Modern Banking
.pdf
[ 609 ]
C A S E S T U D I E S
had numerous acquisitions and alliances with foreign banks whose clients were likewise defecting to the capital markets.
žIn its quest for rapid growth, CL had accumulated many bad loans, leaving the bank with a weak loan portfolio and vulnerable to recession. By early 1994, the sluggish French economy, together with high interest rates, caused a marked deterioration in the French property market, and the bankruptcy of many small and medium-sized firms.
žCredit´ Lyonnais reported escalating losses in 1991, 1992 and 1993. In 1993, Mr Harberer was dismissed, and Mr Jean Peyrelevade took over as CEO. Harberer became the head of Credit´ National, but under public pressure was sacked from this post after CL’s 1993 results were publicised.
10.6.9. The State Rescue of Credit´ Lyonnais
In March 1994, CL reported 1993 losses of FF 6.9 billion ($1.2 billion), substantially higher than the 1992 losses of FF 1.8 billion. In late March, the government announced the first of four rescue plans. FF 23 billion ($4 billion) of new capital was injected into CL, on condition it sell off some of its assets and cut costs, mainly by reducing the number of employees. However, CL, under the new chairman, M. Peyrelevade, was slow to put its affairs in order. Administration costs fell by 3% in the first half of 1994, due mainly to staff cuts, but little progress was made on the sale of assets. CL chose to dispose of non-core activities, such as:
žThe bank’s stake in the FNAC retailing chain.
žThe Meridian hotel chain.
žTFI, a television channel.
žAdidas, the German shoe company.
The bank raised about FF 20 billion from these disposals. In late 1994, CL sold a 57% stake in Banca Lombarda, an Italian bank, but still owned another sizeable bank in Italy and a majority stake in the German bank, BfG. Mr Peyrelevade aimed to sell an additional $20 billion in assets to shed troubled businesses and boost the bank’s efficiency. However, little was done to reduce the bank’s expanding pan-European banking network. On the contrary, CL announced its future growth would come from CL’s remaining retail banking operations in Europe.
After the 1994 bailout, a French parliamentary commission investigated and reported on CL’s affairs on 12 July 1994. The Commission concluded CL had lacked a risk management system capable of controlling the risks it took. Many of the problems originated with one or another of its four subsidiaries: Credit´ Lyonnais Bank Nederland (CLBN), Altus Finance, Societ´e´ de Banque Occidentale (SDBO) and International Bankers. For example, one of SDBO’s clients was Bernard Tapie, a heavily indebted left-wing businessman, convicted in 1994 of rigging a crucial football game. CLBN, the Dutch subsidiary, had loaned $1.3 billion to an Italian, Sgr Giancarlo Parretti, to buy the Hollywood giant Metro-Goldwyn-Mayer (MGM). After Sgr Parretti was ousted, Credit´ Lyonnais assumed direct control of MGM and injected more money into it, hoping to find a buyer and recover the funds it had
[ 610 ]
M O D E R N B A N K I N G
invested. Eventually (1996) MGM was sold with its cinema chain to Virgin for $1.6 billion, recouping less than half of CL’s total investment.45
In 1994, CL’s losses nearly doubled to FF 12.1 billion mainly because of a decline in the domestic retail banking business. New account openings were down by 20% in 1994. Roughly a year after the first rescue plan, the bank was seeking a new capital injection. The government had little choice but to oblige or risk prompting a run on deposits. The second rescue was announced in March 1995, and involved the creation of a ‘‘bad bank’’. Recall the creation of a bad bank was discussed in some detail in Chapter 8 (see Box 8.1). These ‘‘bad banks’’ or asset management companies assume some or all of the bad debt, cleaning up the balance sheet of the troubled bank. The French equivalent was the Consortium de Realisation (CDR), to be financed by a new state entity, the EPFR,46 which in turn was backed by a 20-year loan (FF 145 billion) from Credit´ Lyonnais, and guaranteed by the French government. The CDR would sell the bad assets it had taken from CL, saving the bank from having to make substantial provisions and write downs. Put simply, the CDR, indirectly financed (via the EPFR) by a loan from CL, was to use the money to purchase CL’s bad assets!
Under the second rescue plan, CL moved $27 billion from the CL balance sheets to the CDR, including key dud assets:
ž$8.5 billion in problem real estate loans.
ž$4 billion exposure from the ownership of MGM studios.
ž$9 billion in equity holdings.
