It has been a troublesome year for the French financial system. Standard & Poor’s decision to strip France of its cherished AAA credit rating at the start of 2012 was perhaps more symbolic than substantial, but it capped a problematic period for the country that involved dealing with the eurozone crisis, a fresh set of capital adequacy reforms in banking and a lethargic interbank lending market.

The country’s largest commercial banks, which navigated the credit crunch relatively safely, have been the biggest losers. The most obvious impact of this weakness has been in jobs, with the big three French banks – Société Générale (SG), BNP Paribas and Crédit Agricole – cutting 1,800 corporate and investment banking positions (around 10% of staff in these divisions) between them in the last two months. But while staffing levels at such institutions are always volatile, the more seismic shift has been with the disposal of billions of dollars of structured finance debt.

The sale of project finance portfolios is a more widespread phenomenon; Bank of Tokyo Mitsubishi UFJ (BTMU) spent £3.8 billion ($6.02 billion) on Royal Bank of Scotland’s project finance book, as well as some of its staff, in 2010 while last year Bank of Ireland offloaded its infrastructure project finance book to Sumitomo Mitsui Banking Corporation (SMBC) for Eu590 million ($778.1 million) and its energy book to GE Energy Financial Services.

Some French lenders are having a better time. Natixis had less international exposure, began to ramp up overseas at the same time as the crunch hit, and has remained fairly solid in lending. It even plans to establish a mortgage division in Germany. For some the outlook is even worse. Dexia has been closed to new project finance business for several months, and is facing the loss of its global head of project finance, Patrick Blanchard. The bank’s project finance division may not survive a dismemberment of Dexia, which France, Belgium and the European Commission have set in motion.

This is, however, new territory for the French giants. BNP is said to be selling $11 billion of oil and gas projects, and market rumour suggests that it may be looking to sell its US project finance book too. SG is said to be reviewing its aircraft and ship portfolio – following a European commercial property loan portfolio sale launched in late 2011 – as well as parts of its Australian business. Crédit Agricole is also believed to be looking at divestments and pulling out of certain markets.

What makes these restructurings different is not so much that they are the result of the global slowdown, but that they stem from specific issues affecting the French banks. A large book of Greek business does not help, but a focus on short-term US dollar debt and new liquidity restrictions have conspired to chisel away at the market shares of the big three. “The implementation of Basel III will have a major affect on banks’ liquidity and there are tensions over US dollar financings,” one adviser explains.

Basel brush-up

The Basel Committee on Banking Supervision’s Basel III reforms – drafted to make banks more resilient to economic and financial shocks after several buckled during the credit crunch – require lenders to hold more capital against their loans. The reforms affect long-dated and illiquid assets like project finance loans particularly severely, and hit the French banks hard, as they have been ambitious in growing a global business and making some relatively risky commitments.

Lenders will have to maintain a capital ratio of 7%, comprising a core tier-one capital ratio of 4.5% (up from 2%) as well as a counter-cyclical capital buffer of 2.5%, and the French banks were well short of that target. This means trying to sell billions of dollars of potentially troublesome assets, with project finance loan books high on the agenda. BNP and SG are meant to be reducing exposure by a combined Eu150 billion, including loans in the Middle East, Russia and Asia and the US.

Some market observers, such as Paris-based Herbert Smith finance partner Jacques Bertran de Balanda, believe this is not a sign of weakness, though. “The banks started to make progress towards being able to comply with Basel III requirements a few years ago so they were in a decent position to comply now it is finally implemented,” de Balanda observes. “This has meant the disposal of some capital consumer accounts but, rather than restructuring over the course of five years, the banks have done so in 18 months in an open market.”

Parts of their project finance portfolios, whether for reasons of geography or industry, are in US dollars. This has been the other major problem for the French banks: US lenders have not been reassured with the way that Europe’s leaders have handled the euro crisis, and their fears – expressed as their perceived risk of a default – are heightened. US banks are much more reluctant to lend dollars to European banks over a long tenor, which can make banks’ ability to hold dollar-denominated debt expensive and risky. “I think the biggest challenge is not so much Basel III but access to dollar liquidity,” de Balanda continues. “This has made it difficult to lend to sectors such as aviation, shipping and equipment-based financings, as more of these are done in dollars.”

This has meant the disposal of various US dollar investments, from bond holdings to loan books, in what observers claim is an attempt to de-risk the investment banking side of the business. In terms of US dollar debt, BNP is said to being trying to slash $60 billion from its books while SG is aiming for a $55 billion reduction.

Proposition to reposition

Project finance is just one component of French banks’ investment banking operations, which will suffer in aggregate from a renewed focus on retail banking. BNP already has a strong retail banking division, while SG is one of the leading foreign retail lenders in Russia. But a wholesale withdrawal from the projects market is unlikely. Instead, the big French banks will try to create a tighter, narrower focus on core industries and sectors.

The international scope is one thing that is likely to shift. “By default, French banks will have to be less ambitious in their international reach and perhaps pull out of certain markets,” one adviser predicts. “I think the French banks will change their focus, at least in the short-term.” The reduced access to US dollar funding means that projects that generate revenues in US dollars, such as energy, resources, and oil and gas, will become very difficult to pursue. Logically, this will mean a reduced presence in places like the Middle East and Asia, where dollar financings are common.

