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* Some investors positive re steps on eurozone, capital
* Uncertainty remains on business model, strategy
* Brainy "French touch" no longer a competitive edge
* Relatively benign regulator offers advantage
By Lionel Laurent
PARIS, Sept 3 (Reuters) - French banks, their metamorphosisfrom battered euro-crisis victims to European outperformerscomplete, now risk being outgunned as rivals take more radicalsteps to drive profits and deal with rules on capital.
Shunned as pariahs two years ago for their exposure totrouble spots such as Greece and Italy, French bank stocks havebeen the picks of Europe over the past year, outperforming thesector by around 30 percent after shedding risky assetsand boosting their capital defenses.
There may still be some share price upside left, someinvestors say, as the banks launch fresh plans to cut costs andas the eurozone hauls itself out of recession. But anyenthusiasm is tempered by concerns the French banks have yet tocarve out a competitive niche that can withstand increasedregulation and market jitters linked to higher interest rates.
"The Greek problem has been taken care of (and) exposure toItalian debt has been cut across the board," said FredericRozier, a fund manager at Meeschaert Gestion in Paris.
"The French banks have realigned themselves ... But withinterest rates on the rise, a potential property correctionahead and mounting regulation, there is still a question markover the business model to choose."
RADICAL CHANGE
Over the past 18 months, BNP Paribas, SocieteGenerale and Credit Agricole have cut acombined 100 billion euros ($131.9 billion) in assets from theirrisk-adjusted balance sheets.
But even as they broadly cut risk, the French - helped by aresilient home market and an accommodating regulator - haveavoided radical change of the sort carried out at the likes ofRoyal Bank of Scotland and UBS, who haveexited business lines and adapted to post-crisis conditionsunder pressure from regulators and investors.
The result is that French banks have stayed conservative ontheir outlook. While UBS and HSBC are targeting returnson equity of up to 17 percent and 15 percent respectively by2015, SocGen is eyeing 10 percent within the same timeframe. BNPhas declined to even set a profit target until next year.
"The French banks will soon have to start looking for growthlevers now that they are on the path to normalization," saidYannick Naud, portfolio manager at Glendevon King in London.
BNP and SocGen are talking up their geographic footprint:the former is seeking to expand in the United States, Germanyand Asia, while the latter is trumpeting its exposure tonon-euro economies like Russia and eastern Europe.
But some say that despite pockets of strength in equityderivatives and euro bonds, these banks lack a competitive edge.
"We don't think SocGen has a business model that isprofitable enough or differentiates itself enough," saidEspirito Santo banks analyst Shailesh Raikundlia. "As for BNP,which seems to be focused on growing the business ... I'm notsure the market is looking for banks to expand."
WHIZZ KIDS
Part of what used to set French lenders apart before thefinancial crisis was their access to pools of talent from thenation's elite engineering academies, who found they could makemore money building complex financial options and structuredproducts than making bridges and trains.
But over the past five years, the "French touch" has becomemore synonymous with market failures than lucrative equations:Jerome Kerviel's rogue trades at SocGen, Fabrice Tourre'sconviction for mortgage fraud at Goldman Sachs and BrunoIksil's alleged "London Whale" losses at JPMorgan Chase.
French banks themselves have become more risk-averse,shuttering proprietary trading desks and focusing instead onsleepy but cash-rich retail banking to boost profits. While thishas helped cushion losses from whipsawing financial markets,retail is now stagnating and branches are being shut.
"(SocGen's) line is radically different from what it used tobe ... The days when SocGen was the most aggressive in corporateand investment banking are over," said Bruno Bernstein, fundmanager at Keren Finance in Paris.
"What used to set the French banks apart was the maths-whizside, that ability to structure complex products," Bernsteinadded. "I don't see any appetite today from private orhigh-net-worth clients for that sort of thing."
Despite the recent run-up in their share price, French banksare still valued only broadly in line with the sector, withprice-to-tangible-asset ratios of between 0.6 to 0.8 versus aEuropean sector average of around 0.7.
RELAXED REGULATOR
French banks have also benefited from their regulator'srelatively flexible approach to capital and leverage.
Unlike whip-cracking watchdogs in Britain and Switzerland,France's ACPR has publicly opposed going beyond minimum capitalrules for its own banks and was seen as instrumental in wateringdown the government's bank-reform law last year.
While Britain's regulator has put banks under pressure tomeet new rules on leverage, prompting Barclays toannounce a 5.8 billion pounds ($9 billion) rights issue, theACPR has publicly slammed analyst reports that say CreditAgricole and SocGen face capital holes.
"French banks have reached or are not far from reaching theleverage ratio ... They should be able to avoid the scenario ofhaving to raise capital," top ACPR official Frederic Visnovskytold newspaper Les Echos in August.
Such a stance is good news for French banks, argues EspiritoSanto's Raikundlia. "You can see why the French banks arehappy," he said. "There is a very low risk of the Frenchregulator asking banks to raise capital."
But there is a question over whether the regulatory approachwill stay the same when the European Central Bank takes overdirect supervision of the bloc's top banks late next year.
In the meantime, French lenders run the risk of falling intocomplacency - until the market next tests them.
And with the U.S. Federal Reserve already signalling the eraof ultra-cheap cash may be coming to an end, some investorsbelieve now is the time for the French banks to make tougherdecisions on hiving off business lines and refocusing on lesscapital-intensive operations to appease market concerns.
"Banks have been basically getting their main commodity forfree," said Meeschaert's Rozier. "Choices will have to be made."
