Few investment banks have benefited as much from the explosion in capital markets over the past five years as Société Générale. The French bank’s strengths in equity derivatives and structured credit have helped to fuel rapid growth in its corporate and investment banking business, which generated more than 40 per cent of SocGen’s total net income in the first half of the year.
Yet if Jean-Pierre Mustier is worried by the current crisis in the capital markets, he is putting on a brave face. As the chief executive of SocGen’s corporate and investment banking division, he spent much of August closely monitoring developments in the markets and assessing their impact on his business. His conclusion: the current shake-out could ultimately prove to be a healthy development.
Mr Mustier says the meltdown of the subprime mortgage market in the US, the extent of which has taken months to become clear, has triggered an “irrational mistrust” of credit ratings among investors. This has been exacerbated by the holiday season.
SocGen has not been immune from this panic. At one stage, it was forced to issue a statement denying rumours of losses at Lyxor, its platform that provides investors access to hedge funds. “This irrational behaviour about credit has in August created an environment where, because you had junior participants in the market, people said, ‘I don’t understand, I don’t want to touch, and we’ll see later what to do’.”
For Mr Mustier, this has exposed a misunderstanding among credit investors. “People are questioning why their highly rated, AAA paper is moving in value. But if you bought at a tight credit spread, you have to mark it to market.”
For some critics, the recent problems in the market have called into question the whole risk distribution mechanism that has been at the core of the growth of the capital markets in the past five years.
The system that parcels up credit risk and spreads it around has helped trigger a crisis of confidence because investors are no longer sure what their exposure is.
What is more, the mechanism encouraged excessive risk-taking by allowing subprime mortgage lenders in the US to originate loans that they knew they could pass on.
Mr Mustier acknowledges these limitations, but remains confident that after a correction that will last for at least another few months, investors will once again develop an appetite for credit risk.
“This crisis from my point of view is very sound and very welcome for the medium term to make sure that one of the very important things that has happened in the past five years, which is disintermediation of credit, is something that continues and lasts.”
Nevertheless, there will need to be a change of approach.
To begin with, Mr Mustier says that investors will need to become more sophisticated and more specialised about the types of securities in which they choose to invest.
“For investors willing to invest in credit it’s a question of not just investing in a rating, but investing in a credit you understand,” he says.
“Investors will have to be much more specialised and invest in underlying assets where they understand not just the sector but all the mechanics of the ratings and the stress scenarios.”
This should lead to the creation of narrower, more focused and ultimately more transparent asset classes.
Mr Mustier says it is “too early to say” whether the recent turmoil will have any lasting impact on the real economy.
However, he remains optimistic about SocGen’s investment banking business, which he expects to carry on growing at about 10 per cent a year, reflecting underlying growth in the gross domestic product of its markets.
He also believes that structural trends mean that capital markets in Europe will continue to catch up with the US.
He is confident that demand from investors for structured investment products – in which SocGen specialises – will not be undermined by the turmoil.
What is clear, however, is that the credit bubble of the last few years is not coming back.
Mr Mustier reckons that credit conditions will normalise at around the level they were late in 2004. This means that private equity groups will be able to borrow to finance leveraged buy-outs, but at one or two multiples of cashflow less than the average level earlier this year, he says.
Similarly, he believes that credit spreads for senior debt instruments will ultimately end up at about 60 basis points higher than they
were at the market’s peak.
“We have to go through the rationalisation, leave behind the irrational mistrust and move to a more rational and a more normalised view of what the world should be,” he says.
“And the normalised view is not June 2007.”
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