Since the second rescue plan involved a government subsidy (estimated to be worth $9.4 billion) to a state owned entity, it had to be approved by the European Competition Commission, which it was, in July 1995. However, the Commission threw out the CL’s assertion that it should decide on which bad assets were to be sold, nor was CL to be allowed to buy back any of these bad assets. The Commission also specified that by the end of 1998, at least 35% of its assets outside France had to be sold off, worth FF 300 billion – over the previous 17 months, CL had only managed to sell FF 15 billion worth of assets. Meanwhile, The Banker reported (May 1995, p. 22) that CL was effectively bankrupt, because losses (equal to FF 50 billion) exceeded its capital base.
1996 was a bad year all round. The Paris head office of Credit Lyonnais was almost completely gutted in a mysterious fire, which spread to the archives and destroyed many documents that would have been of use to the official French investigation into how the bank got into such a big mess. By late summer, it was apparent that a third bailout would be necessary because of problems arising from the second rescue plan, especially the loan CL made to set up the bad bank. CL had been obliged to make the loan at below market rates, but deep recession hit the French economy, with knock-on effects in the French banking market. Interest rates collapsed, and the amount of the loan outstanding was much higher than had been forecast, as was the cost of financing it – CL was receiving just 2.975% on
45Source: ‘‘Banking’s Biggest Disaster’’, The Economist, 5 July 1997, pp. 69 –71.
46The Etablissement Public de Financement et de Restructuration (EPFR) was created to fund the selling off of the bad assets (worth about FF 190 billion) that the state had ‘‘bought’’ from CL.
[ 611 ]
C A S E S T U D I E S
the loan but paying 5.8% on its own debt. Also, CL’s bad debt situation was worse than it might have been because the government pressured the bank to keep lending to prevent bankruptcies and therefore loss of jobs in a recession. Though the bank had always denied it was subject to interference by the state, M. Harberer (the former chairman) claimed that CL was frequently pressed to support key industrial companies in an attempt to boost economic growth and reduce the unemployment rate.
CL was set to lose another FF 3.9 billion ($762 million) in 1996. The European Commission agreed to a third rescue: FF 3.9 billion as ‘‘emergency’’ state aid.47 In 1997, the French government injected an additional FF 3 billion without the Commission’s approval, raising the total amount to FF 6.9 billion.
The EC was irritated by the failure of CL to adhere to the conditions of the earlier rescue plan. Nonetheless, in May 1998, the European Commission approved a fourth rescue plan. The EPFR was to pay the market rate on the loan from CL. Also, CL could swap shares with EPFR to buy back the original loan, but the shares had to be sold on the open market.48 CL was required to make a minimum dividend payout on these shares of 58% of net profit through to 2003.
Other explicit EC requirements were:
žThat CL sell FF 675 billion worth of holdings including Credit´ Lyonnais Belgium, Asian banks and Bank fur¨ Gemeinwirtschaft, Harberer’s German prize.
žCredit´ Lyonnais was to divest itself of all its retail holdings outside France.
žThe bank’s growth rate was subject to limits until 2014.
žBetween 1998 and 2000, 78 of its 1923 branches must be closed.
žThe state owned 82% of CL but it must be fully privatised by 1999.
žThe Commissioner was to receive quarterly reports to ensure France was complying with the rules.49
10.6.10. The ‘‘Bad Bank’’ Bungle50
The state owned bad bank, CDR, was a miserable failure in contrast to most of the ‘‘bad banks’’ (e.g. the United States, Scandinavia and Korea) set up to dispose of dud assets. Why? There are a number of reasons. First, both CL and the government were anxious to give the impression that CL was financing its own rescue, and did this by having CL make a loan to the EPFR, which was funding the CDR. However, as has been noted, the below market rate on the loan caused even more problems for CL, and was a contributory factor to a third rescue plan. When the rate was raised to a market rate, it meant the CDR (via the taxpayer) was injecting money into CL. Second, it wasn’t just bad assets the CDR took on. Assets in some healthy French firms were also transferred: it was reasoned that if the CDR could sell some good assets, it would reduce its overall losses. But their transfer to the bad bank immediately lowered the market value of these assets. As a result, the CDR recouped
47The details reported in this paragraph are from ‘‘Banking’s Biggest Disaster’’, The Economist, 7 May 1997, pp.
69– 71.
48This effectively privatises part of CL.
49This summary of conditions is from ‘‘The Bitter End’’, The Economist, 23 May 1998, p. 67.
50This account is from ‘‘Crisis and More Crisis’’, The Economist, 7 May 1997, p. 17.
