DBRS Downgrades SocGen (Canada) to R-1 (mid) following Q1 09 Results of its parent, Société Générale

DBRS has today downgraded the Short-Term Instruments ratings of Société Générale (Canada) (SocGen Canada) and Société Générale (Canada Branch) (SocGen Canada Branch) to R-1 (middle) from R-1 (high). The trend on the short-term ratings has been revised to Stable from Negative. These ratings actions take into consideration the recently released Q1 2009 results for Société Générale (SG or the Group). The ratings of SocGen Canada and SocGen Canada Branch reflect the strength of their parent, SG, which guarantees the rated debt instruments of these entities and owns 100% of the shares of SocGen Canada.

The ratings downgrades reflect the increased stress on the parent Group from the deteriorating economies in its footprint and the still disrupted financial markets. With credit costs rising sharply across most of its businesses, results for Q1 2009 revealed the burden that the Group faces from weakening economies and its remaining legacy exposures. While SG’s commitment to its growing franchise in the emerging markets opens up important growth opportunities in the medium-term, deterioration in these economies is an important contributor to rising credit costs for the Group in the near-term.

The current ratings level and the Stable trend take into account the continued strength of SG’s broad based franchise and its ability to sustain its operating income before provisions and taxes (operating IBPT) that can enable it to cope with the rising cost of credit. Any sustained decline in operating IBPT across the businesses would cause DBRS concern, if it suggested significant weakening in the Group’s franchise strength. During Q1 2009, helped by expense control, operating IBPT in each business showed resiliency, although revenues dipped from the prior quarter in most businesses with slowing demand in weakening economies. Taking advantage of the French Government’s program, the Group will bolster its capitalization and further enhance its capital cushion above required regulatory levels. DBRS sees this enhancement, as well as the Group’s steps to adjust its risk profile, control its expenses and strengthen its franchise as important for maintaining SG’s financial fundamentals.

Rising credit costs and the burden of legacy assets, offsetting 15.8% growth in underlying revenues excluding writedowns, resulted in a net loss of EUR 278 million for Q1 2009, as SG’s operating businesses produced mixed results. This loss followed marginally positive net income of EUR 87 million in Q4 2008 and net income of EUR 1.1 billion in the prior year’s quarter. On a linked quarter basis, net banking income (NBI) declined by 10.6% to EUR 4.9 billion, as revenues were down in several businesses. In Corporate and Investment Banking (CIB) revenues were up strongly, excluding the EUR 1.5 billion in legacy assets writedowns related to European and U.S. asset-backed securities, U.S. real estate assets, credit downgrades of monoline insurers and tighter valuation assumptions. With the Group’s focus on right-sizing the business for the current environment, there were indications of success in the reduction in operating expenses by 4.8% to EUR 3.8 billion on a linked quarter basis. Even with this expense reduction, SG did not generate enough operating IBPT to absorb increased provisioning expense in the quarter. With lower NBI in the quarter, SG’s cost-to-income ratio increased to 76.9% in Q1 2009 from 72.2% in the prior quarter.

Showing the resiliency of the Group’s retail franchise, the French Networks and International Retail Banking were the important contributors to net income for the quarter. The French Networks reported NBI of EUR 1.7 billion for the quarter, which compares well with the historic quarterly run rate of approximately the same level, although the net interest margin continues to decline. International Retail Banking (IRB) generated NBI of EUR 1.2 billion in Q1 2009, consistent with the prior four quarters which ranged between EUR 1.1 billion and EUR 1.3 billion. The retail banking businesses saw an inflow of new customers and growth in both loans and deposits, evidencing the strength of the customer franchise. Within IRB, the Group has focused on realigning its operating platforms to cope with a more challenging environment. To date, SG has been able to generate revenues within IRB to absorb growth in provisions at a rate of approximately 40% to 60% on a linked quarter basis for the past four quarters.

Despite outsized fixed income revenues in the quarter, the main driver of the loss in Q1 2009 was in CIB, which struggled with both large writedowns on various asset classes and the increasing cost of risk. CIB’s revenues were largely generated in fixed income, currencies and commodities as SG had a strong quarterly performance in structured fixed income, currency, interest rate and treasury products. Excluding the EUR 1.5 billion in one-off writedowns, the NBI of CIB was approximately EUR 2.3 billion in Q1 2009. After operating expenses of EUR 911 million and inclusive of the writedowns, CIB reported operating IBPT of negative EUR 70 million, providing little capacity to absorb provisions of EUR 567 million in the quarter. The Group’s drive to constrain its risk taking in CIB is positive from a credit perspective, but may constrain trading revenue growth in certain capital markets businesses. DBRS views the rebound in revenues as a positive sign for future earnings even with more constrained risk appetite, but sees a reduction in the burden of the legacy assets as a required precursor for enabling this revenue rebound to feed through to earnings.

Results in other businesses were mixed. Financial Services reported marginal net income of EUR 31 million in the quarter, as consumer finance was negatively impacted by the economic slowdown and a rise in the cost of funding, particularly in emerging market countries. While the operational vehicle leasing and fleet management business experienced year-over-year growth in its fleet under management, the second-hand auto market remained challenging. Global Investment Management & Services generated only marginal net income of EUR 18 million versus a net loss of EUR 70 million in the prior quarter. The asset management unit continued to experience net asset outflows, as assets under management declined 17% year-over-year to EUR 264.2 billion. SG completed the disposal of its UK subsidiary in Q1 2009 and is in the process of merging a good part of its traditional asset management business with that of Crédit Agricole, as announced in early 2009. DBRS views this action positively, Provided the benefits from the combination are achieved, this will enable SG to gain from the scale of the combined businesses, rather than struggle as a medium sized competitor in an industry where scale can be an important advantage. While private banking experienced net asset inflows in the quarter, client-driven activity remained slow. Securities and services, brokerage and online banking revenues were negatively affected as trading volumes were down and interest rates declined.

Provisions increased to EUR 1.4 billion in the quarter, up from EUR 983 million in Q4 2008 and EUR 598 million Q1 2008, due to a rise in consumer credit risk in emerging markets, risk related to business customers, specifically auto suppliers and construction, deterioration in certain portfolios and, additional conservative (or “collective”) provisioning. The Group’s doubtful loans increased by 10% on a linked quarter basis to EUR 16.4 billion, but by appropriately adding to reserves, SG maintained a coverage ratio of 63%, consistent with prior quarters.

SG’s capital levels remain solid, as the Group’s Tier 1 capital ratio will rise to 9.2% on a pro-forma basis, inclusive of the second round of financing from the French government, which will provide SG with an additional EUR 1.7 billion.

Notes:
This rating is based on public information.

All figures are in Euros unless otherwise noted.

The applicable methodologies are Analytical Background and Methodology for European Bank Ratings, Second Edition, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.