EurobusinessMedia (EBM): BNP Paribas, one of Europe's largest banks, reports earnings for the first-half of 2009. Baudouin Prot welcome. You are the CEO of BNP Paribas. There are many moving parts in this set of results. How would you summarize the 2Q09 performance?
Baudouin prot (BP): This quarter BNP Paribas has made a huge leap forward in becoming a key player in the industry. This has been achieved as a result of significant market share gains, such as in bonds in Euros, where BNP Paribas now ranks first, and also, thanks to the Fortis acquisition this quarter, BNP Paribas has been propelled to the #1 position in the Eurozone by deposit base. Having closed the Fortis transaction on the 12th of May, the Group’s consolidated accounts therefore include 6 weeks of results from BNP Paribas Fortis, as it is now called. At an operating division level, setting aside both BNP Paribas Fortis and the Corporate Centre, the Group posted very strong results. At €9bn this quarter, revenues were up +20% against the second-quarter of last year whereas cost growth was contained at 5%, leading to a 44% jump in Gross Operating Income to just over €4bn. This improved operating efficiency has considerably dampened the effect of the rise in cost of risk that reached €2bn this quarter. This figure is significantly increased compared to pre-Lehman levels but only slightly up, +12%, on first quarter figures. All in all, the operating divisions posted a €2bn profit before tax, down by only 6.6% compared to the second-quarter 2008 and 10% compared to the first-quarter of this year. Hence, BNP Paribas again confirms its strong earnings generation capability.
EBM: In Q2, your CIB revenues remained at very high levels, only slightly below your all time record first-quarter revenue levels. Where is this momentum coming from? How sustainable is this trend, and if indeed the trend is of an exceptional nature, then what percentage of your CIB revenues should we consider to be recurring?
BP: This quarter, CIB posted very strong revenues, at €3.4bn, in a context of progressive normalization of capital markets after the record first quarter which was, as you can certainly recall, characterized by exceptional market conditions in January. This remarkable performance was achieved again thanks to sustained client demand across all businesses, and ongoing market share gains -- all without increasing our exposure to market risks as shown by the decrease in the value at risk over the period. Fixed Income, ranking #1 in bonds in Euro issues again, posted very good results again. These were achieved thanks to very large volumes, sustained by a high level of client demand -- essentially on flow products -- and to still wide, albeit tightening, bid/offer spreads. EQD recovered thanks to the successful completion of risk reduction and a strong commercial drive. Finally, financing businesses posted strong and solid revenues again. The sustainability of these performances will depend on further normalization of market conditions as well as on client demand/appetite over the coming period.
EBM: Ever since you participated in the second tranche of the French government’s aid to the banking sector, the recurring question is when, and how, you will pay back the €5,1bn to the French government, in particular at a time when such aid costs you close to 8% whereas 10-year interest rates remain at 4%.
BP: The issuance of €5.1bn of non voting shares to the French government early this year provided BNP Paribas with a capital buffer in a very challenging environment. Since then, in the first-quarter, as well as in the second, BNP Paribas’s strong earnings capacity, combined with the reduction of risk weighted assets, significantly increased the Group’s solvency and its Tier 1 ratio to 9.3% as of the 30th of June. This compares to 8.8% at the end of the first-quarter and 8.4% at the beginning of the year pro forma, i.e. post government aid. The non-voting shares now represent 80 bps of Tier 1. We will evaluate the environment at the end of the year before deciding whether to gradually start buying them back out of retained earnings. At 9.3%, the current level of BNP Paribas’s Tier 1 ratio provides us with an additional safety margin in this challenging environment. Nevertheless, taking our balanced business model into account, combined with our strong earnings capacity, we still consider 7.5% as a relevant floor over the cycle.
EBM: What can you tell us today, in simple terms, to help us better understand how we should interpret the Fortis Purchase Price Accounting?