[ 612 ]
M O D E R N B A N K I N G
far less than had been expected when they were sold. The treatment of certain dud assets was also questionable. The troubled subsidiary of CL, the Societ´e´ de Banque Occidentale, was transferred to the CDR, its bad assets sold off and new capital injected, only to be sold back to CL rather than being sold on the open market. Societ´e´ Gen´erale´ complained to the European Commission, claiming it never had an opportunity to buy SBO, though the CDR denied this, saying there was no market interest in it. Third, after the European Commission insisted the CDR be independent of CL, the government announced that the CDR was to sell 80% of its assets within 5 years. The target effectively forced the CDR to sell at even heavier discounts because buyers knew it was under pressure to offload its portfolio. Finally, one of the bad assets the CDR took on in 1996, Executive Life, eventually implicated it in a criminal prosecution in the United States – see below.
10.6.11. Return to Profit and Privatisation51
Having offloaded its bad assets, the bank had returned to profit in 1997, reporting pre-tax profits of $702 million and in 1998, $588 million. The year the bank was privatised, 1999, profits were $1.1 billion.52 Yet its cost to income ratio remained stubbornly high, at 79% in 1997, 76% in 1998 and 75% in 1999, compared to an average of 64% for the Credit´ Agricole Group. In most years CL’s ratio was well above those of its key competitors, suggesting this bank had done little to cut costs or improve efficiency.
The French government announced the plans for privatisation in March 1999 – 33% was to be sold to a group of institutional investors, 4.3% to employees and 51.8% to retail investors. The government would keep a 10.9% stake. At the end of June 1999, the share price was announced: 26.2 euros ($27.33) per share. The sale was completed in early July. It was 30 times oversubscribed by institutional investors: the final group consisting of several firms led by Credit´ Agricole, and including Credit´ Commercial de France, Commerzbank, BBV of Spain, Allianz, AXA, AGF (a French insurer) and Bank Intesa. No institution could buy more than 10% of the total shares. They also agreed not to sell their shares (up to July 2003) to an outsider until they had been offered to another institutional investor within the group of seven. The individual investor sale was three times oversubscribed.
Mr. Peyrelevade stayed on as chairman. The next issue was what the bank was going to do with the government stakeholding, which, under the Commission agreement, it had to sell off. For many months, negotiations had been going on between Credit´ Agricole and the government, and it was widely assumed this bank would buy the government stake in a private deal. In a surprise move, the French Finance Minister, M. Mer, apparently frustrated by the slow progress of the negotiation, announced, in November 2002, that the government was to sell the shares by auction to the highest bidder, including any foreign bank – bids had to be in within 22 hours. BNP Paribas won, having bid 49% over the going market price. Credit´ Agricole, having refused to pay ¤44 ($44) per share in the private deal, apparently offered this amount in its bid, only to lose out to the ¤58 offered by BNP Paribas.
51Sources for the statistics reported in this subsection: Lanchner, D. (2003), ‘‘Agricole’s Carron goes Courting’’, Institutional Investor, 37(1), 14 and ‘‘Farmer’s Folly’’, The Economist, 21 December 2002, p. 103.
52Source: The Banker, July issues, 1997, 1998.
[ 613 ]
C A S E S T U D I E S
By mid-December, it was all change again. Credit´ Agricole was stung by losing the government shares to BNP. The bank’s unusual corporate structure was a key reason why it was slow to reach an agreement with the government. Credit´ Agricole SA is a listed company, but 70% of it is owned by 45 regional mutual banks – the Fed´eration´ Nationale du Credit´ Agricole. The Chairman of CA SA (M. Bue)´ had dithered over whether or not CA SA should buy the shares. When the auction was announced and CA lost out to BNP Paribas, there was great consternation, which galvanised the regions into action. M. Bue´ stepped down and M. Carton (Chairman of Fed´eration´ Nationale du Credit´ Agricole) became Chairman of CA SA. Within a fortnight, M. Carton bid for Credit´ Lyonnais. The bid was worth ¤16.5 billion ($17 billion), or ¤56 per share, 2 euros less than the BNP bid for the government shares. This was equivalent to 22.5 times CL’s estimated 2002 earnings.
Not all the regional mutuals supported the bid, but most recognised that the alternative (BNP Paribas taking over CL) would put them at a considerable disadvantage. The takeover meant the combined assets of the new bank, called Credit Agricole, were ¤716.8 billion, only slightly smaller than BNP Paribas (¤759.4 billion). For the first time, Agricole was represented in the urban areas, where CL had a 10% market share. Peyrelevade was concerned that if BNP bought CL, there would be large job losses, because of the high degree of urban overlap between the two banks. At the retail level, the new bank had a 30% market share. The plan is to maintain separate retail branches, similar to the strategy adopted by NatWest and The Royal Bank of Scotland. However, it is hoped some cost cutting will be possible through the integration of back office operations.
