DBRS Comments on Société Générale’s 2Q12 Results; SocGen (Canada) ST Ratings at R-1 (mid), Stable

DBRS, Inc. (DBRS) has today commented that its ratings of Société Générale (Canada) (SocGen Canada) and Société Générale (Canada Branch) (SocGen Canada Branch) remain unchanged following the 2Q12 results of the parent, Société Générale (SG or the Group). These entities have a Short-Term Instruments rating of R-1 (middle) with a Stable trend.

While results held up well in the French Network (FN) with growth in loans and still low cost of risk, and in SFSI with revenue growth, this was nevertheless a weak quarter for SG in a difficult environment. This weakness reflected various exceptional items in International Retail Banking (IRB) and Global Investment Management & Services (GIMS), lower revenues in Corporate and Investment Banking (CIB), and still elevated credit costs in IRB, driven by its subsidiaries in Greece, Romania and Russia. Group share of net income was EUR 433 million in 2Q12, 42% below net income of EUR 747 million in 2Q11 but above net income of just EUR 100 million in 4Q11.

In 2Q12, negative one-off items amounted to EUR 700 million, including goodwill impairments (EUR -200 impairment in the US/GIMS, EUR -250 million in Russia/IRB), legacy asset costs (EUR -114 million), and impact of deleveraging (EUR -110 million). This was partly offset by EUR 340 million positive one-off items, which included the buy-back of Tier 2 debt (EUR + 195 million), and the positive revaluation of the Group’s own debt (EUR +136 million). Excluding one-off items in each quarter, Group share of net income was EUR 793 million in 2Q12, up from EUR 747 million in 2Q11, but down from EUR 851 million in 1Q12.

Net banking income of the Group (NBI or net revenues) was EUR 6.3 billion in 2Q12, down 3.6% from 2Q11, and stable from 1Q12. In 2Q12, the Group reduced its operating costs by 6.0% relative to 2Q11 illustrating the Group’s initiated plan to improve operating efficiency across all business lines. In the French Networks (FN), the expense ratio improved to 63.3% in 2Q12, down from 64.4% in 2Q11 and 65.8% in 1Q12, due to the convergence of the IT platform. Excluding bonuses, operating expenses in CIB significantly decreased by 9% year-over-year (YoY) and 4% quarter-over-quarter (QoQ), illustrating the benefits of the restructuring plan with more benefits to come in 3Q12. Costs in IRB appear under control, with the expense ratio slightly down to 61.2% in 2Q12 from 61.8% in 1Q12 in the context of inflation in certain countries. DBRS views positively the Group’s success with its plan in the retail banking networks as well as in CIB. Given SG’s flat outlook for both segments, this remains an important avenue for generating more net income from these businesses.

With lower revenues compensated by lower costs, SG generated gross operating income, or income before provisions and taxes (IBPT), of EUR 2.3 billion in 2Q12, up from EUR 2.0 billion in the previous quarter and stable from EUR 2.3 billion in 2Q11. This level was more than sufficient to absorb lower provisioning of EUR 0.8 billion in 2Q12 (vs. EUR 0.9 billion in 1Q12 and EUR 1.2 billion in 2Q11). Provisions absorbed 36.0% of IBPT in 2Q12, vs. 45.6% of IBPT in 1Q12, vs. 52.4% in 2Q11, and 66.8% in 4Q11. DBRS views positively that the 2Q12 level remains at a manageable threshold.

The Group’s retail banking operations are important components of its franchise that contribute to the resiliency of its overall results. In 2Q12, the FN generated 32.5% of net revenues, while the IRB generated 19.8% of net revenues. In the FN in 2Q12, activity levels continued to be robust, with strength shown by continued growth in loans (up 3.8% vs. 2Q11) and deposits (up 3.4% vs. 2Q11). SG decreased its loan-to-deposit ratio in the FN to 125% from 128% in 1Q12, and 127% in 2011. Helped by loan growth, FN generated NBI of EUR 2.0 billion in 2Q12, stable from 2Q11as fees and commissions decreased as a result of local regulators requirements. Within IRB, while Czech Republic and Mediterranean Basin achieved stable performance in 2Q12 relative to 2Q11, Russia stood out with goodwill impairment at Rosbank linked to a one-off reassessment of collateral. With a high inflation and low spreads, operating in the region is likely to remain a challenge. The Other CEE countries are impacted by Greece’s continued high cost of risk. Both Romania and Sub-Sahara Africa, French territories and others also deteriorated compared to 1Q12. NBI in IRB was down 1.7% to EUR 1.2 billion in 2Q12. As a result, IRB’s Group net income excluding impairments was a small EUR 19 million gain, lower from EUR 116 million in 2Q11. The emerging markets remain an important component of SG’s strategy and DBRS views its well-diversified presence across various regions as enhancing earnings resiliency over time.

As a result of difficult markets, and reflecting a defensive strategy, CIB delivered lower results in 2Q12 than in 1Q12, when it benefited from very good momentum in fixed income. The Group is now focused on adjusting CIB’s profile and delivering more stable performance. In line with peers , CIB generated NBI of EUR 1.3 billion in 2Q12, down 25.5% YoY, but higher than 4Q11, which was a particularly weak quarter with only EUR 0.7 billion in NBI. While results carry the burden of legacy assets, CIB reported positive net revenues in its core business as in 1Q12, compensating for the costs associated with the strategic sale of loans and disposals of part of the Group’s legacy assets.

