Credit Agricole shows challenges for mid-tier investment bank players
* European players drop down rankings vs US and Asian rivals
* European market overcrowded but consolidation difficult
* Some want to keep investment bank to service corp clients
* Nordics show it is possible for smaller players to prosper
PARIS, March 26 (Reuters) - Europe's mid-tier banks, having already shrunk their investment banking activities, may face increasing pressure to scale back in areas like proprietary trading and M&A advisory as costly regulation and weak demand eat into earnings.
From Credit Agricole in Paris to Commerzbank in Frankfurt, many European banks have fallen further behind Wall Street institutions such as Goldman Sachs and JP Morgan in industry rankings as they cut most types of lending and scale back risky trading bets.
As the chasm widens, uncomfortable questions are being asked about the presence of some second-division players.
"We don't have the room for four investment banks in France," said one senior Paris-based banker, who declined to be named because of the sensitivity of the topic.
The problem is particularly acute at Credit Agricole, France's third-largest bank by stock market value.
While France's largest lender BNP Paribas is expanding in Asia after shrinking its balance sheet and boosting capital ratios, Credit Agricole, along with domestic rivals Societe Generale and Natixis, has been retrenching.
Agricole has cut back on equities, derivatives and M&A advisory to focus on a future as a pared-back investment bank catering to clients in France and elsewhere in Europe.
"We've streamlined the investment bank and it seems to us that the plane can fly in these kind of conditions," Chief Executive Jean-Paul Chifflet said recently.
But with a return on tangible equity of 1.6 percent, according to a recent Mediobanca report, even after substantial job cuts and asset sales, there are questions about whether Agricole's investment bank is adding or subtracting value.
The lender, which has a medium-term target for return on equity (ROE) of 10 to 12 percent for its investment bank, declined comment.
Mediobanca analyst Antonio Guglielmi said Agricole should consider selling its investment banking business and refocus on its much higher return asset management unit, Amundi as well as French retail banking.
But there is a lack of buyers generally for mid-table investment banks, as larger players seek to conserve capital and avoid taking on loss-making assets.
"If you mark-to-market their balance sheet it would come out negative. They have a lot of legacy positions, which are worth a lot less than book (value)," said one London-based investment banker who declined to be named.
"Maybe there are some attractive parts, good teams, but the trouble is you would only want the people, not the legacy positions, so rather than buy the whole thing you may as well hire the people.
"As far as I can see, they will continue to weigh on their parents as they consume a lot of capital and funding and don't make an attractive return," the investment banker said, referring to Societe Generale, Credit Agricole and Commerzbank.
Banks in markets like Sweden have shown it is possible for smaller players to prosper on the basis of regional expertise. But their model is difficult to replicate in the wider - and more competitive - European market.
"We are not a global player, but when I meet with the 'bulge bracket' (of leading investment banks) they say we are the most difficult competitor regionally," Nordea CEO Christian Clausen told Reuters, adding the Swedish bank's strength was its focus on the Nordic region.
"We have the competencies and the customer relationships."
Banks like Nordea and SEB are helped precisely because they have little or no presence in areas such as proprietary trading, where returns have shrunk due to the impact of tough new capital rules, known as Basel III.
"What they mainly have is retail banking, which is very profitable, offering an ROE in the 15 to 20 percent range," said a Paris-based fund manager, speaking not for attribution.
With the Basel III rules, ROEs on investment banking are more like 8 to 10 percent, so they're dilutive, he said.
As they cut back their risky assets and loan books so their parent lenders can bring their capital and liquidity ratios in line with the looming regulations, Europe's mid-tier investment banking arms are losing further ground in deal and lending rankings.
Credit Agricole, which has long boasted a top-ranked project finance practice providing long-term funding for big transport and energy ventures, dropped last year into seventh place among arrangers of such loans from fourth in 2011 and second in 2009, according to Thomson Reuters data.
BNP and SocGen have also slipped down the rankings as they cut lending and as the Asian portion of the global market expanded, helping banks such as Japan's Mitsubishi UFJ Financial Group Inc and Sumitomo Mitsui Financial Group Inc , which have expanded overseas, to counter sluggish domestic demand.
Credit Agricole's revenue from fixed income, commodities and currency (FICC) trading was just 322 million euros in the fourth quarter, far below a peer group average of 1.28 billion euros ($1.7 billion), according to Mediobanca research.
Domestic rival Societe Generale's FICC revenue came in at 644 million euros, while Credit Suisse generated 771 million.
Unlike U.S. rivals such as JPMorgan and Bank of America , European banks typically never built the scale necessary to become global players.
The region does have some world players, with Britain's Barclays - bolstered by its crisis-era acquisition of Lehman Brothers - and Germany's Deutsche Bank, ranked sixth and fourth respectively in terms of global fees from bond issuance for instance, according to Thomson Reuters data.
Some investment banking units were built up to sate the ambitions of executives during the boom years. But with their cost of capital now about 12 percent, compared with nearer 10 percent for retail operations, that's a luxury many can no longer afford.
Britain's Royal Bank of Scotland has radically shrunk its investment bank in the aftermath of the disastrous takeover of Dutch bank ABN AMRO and will cut it further due to pressure to shore up its capital cushion.
Traditionally, banks looking to retrench make the first cuts in equities, derivatives and M&A advisory, while trying to keep a presence in foreign exchange and treasury, areas that are most useful for corporate clients.
"It's the same for a lot of banks," said Yannick Naud, a portfolio manager at Glendevon King Asset Management in London. "There's not a lot of capital market products that they will be able to compete on if they're not able to use their balance sheet. That's really the tricky thing."
In such a low-return, high-cost environment, the future for mid-sized investment banks is focused on serving corporate clients' needs, even if they remain bit players on the global, or in some cases, even European stage.
Serving such client needs has been the focus for Spain's two top banks, Santander and BBVA, even as they have opened bigger offices in London, and in BBVA's case actually done some hiring.
"Besides classic loan and transaction banking products, our clients - especially the medium- and small-sized corporates - need investment banking services," Commerzbank Chief Executive Martin Blessing said recently, referring to everything from foreign exchange to interest rate and raw materials hedging.
"Therefore, we will of course continue our investment banking activities."