This could well result in a move towards domestic and European deals as well as a change in the types of products offered. The chief executive of Crédit Agricole’s corporate and investment bank, Jean-Yves Hocher, recently declared the bank is moving towards an “distribute-to-originate” model, where it arranges a loan but sells on most of the debt. This system encourages banks to pass on debt to the secondary market more quickly in order to focus on the fees.

The model is not a new one, and explains how US investment banks were able to maintain a substantial presence in leveraged lending, including B loans for power projects, despite making little in the way of balance sheet capacity available. But an ability to sell down debt supposes adequate credit analysis capacity on the part of buyers, which will either need to build it in-house, or be able to rely upon ratings. But sponsors still frequently view the ratings process with distaste. A unilateral decision to make less balance sheet capacity available will allow lenders that still have capacity – US and Japanese banks in particular – to simply edge constrained institutions out of clubs.

French banks have hinted that they may be able to lay off much of the risk from project portfolios, whilst still making substantial nominal commitments, using bilateral agreements such as credit default swaps with long-term investors such as life insurance companies and pension funds. Another potential outlet for growth is developing products for which banks can receive fees but do not have to put in much of the capital upfront such as project bonds.

French banking involvement in dollar bonds has been increasing. Deals during the last six months include: the £600 million issue for Gatwick Funding (Crédit Agricole and SG); Dolphin Energy’s $1.3 billion bond refinancing (BNP and SG); and the $2.2 billion bond refinancing of the Shuweihat 2 project (BNP). Project bonds in France, however, not to mention the rest of the Eurozone, have been less prevalent,.

The working group looking into funding French infrastructure, Finance Groupe de Travail du Financement des PPP, has highlighted bonds as one solution and certainly, for the French banks, which have access to as much of a distribution pipeline as any other bank, it may be a workable model. One breakthrough deal could be the Eu4.2 billion Canal Seine-Nord project, which has been earmarked for a bond issue, but it will be hard to persuade bond investors to assume construction risk and the relative scarcity of pension funds in the French market also raises questions over the appetite for long-term bonds.

Home sweet home?

Any retrenchment to domestic project financing will coincide with the arrival of much tougher competition than in years gone by. The problems with the French investment banks have coincided with a boom in French infrastructure projects. France’s ability to maintain a strong PPP project pipeline and offer a hefty suite of guarantees has made it a favoured destination for PPP bankers from elsewhere in Europe.

As the major French banks become more risk-averse during the Basel III restructuring process, lending syndicates on French PPP have become much more cosmopolitan:

* Eu88 million debt for Barclays European Infrastructure Fund II and GTM on the French military sports centre PPP (Mandated lead arrangers: BTMU and Dexia);

* Eu85 million on two school PPPs for the Lylopolis consortium (MLAs: Dexia and SaarLB);

* Eu114 million to Vinci-Fayat’s new Bordeaux stadium PPP (MLAs: Dexia and SMBC);

* Eu660 million for Bouygues’ Paris courthouse PPP (BayernLB, BBVA, BTMU, HSBC, Nord/LB, SMBC and SG);

* Eu650 million for the Atlantia-led Ecomouv heavy goods tolling PPP concession (MLAs: Deutsche Bank, Crédit Agricole, UniCredit, Banca IMI and Mediobanca); and

* Eu110 million funding for the A150 toll road project in Normandy (MLAs: Banco Santander; WestLB and Natixis).

Many of these projects were awarded to a bidder outside the big three construction firms of Bouygues, Vinci and Eiffage. ALBEA (NGE, Razel, Fayat, TIIC and OFI Infravia) won and closed the A150 deal, for instance, which was small enough not to require a big domestic bank.

So are the French banks undertaking a tactical retreat or merely repositioning themselves in order to re-launch the business once the various challenges have been met? Few believe that the French are gone completely from the global projects market, but the short-term outlook is gloomy. SG’s 2011 profits tumbled by 39% while the bank found itself on a list of banks that Moody’s assembledforpossibledowngrade,alongsideBNP,suggestinga ratings downgrade is a distinct possibility. The French Presidential election, due to run on 22 April and 6 May this year, has also meant that little movement is expected on either economic reforms or investment programmes.

Beyond then, the future is less clear. “The French banks will remain active and important, especially in vital sectors such as emerging markets and natural resources; these provide long-term financing opportunities so I think they will keep their options open,” de Balanda concludes.

Recent deals with French participation include DP World’s £731 million financing for the London Gateway container port project, which included SG as a lead arranger, while the bank was also mandated with Crédit Agricole on the $1.136 billion Autopistas Metropolitanas de Puerto Rico financing. BNP and Crédit Agricole are supporting the Milan Metro Line 4 PPP concession, while domestic deals of note include the blockbuster, and closed, LGV Tours-Bordeaux and the forthcoming Nimes-Montpellier high- speed rail PPPs.

The French banks may be down in the project finance stakes, but they are certainly not out.