British counterparts:

"French banks held $40.1 billion in Greek public and private debt at the end of June, or 55 percent of all foreign claims, according to data compiled by the Bank for International Settlements. German lenders had $5.5 billion in Greek debt holdings while U.K. banks held $5.6 billion, BIS data show."

Putting the extent of French banks' precarious situation in context, should the $40.1 billion of Greek debt be written off in an entirely realistic scenario were Greece to default in the coming months, such an "event" will wipe out at least 40% of the market capitalizations of France's three biggest banking groups (BNP Paribas; Societe Generale, and Credit Agricole).

How much of that Greek debt's been sold in the secondary market yet, and at what kind of write-downs is anybody's guess today?

Coming down to balance sheet risk, Credit Agricole holds an eye-watering 136 times in assets (1.9 trillion Euro) vis-a-vis its equity value (13.9 billion Euro).

To quote Jonathan Weil, Bloomberg View columnist:

"Total assets at Credit Agricole were 1.9 trillion euros as of Sept. 30. Risk-weighted assets, however, were a mere 298.3 billion euros. In essence, we're supposed to believe that 84 percent of Credit Agricole's assets were riskless, even though that obviously is impossible.

For a more realistic capital ratio, take tangible shareholder equity (which excludes intangible assets such as goodwill) and divide it by tangible assets. At Credit Agricole, the figure was 1.4 percent as of Sept. 30, which translates into leverage of about 73-to-1."

To make a mockery of Basel III compliance, Credit Agricole refused to provide visibility on its current core Tier 1 capital levels (as a reminder, Tier 1 capital ratio principally comprises of common stock and earnings v/s risk-weighted assets).

To quote Financial Times:

"Mr Chifflet (Chief Executive) said the whole Crédit Agricole Group - the quoted entity and the regional banks - were on track to reach a core tier one ratio of 10 per cent by the end of next year (2013). The key measure of balance sheet strength is set at a minimum of 9 per cent under the incoming Basel III rules. The bank would not disclose a figure for the end of September."

Credit Agricole's latest press release on Credit Agricole's website states that the banking group's core tier capital ratio is 11.3 per cent at 30 September, 2012.

However, the Credit Agricole release goes on to say:

"The Group also reaffirmed its target of a fully loaded Basel 3 Common Equity Tier 1 ratio of over 10% by the end of 2013, above regulatory requirements, integrating the necessary buffer to be constituted as global systemically important bank (1%)."

So, the loaded question (pun intended) is, what does Credit Agricole Group consider as "fully loaded" Basel 3 Tier 1 ratio where the banking group is falling short right now?

How is this "fully loaded" calculation different and more conservative from the 11.3% reported by the banking group that the management is not even willing to disclose the group's current standingon this metric?

Such efforts by management to deliberately obstruct and obfuscate the true state of the bank's health is alarming, unhealthy, and frankly, can be construed as arrogant.

After all, last time I checked, French capital markets reside within an advanced economy where management is accountable to public scrutiny - be it from depositors, investors, regulators, media, or citizenry.

Moving on to impact on Credit Agricole's earnings from its Greek unit:

Since 2008, Credit Agricole's Greek unit Emporiki Bank has generated losses to the tune of 4.42 billion Euro, and another 1.28 billion loss in the first six months of 2012.

In the quarter ended September, 2012, Credit Agricole took a 2 billion Euro charge in order to let go off its disastrous foray into Greek banking through its subsidiary: Emporiki Bank. The Greek subsidiary was recently sold to Alpha Bank for the princely sum of 1 Euro, and the transaction is expected to close by end of 2012 (until its not). The deal could easily unravel if "Grexit" happens. In the event of a Greek sovereign default, Credit Agricole is expected to be on the hook for a number of contingent liabilities of Emporiki Bank (which would very likely go belly-up if "Grexit" comes to pass). In addition, to wash its hands off this cash-hemorrhaging misadventure, Credit Agricole has committed to a capital injection of 550 million Euro and convertible bonds worth 150 million towards the combined entity's equity - which incidentally would be less than worthless because all of Alpha Bank's equity owners (including Credit Agricole) would be on the hook for billions of Euro in additional liabilities should the combined entity come under stress or go under during the next Greek restructuring or outright default.

For all the rhetoric surrounding the banking group's "adjustment plan" to de-leverage the entity off its massive balance sheet relative to its equity, let me quote Credit Agricole's most recent press release about its enormous Q3, 2012 loss:

"The Regional Banks registered a 3.9% increase in revenues in the third quarter of 2012, while continuing to improve their loan-to-deposit ratio, which contracted to 126% from 127% at 30 June 2012 and 129% at 31 December 2011."

A 300 basis point change over 3 quarters for a crucial chunk of the group's business is hardly an "improvement." It's the proverbial management fiddling away while Rome (or shall we say, Paris) is burning.