There are some tricky issues related to the integration of the two banks. The bank estimated that it can gain ¤760 in synergies, but by the spring of 2004, it had managed just 5% of that estimate.53 The fact that Credit´ Agricole has a complex ownership structure does not help, nor do the problems with top management at Caylon – created to run CA’s corporate and investment banking business. Caylon is supposed to be the source of two-thirds of the synergies, which translates into job cuts. The new chief executive, from Credit´ Agricole, is known for making efficiency gains but has no experience in investment banking. The atmosphere at Caylon is grim, and its two rivals, BNP Paribas and Societ´e´ Gen´erale,´ have been quick to poach key staff.
The total cost of bailing out Credit´ Lyonnais was put at $17.25 billion by the chairman, M. Peyrelevade in June 2003. Other estimates in 199754 put it as high as FF 170 billion, about $22 billion at current (2003) exchange rates. While Japan’s recent problems involve numerous banks and will leave it with a much higher bill (up to $580 billion – see Chapter 8), CL stands out as the most costly single bank rescue in history.
10.6.12. Executive Life: An Expensive Ghost from the Past
In 1998, following a tip-off from a French informant, the US regulatory authorities began to investigate the claim that Credit´ Lyonnais had used a front organisation to bypass laws
53Source: ‘‘French Banking – Town and Country’’, The Economist, 13 March 2004, pp. 92– 93.
54Charles de Courson, a deputy in the French parliament who became an expert on CL documentation – cited in ‘‘Banking’s Biggest Disaster’’, The Economist, 7 May 1997, pp. 69 – 71.
[ 615 ]
C A S E S T U D I E S
Then came their Waterloo:
žJune 2003: M. Harberer was fined and received a suspended prison sentence by a French court for failure to disclose the extent of CL’s losses. He has said he will appeal.
žSeptember 2003: M. Peyrelevade resigned as Chairman of Credit´ Lyonnais, which had been taken over by Credit Agricole in December 2002.
žDecember 2003: The US Department of Justice announced plea and settlement agreements with Credit´ Lyonnais, the bad bank, CDR (which had taken over the assets of Executive Life in 1995), MAAF Assurance (one of the leading members of the consortium paid to buy Executive Life, renamed Aurora, with an agreement that it would be sold back to Altus) and MAAF’s chairman. All agreed to plead guilty to a criminal charge of making false statements to US regulators in the acquisition of the junk bond portfolio and life insurance business of Executive Life. These parties, and Artemis, are to pay fines totalling $771.75 million, believed to be the largest settlement of a criminal case in the USA.
žA Grand Jury indicted a number of individuals on several counts of fraud, and criminal violation of the Bank Holding Company Act, including Harberer, Peyrelevade, M. Henin (managing director of Artemis) and three other French nationals. They are to be tried in February 2005, though US attorney D. Yang has said there could be an out of court settlement before then.57
10.6.13. Conclusion
M. Harberer’s expansionist vision for Credit´ Lyonnais began when he was appointed chairman in 1988. It was two years after London’s Big Bang, the culmination of a series of reforms aimed at ridding the City of restrictive practices, and giving its financial institutions a favourable, free market environment balanced with regulation. There were some celebrated banking disasters, such as BCCI and Barings, but the majority of London’s banks have been highly successful. In France, the attitude could not have been more different. M. Harberer belonged to a meritocratic elite committed to the French government’s belief that the state knew more than the markets. France was one of the democratic countries that suffered a prolonged bad dose of this disease, which is more frequently observed in communist or fascist states. Credit´ Lyonnais’s existence as an independent bank ended just short of its 140th birthday, though its state bank status had denied it true independence for some time. The case study illustrates how a bank can end up a costly failure because of meddling by the government while attempting to achieve so-called ‘‘national economic objectives’’. Egocentric executives lent enthusiastic support to the state’s plans, envisioning a French global economic empire, with banks and other institutions dominating the European Union. Previous cases have illustrated the need for close supervision of banks, but that is quite different from state ownership, which encourages greater mistakes and risk taking. If governments must own banks, they should be left to sink or swim in a free market where they are treated on a par with private banks.
57 Source of information on the settlement and indictments: press release from the US Department of Justice, D.W. Yang, US Attorney, Central District of California, 18 December 2003.