Contributing to the resiliency of SG’s earnings, Specialised Financial Services & Insurance (SFSI) posted another good quarter with good commercial performance in Insurance and other SFS lines combined with stabilisation in credit costs vs. 1Q12 and well down by -21.5% from. 2Q11. While SFSI generated NBI of EUR 0.9.billion in 2Q12, up 0.7% from 2Q11, its net income increased by 14.4% to EUR 167 million in 2Q12 relative to 2Q11. The Global Investment Management & Services (GIMS) segment makes a smaller, but important contribution to net income with net revenues that totaled EUR 0.5 billion in 2Q12 relatively stable from 2Q11. Nonetheless, the EUR 200 million goodwill impairment for SG’s U.S. Asset Manager, TWC, negatively impacted the segment’s bottom line in 2Q12. Excluding this, GIMS’s contribution to net income would have been around EUR 71 million in 2Q12, as compared to EUR 59 million in 2Q11. SFSI generated 14.0% and GIMS generated 8.5% of the Group’s net revenues in 2Q12. Net revenues included in the Corporate Center (C/C) can distort the perspective on the share by business over time; C/C registered positive revenues of EUR 0.3 billion in 2Q12 reflecting mostly the positive revaluation of the Group’s own financial liabilities and gains on buy back of Tier 2 debt.

While positive trends were evident in cost of risk throughout 2011 and in 1H12 for the French Network, CIB and SFSI, they deteriorated within IRB, leading to downward trend on the Group’s provisioning overall as compared to 2Q11 and 1Q12. While Greece remains an area of concern with a run rate in the range of EUR 50-100 million of provisions a quarter, “Other CEE” represented 26% of total provisioning in IRB in 2Q12, up from 22% in 1Q12. In addition, Romania and Russia remain under more pressure, as reflected by EUR 86 million provisions in Romania or 25% of total provisioning in IRB, and EUR 75 million in Russia – albeit impacted by a one-off - or 21% of total provisioning. North Africa also deteriorated with provisioning higher than gross operating income in 2Q12.

Doubtful loans have stabilized at 4.7% at end-June 2012 vs. 4.7% at end-March 2012, excluding legacy assets. In DBRS’s view, the Group faces economic weakness and political uncertainty stemming from the Euro Area, although now with reduced exposure to EU peripheral countries, Central and Eastern Europe, Russia and North Africa through its international retail network. At this stage, however, SG still sees only a moderate deterioration ahead and no signals of upcoming large deterioration.

DBRS views positively that the Group continues to improve its liquidity position in 2Q12 relative to 2Q11 with a substantial decrease in its reliance on short-term wholesale funding achieved mainly through a decrease in USD funding. As of June 2012, SG had EUR 114 billion available liquid asset buffer relative to EUR 56 billion in short-term funding and EUR 59 billion in interbank funding (covering 99% of short-term (ST) needs). By comparison, the Group’s liquid assets buffer stood at about EUR 105 billion at 30 June 2011, compared to EUR 96 billion in short-term funding and EUR 68 billion in interbank funding (covering 69% of ST needs). SG achieved its 2012 refinancing needs of medium- and long-term (MLT) debt issuing EUR 16.8 billion, of which EUR 2.6 billion was prefunded in 2011. Issuances of EUR 14.2 billion in 2012 encompassed a diverse mix of funding sources, including senior public issues (28%), structured private placements (33%), vanilla private placements (6%), securitisation (8%), and secured funding (25%). At end-June 2012, long-term funding sources (including equity, customer deposits, and MLT debt) exceeded long-term assets (including customer loans, securities and other long-term assets) by EUR 53 billion. The Group’s loan to deposit ratio improved to 114% at end 2Q12 vs. 118% at end 1Q12, 121% at year-end 2011, and 122% at end 2Q11. IRB, mostly in CEE and Russia, also utilises about EUR 6 billion in Group funding that SG intends to further reduce by increasing self-funding in its subsidiaries, as they grow their deposits. Positively, Geniki in Greece does not rely on Group’s funding, and some businesses in other areas of the Group have started raising deposits on their own (SFSI, German operations).

DBRS maintains its view that the Group has the ability to adjust to the evolving environment as illustrated by its steadily strengthened capital levels. SG’s core capital ratio was 9.9% at 2Q12, up from 9.4% at 1Q12, and 9.0% at end-2011 under Basel 2.5 and the EBA method. While RWA decreased in 2Q12, SG made progress in disposing (or “cracking”) legacy assets leading to capital relief. Improved capitalization was achieved mainly through internal capital generation (48 bp in 1H12), further disposal of legacy assets and the Group’s deleveraging (24 bp in 1H12).

Notes:
All figures in Euros (EUR) unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents, the European Banking Authority, and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Roger Lister
Approver: William Schwartz
Initial Rating Date: 11 October 2006
Most Recent Rating Update: 15 December 2011

For additional information on this rating, please refer to the linking document under Related Research.