The press release is available here:

Quoting Bloomberg's article on the bank's most recent quarterly loss:

"Credit Agricole recorded a 572 million-euro writedown mostly on its Italian consumer-credit business, a 181 million- euro loss linked to its sale of CA Cheuvreux, and a 193 million- euro accounting charge on its stake in Spain's Bankinter SA. Credit Agricole is selling Athens-based Emporiki for a token price of 1 euro to Alpha Bank, it said Oct. 17. The French bank will inject more funds into Emporiki, bringing the total capital boost since July to 2.85 billion euros, and buy 150 million euros of convertible bonds issued by Alpha Bank. Credit Agricole's corporate and investment bank had a 302 million-euro net loss in the quarter, hurt by own-debt charges and the cost of selling CA Cheuvreux. Excluding one-time items, the division's like-for-like profit fell 15 percent to 325 million euros, the bank said."

The pattern that emerges from all of these exits is that these transactions are large, multi-hundred million Euro write-downs attributable to a de-leveraging process that can be described as nothing less than a "fire-sale". It begs the question: When does a business let go off assets at such deep discounts to book value?

It is when the entity's finances are so depleted that it is fighting for its life, i.e. solvency.

Then, there is the even more pedestrian issue of profitability.

To quote Financial Times:

"The French bank, which had prepared the market last month for bad news, reported a result that was about €1bn worse than expectations of a net €1.8bn-€1.9bn loss in the three months to the end of September, marking a sharp fall from the net profit in the same quarter last year of €258m. Revenues of €3.4bn were 32 per cent down on the third quarter of last year."

Between Fiscal Year 2010 and 2011, Net Profits declined a staggering 72.4% from 4.09 billion Euro to 1.12 billion Euro. With 3 months to go in the current fiscal year (2012), Credit Agricole has recorded a net loss of 2.48 billion Euro thus far - and the full year numbers are likely to fall further for reasons discussed in this note.

Fire-sale of assets can be expected to continue as part of the bank's "adjustment plan" - so more losses can be expected in the coming quarters. There's no way out to profitability for the short-to-medium term.

Yet, what can only be described as an affront to the markets, the company is still contemplating whether it will pay out a dividend this year or not. You can't make this stuff up.

To further quote Bloomberg on Credit Agricole's investment banking activities:

Credit Agricole is also shutting its riskiest investment- banking businesses. The bank has stopped most of its equity derivatives and it has no proprietary trading activity, according to a Sept. 26 presentation. The lender is selling its brokerage CLSA to China's Citic Securities Co. in a transaction valued at $1.25 billion."

Of course, the worst is yet to come.

As the French economic indicators deteriorate (including 10% unemployment levels at a 13-year high), consumer and small business lending (Credit Agricole's forte) will fall further in the coming quarters - which will in turn impact net interest income and margins. With deep and wide provincial exposure through its regional banks, Credit Agricole's retail banking loan provisions are expected to rise significantly - much like their Spanish local lending counterparts or "Caixas". So, one can expect both a top-line and a bottom-line contraction in the coming quarters for Credit Agricole as well as for its peers. Crucially, Credit Agricole is expected to be impacted much more than its other two large French banking peers since the other two (BNP Paribas and Societe Generale) do have more income diversification through investment banking and trading lines of business while Credit Agricole is well on its way to exiting.

To add fuel to fire, Francois Hollande, President of the French Republic wants to bring about a radical transformation of French banking sector with a view to ring-fencing riskier investment banking and trading activities from the more staid, low margin retail and commercial banking businesses. While the objective is admirable, the impact of greater (and no doubt more onerous) regulation and fragmentation of the French banking sector will raise the cost of doing business for French banks precisely at the worst time - thus putting liquidity, margin, and ultimately, solvency pressure on full service banks like the French triumvirate.

Speaking of margins:

Among its large banking peers around the globe, the bank's lack of profitability (Net Margins) at-4.0% can only be matched by industry laggards like Lloyds Banking Group (-4.1%), UBS (-1.2%) and Morgan Stanley (-0.8%). These are, might I add, the most dilapidated homes in a bad neighborhood where several other troubled Eurozone peers are generating double digit profits. For example: Banco Santander (17.4%), BBVA (14.2%), Natixis (13.0%), BNP Paribas (11.5%), and Commerzbank (11.6%). Along that sliding scale, even other large European players are eking out single-digit net profits: Deutsche Bank (9.2%), Banco Popular (8.7%), Caixabank (5.5%), ING (4.1%), Societe Generale (3.3%), and Credit Suisse (3.3%).

Furthermore, at -5.2% Return-on-Equity, Credit Agricole is in the august company of "fallen angels" like Lloyds Banking Group (-2.2%), Royal Bank of Scotland (-6.9%), and Bank of Ireland (-9.1%) - each of whom required a full or partial government bailout wiping out much of existing shareholders' equity.

So, there.

End of Part I

In Part II, I will cover the macro-economic tail risks that could re-price Eurozone financial stocks such as Credit Agricole dramatically lower in a matter of days or weeks. In addition, I will also discuss the strange stock price behaviour of Credit Agricole's stock in detail.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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