BNP Paribas Is a Stable Performer Through the Cycle 

Analyst

Johann Scholtz

BNP Paribas has reported remarkably consistent earnings over the past decade—in an environment where many of its peers suffered from great earnings volatility. Reported earnings have not grown by much, on average, over this period and return on tangible equity was in the mid- to upper-single-digit range. However, interest rates have been at or below zero for most of the past decade. The return to normal monetary policy in the eurozone will support a structural increase in profitability for BNP Paribas to a low double-digit return on tangible equity. BNP Paribas’ midcycle profitability and earnings growth prospects are broadly in line with the average of the rest of the European banks that we cover, but its stable track record indicates it is a less risky prospect than many of its peers.

Retail banking in BNP Paribas' French home market is a challenging industry. Despite the high level of concentration in the French retail banking sector, profitability has lagged cost of capital. Typically, there is a high correlation between industry concentration and profitability for banks. However, the French banking sector is dominated by mutually owned, regional banks. Because the owners and the clients of these banks are largely the same, the profit motive for the mutually owned banks is not as pronounced as it is for BNP Paribas and other listed banks. 

BNP Paribas has been successful in investment banking and has actually looked to grow in this area when many of its European peers have pulled back from market-related activities. Typically we view investment banking as a riskier area where many banks have ran into trouble in the past. It is however, often the smaller players that take outsize risks. BNP Paribas is arguably the only European bank that has the muscle to compete with the large U.S. bulge-bracket investment banks. We believe BNP Paribas should continue to benefit from market share gains in investment banking.

The bancassurance model is well established in France, and combined with BNP’s asset management operations, it allows BNP to capture substantial portions of the value chain on financial products.

Business Strategy & Outlook

We do not believe BNP Paribas has an economic moat. While we found traces of moats in BNP’s operations, these are not compelling or substantial enough to warrant a moat rating. 

We view cost advantages as the primary source of moats in retail and commercial banking, and we divide costs into three primary categories: credit, operating, and funding. In addition, we believe switching costs play a key role in a bank's ability to maintain low-cost funding. We could not find sufficient evidence of a superior ability to control operational and credit costs or to raise cheaper funding for us to award BNP a moat for having a cost advantage. We do believe BNP’s integrated business and wide range of products support switching costs, but we typically do not award a stand-alone moat for switching costs when we analyze banks. 

While we like BNP’s retail banking operations in the concentrated Belgian market, where we believe BNP Fortis holds a current account market share north of 30%, the rest of BNP’s retail banking operations are less attractive. The French retail banking market suffers from competition issues, given the presence of mutually owned banks with a limited profit motive. We believe that BNP’s strategy of carving a niche in banking the professional and mass wealth market in the metropolitan areas of France holds promise and leverages its own strengths; however, this is not a unique approach, as Societe Generaleand Credit Agricole’s LCL Bank have the same plan. Its other operations have low market shares. In Italy, it has a subscale operation in Europe’s most challenging market; in Turkey it is only the tenth-largest bank; in Poland, it has a 5% market share; and in none of its major African operations (Morocco, Algeria, Tunisia, Ivory Coast, and Senegal) does its market share exceed 10%. 

BNP has not historically shown a superior ability to underwrite credit. Since 2006, BNP has raised provisions against 0.6% of its loans on average per year. This is virtually the same as the credit loss ratios of its closest French peers Societe Generale and Credit Agricole, both at 0.8%, and in line with the average long-term ratio of the major European banks at 0.6%. If we look at loan-loss provisions as a percentage of net interest income (which provides a rough indication of risk-adjusted returns), BNP has historically provided for 21% of the net interest it received. This is similar to Credit Agricole’s performance and materially better than Socgen, which gave back 30% of the net interest it earned. It is slightly better than the 24% of net interest income that the average European bank raised impairments against over the long term.

We do not believe that BNP has a funding cost advantage. BNP’s historical net interest margin of 1.1%, while comfortably ahead of its main French rivals (Societe Generale and Credit Agricole both have long-term net interest margins of 0.9%), does lag the European average of 1.4%. We estimate that BNP has a current account market share in France of less than 10%, with the three mutually owned groups each controlling north of 20% of the market. Current accounts are a cheap—often free—and stable source of funding. Interest rates on savings accounts are regulated in France, making it impossible to establish a funding cost advantage. 

