SocGen, Credit Agricole Boosted Risky Assets Before Crisis Hit
SocGen, Credit Agricole Boosted Risky Assets Before Crisis Hit
(Bloomberg) -- Societe Generale SA and Credit Agricole SA, two of the biggest French banks, added billions of dollars of hard-to-value assets in the years before the market carnage triggered by the coronavirus, according to Berenberg.
The lenders are the only two out of a dozen large European and U.S. banks to increase their holdings of the most illiquid securities -- known as Level 3 assets -- since 2015, Berenberg analyst Eoin Mullany wrote in a note to clients. Credit Agricole now holds more than Wall Street giants such as Citigroup Inc. and Bank of America Corp.
While Deutsche Bank AG has cut its holdings, the German lender still has more of them than any of its rivals and has “little room for error on capital,” according to the note.
European banks have tumbled since the spreading coronavirus began to upend financial markets in February. Investors, already worried about how the lenders will fare in a possible global recession, may increasingly focus on Level 3 assets as a measure of financial health, Mullany wrote.
“In this environment, certainty about asset values is key,” Mullany wrote. “As such, we believe Level 3 assets will become more of a focus for the market.”
Level 3 assets include investments that gained notoriety in the 2008 financial crisis, such as bespoke derivatives and some mortgage-backed bonds. While their opacity can make them lucrative for lenders, they are a headache for regulators. Scrutiny has increased since the European Central Bank took over supervision of the euro area’s biggest banks from national authorities in late 2014.
Credit Agricole, based in the Parisian suburb of Montrouge, increased its Level 3 assets by half to about 15 billion euros while Societe Generale boosted its holding 14% to just over 10 billion euros, according to Berenberg. Deutsche Bank’s fell to under 25 billion euros.
A spokesman for Deutsche Bank declined to comment on the report. Officials for the two French lenders didn’t immediately respond to a request for comment.
The two French banks, along with Paris-based rival BNP Paribas SA, also have the lowest turnover of Level 3 assets, according to the note. This means that they are rarely traded and are likely to be “stickier and harder to sell,” Mullany wrote. Credit Suisse Group AG, which has about 15 billion Swiss francs of the holdings, has the highest turnover.
Societe Generale, overseen by Chief Executive Officer Frederic Oudea, is among the world’s biggest players in equity derivatives, complex contracts that derive their value from stocks. Credit Agricole, run by CEO Philippe Brassac, has pulled back from that business but is active in structuring derivatives linked to interest rates, corporate debt, foreign exchange and precious metals.
Banks split their assets into three categories including Level 1 for those with transparent prices, like stocks, and Level 2 for assets where some external data is available, including over-the-counter derivatives such as interest-rate swaps.
There is little market data available for Level 3 assets and banks thus get to value them themselves based on historical data and risk assumptions.
‘Mark-to-Myth’
“Level 3 assets are the most contentious,” Mullany wrote. “These assets have been affectionately known as ‘mark-to-myth’ given the leeway banks and their auditors have in their valuation of them.”
Last year, the ECB continued its efforts with a series of visits to euro-area banks to examine risks in their trading businesses, including monitoring the areas most exposed to valuation risk. While Level 3 assets make up just 2% of trading book assets, 82% of them are located at just three banks, the ECB said in its annual report, without identifying the firms.
The ECB said a campaign it started on valuation risk last year will continue this year and next, although the central bank has subsequently said it will delay inspections to help banks focus on tackling fallout from the coronavirus.
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