BP: As you know, IFRS required that all assets and liabilities of BNP Paribas Fortis be consolidated at their fair value, using BNP Paribas's prudent risk assessment methods and valuation models when they entered the Group's balance sheet. This resulted in net negative adjustments of -€6.5bn to BNP Paribas Fortis net equity, at 100% and net of tax. These adjustments include a complete write-off of all goodwill, value adjustments on assets and liabilities for a negative total of €4.1bn and additional credit risk provisions for €3.2bn. After these adjustments, the integration of BNP Paribas Fortis assets and liabilities resulted in a net badwill of €815mn, which IFRS required us to book as a one-off gain in the P&L. But this one-off gain was offset by one-off charges we booked at the same time: goodwill depreciation for a total of €524mn, including the UkrSibbank one, and participation impairments for a total of €440mn.
EBM: What is your update today on the risk portfolios that you took over from Fortis, especially the IN portfolio of structured credit, and the European portfolio of loans to SME's in a number of countries where you have no local presence?
BP: As you know the high-risk assets have been transferred to a new company, Royal Park Investments. This portfolio was already marked by Fortis at 58% of the nominal, for a net value of €11.8bn. We have fully written off BNP Paribas’s exposure to the first loss tranche, i.e. €200m out of €1.7bn, and a large part of the unsecured exposure to the second loss tranche: only approximately €200m remain of this tranche of €5.2bn. The residual exposure, on top of these €200m, is the super senior tranche lent by BNP Paribas Fortis, but any loss on this tranche is very unlikely. The portfolio which is still on the balance sheet of BNP Paribas Fortis, the IN portfolio, has a nominal value of approximately €20bn and a net value of €15.6bn at the end of the second-quarter of 2009. The first loss tranche of €3.5bn has been largely impaired, so that the residual exposure is less than €0.3bn. The second loss tranche of €1.5bn is fully guaranteed by the Belgian government. For the first and second loss tranches to be exceeded, the mark-downs would have to exceed 20% of the nominal, which is unlikely. Now, for the European portfolio of loans to SME’s, outside Belgium and Luxembourg: We were concerned over the credit quality of this portfolio, so within the context of the acquisition we conducted a full due diligence of the portfolio and booked significant provisions, which are part of the purchase accounting adjustments I mentioned earlier. After these adjustments, we believe that Fortis Bank’s credit portfolio is adequately reserved.
EBM: On the face of it, the Fortis acquisition contributed more to your results than expected. Is this merely an accounting phenomenon, or does it reflect a rebound in Fortis' underlying business?
BP: The contribution of BNP Paribas Fortis to the Group’s pre-tax profit was €470mn for 6 weeks of business, whereas the expectations were for a very marginal contribution only. Revenues over this short period were significantly inflated by €243m one-off gains from the improvement of market conditions. Furthermore, revenues also include a positive effect from the amortization of Purchase Accounting adjustments, for €137m. These two factors set aside, the 6 week P&L contribution is positive. The franchise has started to pick up with retail asset collections in Belgium in positive territory every month during the second-quarter, whereas it was the exact opposite over the previous quarter. So, the underlying retail banking business within BNP Paribas Fortis is doing well.
EBM: What is your outlook today on the credit cycle? Deutsche Bank recently stated that they see credit quality continuing to deteriorate. Are you also experiencing a trend of worsening credit quality? In which segments does the deterioration of risk come as a surprise, and where is the deterioration greater than expected?
BP: Cost of risk is very dependant on the economic environment, which in itself is difficult to predict. Two points can nevertheless be highlighted. Firstly, the sequential growth rate of cost of risk at Group level seems to be slowing. And secondly, we are experiencing contrasting trends in the composition of the cost of risk. On the one hand, the cost of risk in Capital Markets and Investment Solutions is dropping from the highs of the second-half of 2008. Counterparty risk is now receding as markets are gradually returning to normal, and this should continue. On the other hand, risk associated with the loan portfolio has been on the rise as a consequence of the evolution of the economic environment. Such a trend was to be expected and has been at the center of our attention for the past year and a half. When considering BNP Paribas’s operating divisions, therefore excluding BNP Paribas Fortis, the cost of risk stands at €2bn. Even at that high level it is twice covered by the €4bn Gross Operating Income.
