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* 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
By Christian Plumb
PARIS, March 26 (Reuters) - Europe's mid-tier banks, havingalready shrunk their investment banking activities, may faceincreasing pressure to scale back in areas like proprietarytrading and M&A advisory as costly regulation and weak demandeat into earnings.
From Credit Agricole in Paris to Commerzbank in Frankfurt, many European banks have fallen furtherbehind Wall Street institutions such as Goldman Sachs andJP Morgan in industry rankings as they cut most types oflending and scale back risky trading bets.
As the chasm widens, uncomfortable questions are being askedabout the presence of some second-division players.
"We don't have the room for four investment banks inFrance," said one senior Paris-based banker, who declined to benamed 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 isexpanding in Asia after shrinking its balance sheet and boostingcapital ratios, Credit Agricole, along with domestic rivalsSociete Generale and Natixis, has beenretrenching.
Agricole has cut back on equities, derivatives and M&Aadvisory to focus on a future as a pared-back investment bankcatering to clients in France and elsewhere in Europe.
"We've streamlined the investment bank and it seems to usthat the plane can fly in these kind of conditions," ChiefExecutive Jean-Paul Chifflet said recently.
But with a return on tangible equity of 1.6 percent,according to a recent Mediobanca report, even after substantialjob cuts and asset sales, there are questions about whetherAgricole's investment bank is adding or subtracting value.
The lender, which has a medium-term target for return onequity (ROE) of 10 to 12 percent for its investment bank,declined comment.
Mediobanca analyst Antonio Guglielmi said Agricole shouldconsider selling its investment banking business and refocus onits much higher return asset management unit, Amundi as well asFrench retail banking.
But there is a lack of buyers generally for mid-tableinvestment banks, as larger players seek to conserve capital andavoid taking on loss-making assets.
LEGACY POSITIONS
"If you mark-to-market their balance sheet it would come outnegative. They have a lot of legacy positions, which are worth alot less than book (value)," said one London-based investmentbanker who declined to be named.
"Maybe there are some attractive parts, good teams, but thetrouble is you would only want the people, not the legacypositions, so rather than buy the whole thing you may as wellhire the people.
"As far as I can see, they will continue to weigh on theirparents as they consume a lot of capital and funding and don'tmake 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 forsmaller players to prosper on the basis of regional expertise.But their model is difficult to replicate in the wider - andmore competitive - European market.
"We are not a global player, but when I meet with the 'bulgebracket' (of leading investment banks) they say we are the mostdifficult competitor regionally," Nordea CEO ChristianClausen told Reuters, adding the Swedish bank's strength was itsfocus on the Nordic region.
"We have the competencies and the customer relationships."
Banks like Nordea and SEB are helped preciselybecause they have little or no presence in areas such asproprietary trading, where returns have shrunk due to the impactof tough new capital rules, known as Basel III.
"What they mainly have is retail banking, which is veryprofitable, offering an ROE in the 15 to 20 percent range," saida Paris-based fund manager, speaking not for attribution.
RISKY ASSETS
With the Basel III rules, ROEs on investment banking aremore like 8 to 10 percent, so they're dilutive, he said.
As they cut back their risky assets and loan books so theirparent lenders can bring their capital and liquidity ratios inline with the looming regulations, Europe's mid-tier investmentbanking arms are losing further ground in deal and lendingrankings.
Credit Agricole, which has long boasted a top-ranked projectfinance practice providing long-term funding for big transportand energy ventures, dropped last year into seventh place amongarrangers 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 theycut lending and as the Asian portion of the global marketexpanded, helping banks such as Japan's Mitsubishi UFJ FinancialGroup Inc and Sumitomo Mitsui Financial Group Inc, which have expanded overseas, to counter sluggishdomestic demand.
Credit Agricole's revenue from fixed income, commodities andcurrency (FICC) trading was just 322 million euros in the fourthquarter, 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 at644 million euros, while Credit Suisse generated 771million.
Unlike U.S. rivals such as JPMorgan and Bank of America, European banks typically never built the scalenecessary to become global players.
The region does have some world players, with Britain'sBarclays - bolstered by its crisis-era acquisition ofLehman Brothers - and Germany's Deutsche Bank, rankedsixth and fourth respectively in terms of global fees from bondissuance for instance, according to Thomson Reuters data.
BIT PLAYERS
Some investment banking units were built up to sate theambitions of executives during the boom years. But with theircost of capital now about 12 percent, compared with nearer 10percent for retail operations, that's a luxury many can nolonger afford.
Britain's Royal Bank of Scotland has radicallyshrunk its investment bank in the aftermath of the disastroustakeover of Dutch bank ABN AMRO and will cut it further due topressure to shore up its capital cushion.
Traditionally, banks looking to retrench make the first cutsin equities, derivatives and M&A advisory, while trying to keepa presence in foreign exchange and treasury, areas that are mostuseful for corporate clients.
"It's the same for a lot of banks," said Yannick Naud, aportfolio manager at Glendevon King Asset Management in London."There's not a lot of capital market products that they will beable to compete on if they're not able to use their balancesheet. That's really the tricky thing."
In such a low-return, high-cost environment, the future formid-sized investment banks is focused on serving corporateclients' 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 twotop banks, Santander and BBVA, even as theyhave opened bigger offices in London, and in BBVA's caseactually done some hiring.
"Besides classic loan and transaction banking products, ourclients - especially the medium- and small-sized corporates -need investment banking services," Commerzbank Chief ExecutiveMartin Blessing said recently, referring to everything fromforeign exchange to interest rate and raw materials hedging.
"Therefore, we will of course continue our investmentbanking activities."