Historically, BNP has not been meaningfully more efficient than its French peers, and its average long-term efficiency ratio of 65% is greater than that of the average large European bank at 63%. Once again, we believe that the mutual ownership of French banks is partially to blame for this high metric. France has one of the lowest client/branch ratios in Europe. We believe this confirms the difficulty in rationalizing branches of locally owned banks for the mutual groupings. Members of the regional bank have an obvious vested interest in keeping their own local branch open. For Societe Generale and BNP Paribas, it is also problematic to effectively compete for current account deposits where the dominant players are happy to run a very wide suboptimal branch network. 

The wide scope of products offered by BNP increases the cost of switching for BNP’s retail and commercial banking clients. BNP’s strong insurance and asset-management capabilities ensure that it can offer retail clients a full financial solution. Its strategy in France of focusing on higher earners dovetails nicely with BNP’s highly regarded wealth-management business.

Typically, we award moats to investment banks for intangible assets and the network effect. Intangible assets in investment banking come from reputation, extent of relationships, expertise, and the ability to attract and retain top talent. A key part of the underwriting and trading business is bringing together buyers and sellers of financial assets; hence, network effect is an important moat source for investment banks. The larger the base of buyers to which an investment bank has access—investment funds, banks, and insurance companies—the more attractive it is to sellers, as it makes it more likely that an asset sale will be completed for a fair price. Similarly, buyers appreciate investment banks connected to many sellers, as they'll have improved access to more exclusive offerings. 

Generally, we do not like universal banking franchises with significant investment banking exposure, as we often find them inferior to the stand-alone investment banks. There are aspects of BNP’s investment banking that we like, notably its high client coverage in France and, to a lesser extent, Europe. However, currently, BNP’s investment banking business is neither fish nor fowl. It is not dominant enough either in Europe or globally to compete effectively against the global bulge brackets, nor is it a true niche player in France. 

An evaluation of the banking system in which a bank operates is critical for us to attain a high level of conviction in the moats we find for an individual bank. We define a banking system in broader terms than merely the regulatory environment in a particular jurisdiction. Competitive, political, and economic elements all contribute to a system’s robustness in withstanding banking crises. Overall, we assign ratings to banking systems into four buckets: very good, good, fair, and poor. We rate France's banking system as fair. 

We see the regulatory environment as fair. The European Central Bank has played a much more important role in banking oversight over the past decade than before. France’s banks largely survived the crisis without the need for any government intervention, though how much of that is attributable to Banque de France is open to debate. However, the European Central Bank has since started playing a much more active role in the oversight of European banks, which reduces regional differences and, in our opinion, strengthens the regulatory framework across the continent. 

We rate France's macroeconomic environment as fair, which balances France's history of stability and reasonable debt/GDP ratio with the lack of control over its currency and one of the most inflexible labor markets in Europe. President Emmanuel Macron’s structural reform initiatives for the ailing French public sector hold promise, but the French labor unions remain a substantial stumbling block to reform. The emergence of Macron’s En Marche party has solidified the political center after a period of strong gains in support for populist left- and right-wing parties.

We rate the competitive environment as poor. The French banking system seems much more concentrated than most other continental European systems, with the five large banking groups controlling virtually the whole market, but this disregards the impact of mutually owned banks where the profit motive is secondary. Three of the five major French banks are mutually owned. Credit Agricole and BPCE (via the Natixis listing) are partially open to investors in listed equity, but their core retail and commercial franchises are mutually owned by their clients. The smallest of France’s main banking groups, Credit Mutuel, remains fully mutually owned. We estimate that the combined market share in French retail and commercial banking of the three mutually owned banks (Credit Agricole, BPCE, and Credit Mutuel) could be as high as 80%.

Mutually owned banks do not have the same incentive to maximize profits that publicly listed banks have. With no distinction between clients and owners, their first objective is to provide high-quality service at the lowest cost possible to its clients. It is also fair to say that there is much less pressure on the management teams of mutually owned banks to increase profitability. Millions of disinterested holders of mutual interest certificates are much easier to please than profit-hungry institutional investors. Credit Agricole, for instance, is a conglomeration of 2,500 local banks organized into 39 regional banks with 7 million mutual owners. The various annual general meetings attract over 500,000 attendees that elect 31,000 nonexecutive directors to represent the interests of the members.

None

Economic Moat

BNP Paribas SA

BNP Paribas SA engages in the provision of banking and financial services. The company operates through the following business: Investment and Protection Services (IPS), Commercial, Personal Banking, and Services (CPBS), and Corporate and Institutional Banking (CIB). The company was founded in 1822 and is headquartered in Paris, France.

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