DBRS Comments on Desjardins Group Purchase of State Farm Canada Business

DBRS notes that Desjardins Group (Desjardins; rated AA with a Stable trend) today announced an agreement to purchase State Farm Canada’s businesses. DBRS has assessed the transaction and concluded that the ratings of Desjardins and its related entities, Caisse centrale Desjardins and Capital Desjardins inc., are unchanged. All trends remain Stable.

Subject to regulatory approvals and compliance with customary closing conditions, Desjardins will acquire State Farm’s Canadian businesses in January 2015. Although most of the business is property and casualty (P&C) insurance, which will be purchased by an existing Desjardins insurance subsidiary, the transaction includes life insurance and other business which will be acquired by other Desjardins subsidiaries.

A key factor for DBRS in making the rating determination is the fact that Desjardins is protected from poor underwriting results in the initial years following the close of the transaction through downside protection arrangements.

The $1.6 billion needed to capitalize the businesses will be primarily financed internally within the Desjardins Group, although State Farm will be investing $450 million in preferred shares to be issued by Desjardins’ insurance subsidiaries, and a long-term partner of Desjardins, Crédit Mutuel, will invest $200 million in preferred shares, common shares and subordinated debt. Desjardins anticipates the acquisition will reduce its Tier 1a capital ratio by approximately 50 basis points, remaining above the stated 15% target.

The acquisition is consistent with Desjardins’ strategy, improving its diversification outside of Québec, particularly in Wealth Management and Insurance. It essentially doubles Desjardins’ P&C insurance business, making it the number two P&C insurance provider in Canada, by Desjardins’ calculation. Desjardins estimates that the new business will contribute to earnings immediately.

The acquisition transfers a substantial Ontario-based workforce and distribution team to Desjardins, which will require material adjustments in order to improve the existing underwriting and operational infrastructure. While Desjardins has appropriate expertise in the Canadian marketplace, the effort is much larger than any other undertaken in the past. The integration risks are notable, albeit much of the initial underwriting risk has been mitigated; consequently, DBRS will continue to monitor developments and reassess whether the transaction proves to be supportive or detrimental to the maintenance of the current ratings profile. This will include monitoring whether there are any sizable departures from the network of more than 500 independent distribution agents or customers.

Overall, the transaction seems to be neutral for the credit rating profile of the Desjardins Group. In the short term, integration risk will be a concern, although mitigating factors do exist to control the underwriting risks. In the medium-to-long term, if the integration of this transaction proves successful, Desjardins will benefit from a stronger presence outside of Québec, which is viewed as supportive of the organization’s current strong ratings profile.

Notes:
The applicable methodologies are Rating Canadian Credit Union Centrals and Desjardins Group (December 2013), Global Methodology for Rating Banks and Banking Organisations (June 2012) and DBRS Criteria: Intrinsic and Support Assessments (February 2009), which can be found on DBRS’s website at www.dbrs.com.which can be found on the DBRS website under Methodologies.