DBRS Initiates Ratings for Société Générale, S.A. – Sr Long-Term Debt at AA (low); Negative Trend

DBRS, Inc. (DBRS) has today initiated ratings for Société Générale, S.A. (SocGen, SG or the Group). DBRS has assigned to SocGen a Senior Unsecured Debt & Deposit rating of AA (low) with a Negative Trend and a Short-Term Debt & Deposit rating of R-1 (middle) with a Stable Trend. At the same time, DBRS confirmed the Group’s intrinsic assessment (IA) of A (high). For Société Générale (Canada) and Société Générale (Canada Branch), DBRS confirmed the Short-Term Instruments rating of R-1 (middle) with a Stable trend and assigned a Senior Unsecured Debt & Deposit rating of AA (low) with a Negative Trend. Société Générale owns 100% of the shares of SocGen Canada and guarantees the rated debt instruments of these Canadian entities.

DBRS notes that these ratings take into account SG’s systemic importance in France and DBRS’s expectation of some form of timely systemic support for SG in the event of a stress scenario, resulting in the Group’s designation as a systemically important bank (SIB) with an SA2 support assessment. This designation results in a one-notch uplift from the IA of A (high) to the final rating of AA (low).

The Negative Trend reflects the downside risks inherent in the economic slowdown and still stressed financial markets, combined with the challenges the Group faces in improving its operating efficiency and increasing its earnings, making more effective use of its balance sheet, and increasing the rewards from its international operations relative to its risks, while also coping with regulatory and legislative uncertainty.

In assigning an IA of A (high), DBRS considers SocGen’s strengths that have enabled it to cope with the sustained crisis. The Group benefits from its strong position in retail banking in France, its focused strengths in corporate and investment banking, the scope of its international retail banking operations, and its diverse financial services businesses. In adjusting to the difficult market conditions and more demanding regulatory requirements, the Group has proved its ability to cope with a challenging environment. After reduced access to unsecured wholesale funding in 2011, the Group improved its funding structure and reinforced its capital cushion through accelerated balance sheet adjustment in 2012. Continued progress with expense control, balance sheet management and franchise development are important to enhance the Group’s resiliency in this uncertain environment.

Demonstrating the strength of the Group’s franchise and its underlying revenue generation capabilities, which are key factors for SG’s intrinsic strength, the Group has sustained its earnings, with some volatility, during this prolonged crisis, even as it absorbed the drag of its legacy assets (2009-2012), the costs of its sovereign exposures (2011-2012), the sale of its struggling Greek subsidiary (2012), goodwill impairments (2012) and the deleveraging in its CIB (2012). Indicative of this strength, Group net income, excluding the revaluation of the Group’s own financial liabilities, was EUR 1.6 billion in 2012, largely unchanged from 2011. While underlying earnings continue to show resiliency, DBRS sees SG as still exposed to a weakening in the recovery in Europe and the ongoing fragile capital markets.

DBRS considers the Group’s strong position in retail banking in France as an important underpinning of its intrinsic strength. Delivering relatively stable earnings with a low cost of risk, the French Networks (FN), which operate primarily under the well-positioned brands of Société Générale and Crédit du Nord, typically generate about a third of earnings. To improve earnings, SG is engaged in a cost reduction program, which DBRS views as essential to sustain earnings in the current environment. Generally the second largest contributor to SG’s earnings, albeit with more volatility, is the Corporate and Investment Bank (CIB). CIB is another core component of SG’s universal banking franchise that has an extensive international presence in more than 34 countries. To economise on balance sheet usage and improve the CIB’s risk profile, the Group is emphasizing flow business. In DRBS’s view, SG has worked to refocus the CIB on its core strengths across its customer franchise and product capabilities to enhance returns and reduce earnings volatility.