EBM: Your asset management arm, Investment Solutions, seems to have sailed through the crisis without posting a single quarterly loss. This is counterintuitive given the drop in equity markets and flight to lower margin products. How do you account for this resilience?
BP: I’m very pleased to see that the franchise has actually strengthened over the crisis as demonstrated by the net asset inflows recorded last year versus outflows at our main competitors, and also the strong net asset inflows recorded in the first-half of 2009: 8% on an annualized basis. Our resilience has been bolstered by a higher proportion of retail originated funds versus institutional funds and by a more diversified business mix, which contains insurance, securities services, etc., on top of the traditional asset management and private banking businesses. The environment is, nevertheless, very difficult and a number of cost adjustment measures have been taken. Within 2 years cost growth has moved from double-digit growth to single-digit reduction, -2.5% this quarter. Brand attractiveness, along with cost adjustments, has enabled Investment Solutions to cope with the fall in the stock markets and the one-offs of last year such as Lehman, whilst remaining profitable in every quarter -- pretax profit is +€319mn in the second-quarter of 2009.
EBM: Given how much you've already been able to improve operational efficiency in the company, some analysts believe that there's little more to be done, and therefore the only remaining driver for profitability recovery is going to come from credit quality improvement, making BNP Paribas's share price more vulnerable to the credit cycle improvement than generally perceived by investors. What is your response to this analysis?
BP: Well no, we are not waiting around for the cost of risk to improve! Cost wise, we had set ourselves a target at the beginning of the year to stabilize the Group’s cost base, excluding variable compensation. With a 0.2% drop in operating expenses on that basis in the first-half of 2009 versus the first-half of 2008 we are perfectly on track with that objective. For example, this quarter French Retail Banking, BNL banca commerciale and Personal Finance were all ahead of their stated positive jaws effect targets. At the same time, Investment Solutions brought down its operating expenses by 2.5% compared to the second-quarter of 2008 and CIB’s cost income ratio reached record low levels at 43.8%. So keeping the cost base under control is a key priority. Beyond that, we are also experiencing market share gains and a better competitive landscape, which will both feed into the bottom line. But more importantly, you must not forget that we are at the very start of the Fortis integration which will yield both revenue and cost synergies in the years to come.
EBM: Now, the banking sector is expected to undergo significant regulatory upheaval in the coming quarters. What are some of the changes you expect, and what are some of the foreseeable consequences for BNP Paribas?
BP: The crisis demonstrates that financial markets are global and the G20, therefore, insisted on an internationally coordinated corrective plan. We agree with, and are not afraid, of a regulatory upheaval provided that it is reasonably risk based, competitively neutral, implementable within a decent time frame, and consistent with the G20 economic development and financial stability objectives. It is also important that the cumulative effects of the planned changes are subject to a global and precise impact study. The danger of an over extensive scope for fair market value accounting is one of the main lessons from the crisis, as it was clearly and explicitly pointed out at the last G20 meeting. Prudence should not be opposed to transparency, particularly when excess of fair valuing leads to overstate gains at every bubble and then losses, participating to the destabilization of the economy. As recently pointed out by the Bank for International Settlements (BIS) chief economist, one concrete threat to economic recovery is the decrease of cross-border liquidity flows -- something that should be resisted by political authorities for the sake of macro-economic prospects. Decreased cross-border liquidity would clearly damage the growth potential of the global economy since it would create trapped pools of liquidity and prevent the financial system from performing its fundamental role of optimizing the allocation of liquidity. To conclude, I would like to insist on the fact that the soundness of banks comes, first and foremost, from their governance, their proper management, and their profitability. This quarter BNP Paribas has again confirmed its strong earnings capability.
EBM: Baudouin Prot, CEO of BNP Paribas, thank you very much.
BP: You’re welcome.
