Wednesday, August 8, 2012

US Money Fund Exposure to European Banks and the “Originate to Distribute” Business Model

On July 26, 2012, Fitch Ratings has published an interesting report on the US money fund exposure to European banks.

Sharp decline in US money market fund exposure to French Banks

The report shows that, since end of May 2011, the exposure of US prime money market funds towards Euro-zone banks has decreased by 78 %. In the case of France, the decrease attains even 88 %.

As you can see on the graph below, the exposure to French banks is in line with the overall exposure to Europe, even though Germany and the UK are less impacted by the US investors' distrust.

The divestment trend is still ongoing today. As Fitch Ratings mentions in its report, the exposure to Euro-zone banks since the end of May 2012 has decreased by further 33 %. Over the same period of time, the exposure to French banks has decreased by further 28 %.

According to Fitch, “the declining MMF allocations to Euro-zone banks are at least partly a reflection of ongoing investor concern about the region”.

Stock price evolution of French banks

Let's now compare the divestment trend of US money markets since last summer with the stock prices of the major French banks BNP Paribas, Crédit Agricole, and Société Générale.

As you can see, the divestment of US money market funds has, amongst other things, triggered a tremendous decline of the stock prices of BNP Paribas and Société Générale.

Strategic response of French banks

How do the French banks respond to the mistrust of US investors and the decline of their stock price?

A first response lies in a sale of US assets, amounting to 65 bn USD in case of BNP Paribas and 55 bn USD in case of Société Générale. Compared to total assets, the intended sales represent roughly 3 % for BNP Paribas and roughly 4 % for Société Générale.

The second response relates to a return to the so-called “Originate to Distribute” (OTD) business model. The basic idea here is that the banks reduce their funding needs in USD by reducing / stopping the issue of USD denominated loans to clients. Instead, the banks will carry out advisory activity and coordinate the direct relationship between their clients and third party investors.

As you can see, Crédit Agricole is especially innovative as it distributes first and then originates... Errare humanum est! There are simply too many presentations to be prepared and held today!

More specifically, the French banks intend to focus on
  • origination and structuring of financing,
  • bond solutions,
  • syndication and securitization, and
  • early-stage partnerships with investors.

Originate to Distribute (OTD) Model

In my view, the term “originate to distribute” does not seem entirely appropriate for the strategic shift that the above banks intend to carry out.

As the name indicates, the OTD model refers to a business model according to which banks do not hold the credit assets they originate until maturity, but distribute them to different types of investors through the issuance of structured finance products (e.g. securitization) or simply through syndication.

The simple advisory activity involves no origination at all and, therefore, the model as such does not apply to this business situation.

The naming of this strategy is all the more surprising as the OTD model has not enjoyed a good reputation in the recent subprime crisis. In this regard, the European Central Bank has carried out, in 2008 an interesting stakeholder analysis from an agency theory perspective.

Principal / Agent Relationships in the OTD Model

Expanding on the ECB's findings in the subprime mortgage context, the main stakeholders, incentives, and interests in the OTD model envisaged by French banks are the following:

To address the above described conflict of interest between the banks and the other stakeholders, the following measures can be put in place:

  • Banks should retain an ownership stake in the deal, leading ultimately to a certain degree of re-intermediation of the banks. However, as no USD refinancing is currently available, this stake must necessarily consist of an off balance sheet item such as a (partial) performance guarantee on the clients' repayment obligations towards investors or a backup liquidity line for the benefit of investors. To protect the general public, the risk management of the off balance sheet items would obviously need to be carried out and monitored properly.
  • To align the clients’ and investors’ goal of a successful finance transaction with the banks’ interests, it could be wise for the latter to perform additional tasks during the entire financing period. As USD financing is currently not available to French banks, this must necessarily consist in additional services. Examples include payment and other commercial banking services, loan administration and, if necessary, future restructuring of the financing transaction.
  • The banks' reputation should be engaged in the deal. This is obviously a win-win situation as the bank benefits from such public exposure in terms of advertisement and the client receives a “pledge” for the success of the transaction in the form of the banks' long-term engagement and reputation.
  • Redesign of remuneration schemes: The idea here would be to spread the fees paid to banks over the entire financing period. Besides ongoing services provided during the financing project, a kind of “success fee”, payable during / at the end of the financing period, might be envisaged.
  • Transparency and adequate flow of information: From the agent theory’s perspective, this is the most important and most efficient instrument to manage conflicts of interest among principals and agents. Only if all participants know exactly what the banks’ role in the respective transaction is (anything from pure advisory to complete bank financing via loans), potential conflicts of interest become apparent and, thus, manageable. This transparency can be enhanced by improving either the legal documentation or the corporate governance mechanisms of potential SPV’s and their shareholders involved in the financing scheme.


  • Fitch Ratings, “U.S. Money Fund Exposure and European Banks: Eurozone Hits Fresh Low”, July 26, 2012
  • BNP Paribas Presentation – Goldman Sachs Conference – June 14, 2012
  • Société Générale – Morgan Stanley European Financials Conference – March 28, 2012
  • Société Générale – Goldman Sachs Conference – June 15, 2012
  • Crédit Agricole – Credit Update February 2012
  • ECB Report – The Incentive Structure of the “Originate and Distribute” Model – December 2008