DBRS views the SG’s International Retail Bank (IRB) as providing an important avenue for growth, although IRB’s current contribution to Group net income is modest and it has contributed to earnings volatility. The IRB’s diversified presence across various regions enhances earnings resiliency and leverages SG’s international capabilities in operating in countries that are at various stages of economic development and financial market sophistication including Central and Eastern Europe, Russia and North Africa. While manageable individually, these businesses can incur material losses, if a country suffers significant deterioration as occurred in Greece. DBRS sees SG’s two other business segments, Specialised Financial Services & Insurance (SFSI) and Private Banking, Global Investment Management & Services (PB, GIMS), as enhancing the Group’s ability to meet certain product needs across the franchise and extend its geographic reach beyond its IRB operations. SFSI has particular strength in Vehicle Leasing and Fleet Finance, Equipment Finance, Consumer Finance and Insurance. The PB, GIMS segment makes a smaller contribution to net income, but also provides important adjuncts to SG’s core business segments. Across its operations, SG is seeking to enhance contribution of its businesses through more effective collaboration between business segments.

SG’s funding profile combines a sizeable, stable deposit base underpinned by its domestic retail banking franchises with significant usage of wholesale funding that is typical of universal banks with significant corporate and investment banking activities. The Group’s franchise strength and adaptability have enabled it to adjust to the stress on its funding, particularly the stress on short-term U.S. dollar funding faced by French banks in 2011. DBRS views positively that SG has improved its liquidity position with a sizeable excess of stable funding and a maximum for short-term funding of 20% of its balance sheet. The Group is complying with impending short-term regulatory requirements with an LCR ratio above 100% at 1Q13. Appropriately, SG has put more emphasis on aligning its funding profile with the assets being funded and utilising incentives to drive more efficient use of the Group’s balance sheet and liquidity by its business units.

Also factored into the IA is SG’s risk profile, which combines the low risk portfolios in its domestic businesses with smaller but higher risk portfolios, principally in the IRB. The low risk portfolios, which comprise the majority of the credit exposures, are generally matched by low yields that provide limited cushions to absorb any spike in credit costs, though this is not currently anticipated in France. While higher yields are expected to compensate for the higher risk in the IRB businesses, DRBS also factors in the potential for rapid deterioration and unforeseen events, such as in Greece, which can cause credit deterioration to significantly exceed such earnings. Given the economic weakness and political uncertainty across its IRB operations, DBRS sees SG as focused on strengthening its risk position. While the cost of risk is highest in the IRB, the Group’s overall doubtful loan ratio was relatively modest at 4.2% at 1Q13 with a coverage ratio of 71%. Exposures to legacy assets and EU peripheral bonds have been much reduced. Market risk contributes only about 9% of regulatory risk weighted assets (RWA), as SG has scaled back its activities that incur market risk with its focus on flow business and less retention of risk. With experience gained from the market turmoil, DBRS views SG’s control of these risks across the Group as having been reinforced.

Given SG’s continued progress with strengthening its capital and streamlining its risk profile, DBRS views the Group’s capitalization levels as satisfactory. Under Basel 2.5, SG’s Core Tier 1 ratio was 10.6% at 1Q13, up from 9.0% at end-2011. The Group anticipates it will reach a ratio of 9.5% by year-end. At 1Q13, core Tier 1 Ratio under Basel III fully loaded was 8.7%.

Ratings pressure could arise if SG were to have significant difficulties in achieving its gains in efficiency and strengthening its profitability. If these difficulties were accompanied by deterioration in SG’s franchise that reduce its capacity to generate additional capital, this could lead to negative ratings pressure, especially if accompanied by renewed pressure on SG’s liquidity and funding or material weaknesses in its international operations that impact its capitalisation. Alternatively, if SG continues to make progress in improving the efficiency of its businesses and strengthening underlying earnings, while further enhancing its balance sheet profile, negative ratings pressure could be reduced. A return to a Stable trend could be foreseen, if this progress were accompanied by less fragility in financial markets, economic recovery and reduced regulatory uncertainty.

Notes: All figures are 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 and DBRS Criteria: Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments. These can be found at: http://www.dbrs.com/about/methodologies.

[Amended on January 12, 2015 to reflect actual methodologies used.]

The sources of information used for this rating include the DBRS rating of the Republic of France, company documents 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
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 26 July 2001
Most Recent Rating Update: 15 December 2011

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

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.