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SocGen capital boost may be short lived, as regulations, low interest rates bite

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SocGen capital boost may be short lived, as regulations, low interest rates bite

Société Générale SA may have cheered investors by achieving its capital target ahead of schedule, but any elation may be short-lived.

The French bank, which is looking ahead to tougher regulation and lower-for-longer interest rates, will find further capital generation a major challenge, according to analysts.

Amid concerns about its capital levels, the French bank has been shedding nonstrategic assets to boost its common equity Tier 1 ratio, a key measure of financial strength. It has also embarked on a cost-cutting drive at its investment banking division after difficult market conditions caused revenues there to fall sharply in late 2018.

It is working to reduce its global markets division's risk-weighted assets — which determine how much capital a bank should hold — by €8 billion, and also posted higher-than-expected earnings in the second quarter. These factors helped it boost its CET1 ratio to 12.0% at the end of the second quarter, up from 11.02% at the end of 2018.

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But concerns about the bank's capital have put pressure on its share price, which has declined by 34% over the past year.

Its CET1 ratio had fallen to 11.02% at the end of 2018, down from 11.92% at June 2017, as profits declined and regulations tightened, before rebounding to 12.00% at June 2019. The bank's operating income fell to €12.36 billion at June 2019, down from €12.99 billion at June 2017, according to S&P Global Market Intelligence data.

Headwinds

"It is encouraging that SocGen reached its 12% CET1 target, but this is for one quarter. I would like to see it maintained," Pauline Lambert, executive director at Scope Ratings, said in an email.

Disposals may have helped the bank achieve its target, but the operating environment remains challenging, particularly in investment banking, she said. Combined with a less supportive macroeconomic outlook, this will make further capital generation more difficult.

"The actions being taken within the investment bank are necessary as returns have been deteriorating — not only in absolute terms but also relative to the amount of capital that is allocated to the business," she said.

Lambert said the bank's average allocated capital to its global markets and investors services division totaled €8.32 billion in 2017, with net income of €872 million, while in the second quarter of 2019, the average allocated capital to the unit totaled €8.25 billion, with net income of €85 million.

Regulatory pressure will continue with the ECB's targeted review of internal models, or TRIM, which is designed to reduce risk in calculating risk-weighted assets, which will shave 30 basis points to 50 basis points, analysts said.

Capital concerns

New post-crisis rules from the Basel Committee on Banking Supervision, known as Basel IV, will require the bank to hold more capital, which will be a major challenge going forward, Tom Kinmonth, fixed-income strategist at ABN AMRO, said in an interview.

SocGen has to balance demands from equity holders to whom they need to return money, with making it has have enough funding for future capital requirements, he said.

The European Banking Authority said on July 2 that the biggest EU banks would need to raise their capital by a weighted average of at least 24.4%, to comply with the tougher capital rules, due to be fully implemented in 2027. These banks currently have a total capital shortfall of €135 billion in relation to the requirements, it said.

But Kinmonth said SocGen was showing signs of progress.

"They're removing a bit of risk now with the investment bank rundown, removing jobs on that side, so in theory it's a safer bank with more capital," he said.

Profits

Tomasz Walkowicz, an analyst at rating agency DBRS, said the low interest rate environment, coupled with tough conditions on the capital markets, would hinder the bank's profitability going forward and challenge the bank's ability to generate capital organically.

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But he said domestic retail revenues had been "resilient" among French banks despite the difficult environment.

"Solid momentum in domestic banking has more room to run and it could offset some of the pressure from low interest rates, leading to a stabilization of revenues from French retail banking in 2019. SocGen could benefit from that trend," he wrote in an email.

The bank is planning to cut 530 jobs in its French retail unit, which Walkowicz said represented about 1.5% of the French retail banking headcount and around 0.4% of the group's total headcount at end-2018.

"This is part of SocGen's strategic push towards a more efficient operational model in French retail, which is not surprising, given a challenging operating environment," Walkowicz said.

The job cuts may be a sign that pressure on cost reductions remains intense," he said.