DBRS Comments on Société Générale Q2 2009 Results, Maintains SocGen (Canada) Short-Term at R-1 (mid)

DBRS has today commented on the Q2 2009 results for Société Générale (SG or the Group). Based on the announced results for the Group, DBRS does not see any impact on the ratings for its subsidiaries, Société Générale (Canada) (SocGen Canada) and Société Générale (Canada Branch) (SocGen Canada Branch), which have Short-Term Debt ratings of R-1 (middle) with a Stable trend. The ratings of SocGen Canada and SocGen Canada Branch reflect the strength of their parent, SG, which owns 100% of the shares of these subsidiaries and guarantees their rated debt instruments.

SG’s net income rebounded to positive levels in Q2 2009 following a quarter of negative earnings in Q1 2009. DBRS views this rebound positively, as it indicates the Group’s ability to generate the underlying earnings to cope with still elevated credit costs, write-downs and other charges. SG’s net income of EUR 309 million compared favorably to a net loss of EUR 278 million in the prior quarter, but was still well down from net income of EUR 644 million in Q2 2008. Indicative of the resiliency of SG’s franchise, revenues were particularly strong in Corporate and Investment Banking (CIB), net of negative valuations adjustments, and held steady in the Retail Banking (RB) businesses. DBRS sees the Group benefiting from its universal banking franchise with the rebound in capital markets and stability in retail banking. SG’s franchise building, however, contributed to the increase in expenses in the quarter as the Group continued to focus on growing its RB businesses both inside and outside of France, strengthening risk control infrastructure within CIB, and reorganizing and resizing certain businesses. Early results from these investments and progress on controlling costs could be important for sustaining the rebound in earnings.

In CIB, underlying revenues remained strong at EUR 3.0 billion, but over half of these revenues were absorbed by EUR 1.7 billion in markdowns on CDS hedges on the loan book, tightening of spreads on certain of SG’s debt instruments and asset impairments. Excluding one-off adjustments in prior quarters, CIB’s underlying revenues compared well with EUR 2.7 billion in Q1 2009 and were up substantially from EUR 1.9 billion in Q2 2008, as SG benefitted from the trading of flow products in a more normalized market environment. The Group’s focus on risk reduction was evident as average trading VaR declined to EUR 50.3 million from a peak of EUR 70.2 million in Q4 2008. CIB’s expenses increased by 25% on a linked quarter basis, reflected in part by higher variable compensation as a result of the underlying revenue generation in the business. While provisions significantly declined by 54% quarter-over-quarter to EUR 258 million, the amount still exceeded gross operating income (net of expenses) of EUR 154 million, resulting in another quarterly net loss in CIB.

Showing the resiliency of the Group’s retail franchise, which DBRS sees as a key underpinning of the SG’s strength, the French Networks (FN) and International Retail Banking (IRB) were the important contributors to SG’s net income for the quarter. The French Networks reported net banking income (NBI) of EUR 1.8 billion and IRB generated NBI of EUR 1.2 billion for the quarter, each of which compare well with the historic quarterly run rate of approximately the same level. The FN saw strong net deposit inflow and an increase in net interest margin, as the rate paid on deposits declined, including on long-term savings accounts (Livret A accounts). Within IRB, the Group has focused on realigning its operating platforms to cope with a more challenging environment in certain geographies. The deterioration in these economies, particularly Russia, has caused provisioning to remain elevated, absorbing approximately 62% of gross operating income. Even so, the IRB remained profitable with net income of EUR 122 million in the quarter.

Results in Financial Services (FS) and Global Investment Management & Services (GIMS) were mixed. FS reported NBI of EUR 801 million in the quarter with lower activity, but improved margins. In consumer finance, the Group adjusted pricing and loan approval criteria to realign with the current economy, which has helped business margins. GIMS generated NBI of EUR 747 million, a 14.6% increase on a linked quarter basis, helped by a high margin rate. The asset management unit continued to experience net asset outflows, while private banking saw net asset inflows in the quarter. SG completed the merger of a good part of its traditional asset management business with that of Crédit Agricole, which DBRS anticipates should benefit the Group through strengthened asset-gathering, broader product capabilities and a much enlarged distribution network.

Indicative of the challenges that DBRS sees the environment still posing for the Group, provisions remain elevated at EUR 1.1 billion on a consolidated basis, equating to a cost of risk of 112 basis points (bps), which is down from EUR 1.4 billion in the prior quarter, but 2.8x the provisioning level in Q2 2008. There are some signs that the overall cost of credit has turned a corner, as provisions declined by 21% quarter-over-quarter with improvement in the CIB and trends in some businesses showing improvement. Nevertheless, the level of provisioning remains elevated, absorbing close to 70% of the Group’s gross operating income, with deterioration in IRB due to Russia and FS. Still weakening credit quality was indicated by the increase in doubtful loans to EUR 17.8 billion, up 8.5% from the prior quarter, and an increase in the doubtful loan ratio to 4.2%, up 40 bps on a linked quarter basis. While SG added to reserves, the coverage ratio slipped to 61% from 63% in the prior quarter.

SG’s capital levels remain solid. The Group raised its Tier 1 capital ratio to 9.5% at 30 June 2009, up 80 bps from 31 March 2009, bolstered by non-voting preferred shares issued to the French government and reductions in risk-weighted assets (RWA). SG continued de-risking the balance sheet in the quarter, including the sale of EUR 3 billion of illiquid assets in the quarter. RWA were reduced to EUR 335.7 billion, or 32% of total assets, at 30 June 2009 from EUR 345.5 billion at year-end 2008.

Given the global economic weaknesses and still fragile financial markets, DBRS sees the Group’s continued progress in strengthening its franchise, working down its exposures and shedding risk as important for the stability of the ratings of SocGen Canada and SocGen Canada Branch. The Stable trend takes into account the continued strength of SG’s broad-based franchise and its ability to sustain gross operating income to cope with the elevated credit costs. With the franchise showing resiliency, DBRS would be concerned, if there were any indications of franchise weakening that resulted from inadequate investment or constraints on risk taking.

Notes:
All figures are in Euros unless otherwise noted.

This rating is based on public information.

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.