DBRS: SG Strategy Leverages Universal Banking Model; Q1 2014 Results Show Positive Trends

• Group Net Income of EUR 315 million in Q1 2014, down 13.3% year-on-year (YoY), after EUR 525 million goodwill write-down linked to SG’s Russian subsidiary. Excluding this write-down, Group Net Income was EUR 840 million for the quarter.
• Capital market activities affected by slowdown in fixed income, currencies and commodities (FICC), partly offset by strong performance in equities and underwriting; revenues up in investor services and assets & wealth management.
• SG’s cost of risk improved overall, with positive trends in France.
• DBRS rates Société Générale’s Senior Long-Term Debt & Deposits at AA (low) with a Negative trend.

At its recent investor day, Société Générale (SocGen or the Group) expanded on its strategy that leverages its universal bank through its three pillars: French Retail Banking; International Retail Banking and Financial Services; and Global Banking and Investor Solutions. Growth under this strategy focuses on the strengths of each pillar, while also seeking to increase collaboration across businesses. From DBRS, Inc.’s (DBRS) perspective, successfully executed, this strategy enables SG to adapt to the evolving environment and generate growth with improving returns to capital. The Group’s results in Q1 2014 showed positive trends that illustrate its strategy.

Excluding one-off items (principally goodwill write-down and reevaluation of own debt), SG’s Group Net Income was EUR 904 million, up 24% from EUR 728 billion in Q1 2013. This improvement resulted from a significant decrease in the cost of risk and a stable operating cost base, as revenues were slightly down. When the 100% impairment of the EUR 525 million goodwill for the Group’s Russian subsidiary Rosbank is included, Group Net Income was only EUR 315 million in Q1 2014.

With lower adjusted revenues and costs relatively flat, SG generated gross operating income, or income before provisions and taxes (IBPT), of EUR 1.9 billion in Q1 2014, down from EUR 2.1 billion in Q1 2013. At EUR 667 million, however, provisions were down significantly from EUR 927 million YoY, and absorbed just 35% of IBPT in Q1 2014, well below the 43% in 2013.

Revenues in French Retail Banking (FRB) were stable despite the decrease in outstanding loans resulting from the still weak growth environment. In this first pillar, which is a core component of the Group’s franchise, SG’s strategy is focused on improving efficiency and growing revenues through collaboration. Such efforts are evident in working with SG’s insurance business, for example, and with its capital markets capabilities, such as, in providing investment products.

In the International Retail Banking and Financial Services (IBFS), the headwinds in Eastern Europe were partly offset by a strong performance in Financial Services. As an important complement to its other businesses, Financial Services is an important source of revenues, which were up 9.7% to EUR 526 million in Q1 2014. SG is committed to its presence in Russia and in Central and Eastern Europe, where it sees growth opportunities albeit in a difficult environment. Czech Republic is more stable, but also a more mature market with slower revenue growth anticipated. Although Africa makes a smaller contribution, SG expects strong revenue growth of 7% by 2016.

Revenues overall in Q1 2014 were down 6% in Global Banking & Investor Services (GBIS) YoY. In Capital Markets, lower adjusted revenues were mostly driven by lower volume and tightening margins in FICC, despite a strong performance in Equities driven by structured products, as well as a strong quarter for debt and equity underwriting. These results illustrate the strength and diversity of SG’s capital markets businesses. Its strategy is focused on leveraging its product capabilities, for example in equity derivatives, and its expertise and client relationships in financing and advising corporate and institutional clients. More broadly, revenues were up in other areas of GBIS, including Investor Services and Asset & Wealth Management. GBIS businesses benefit from SG’s international reach, which is an important element in its strategy that facilitates its capital markets capabilities and its ability to serve its clients.

Signs of improving asset quality were evident in many businesses in Q1 2014. SG reported a drop in its cost of risk down to 65 basis points (bps) from 75 bps in Q1 2013. Including legacy assets, the non-performing loans (NPL) were stable on a slightly declining denominator base leading to a NPL ratio of 6.6%, while the coverage ratio was up to 62%. Notably, the cost of risk was down by 28% in France with improvement in medium size corporates; it also improved in Romania. Outstanding legacy assets totaled EUR 5.2 billion and are no longer a drag on the P&L. The Group does not anticipate negative impacts from the asset quality review (AQR) and European Central Bank (ECB) stress test.

Russian related exposure is a concern, but is manageable from DBRS’s perspective. Overall, Group credit exposure to Russia represented 3% of total Group exposure at default (EaD) at end-2013. SG has exposure to large Russian corporates principally in the energy and commodity sectors, where risk is managed with collateral and other mitigants. SG also has Rosbank, its retail banking subsidiary, and other financial entities in Russia. Rosbank posted a positive net result in Q1 2014, excluding the goodwill write down, with NPL ratio of 12% at Q1 2014. The coverage ratio in Russia is 74% for all banking entities. The Group is working towards greater local funding for its Russian operations with Rosbank’s loan to deposit ratio reduced to 104% in Q1 2014 from 112% YoY, reflecting success in increasing deposits. The Group’s internal funding now stands at EUR 1.2 billion, which it intends to reduce further as it progresses with its appropriate internal policy of self-funding its international subsidiaries.

SG’s Q1 2014 common tier 1 ratio was up to 10.1% under fully loaded Basel III; this was mostly due to retained earnings. The acquisition of the minority interest of Rosbank in Q1 2014 amounted to 6 bps of capital. The strengthening of capital is more evident YoY, up 130 bps. DBRS notes that Tier 1 capital benefited from an additional capital issue in April 2014. SG’s fully loaded Basel III CRD4 leverage ratio is estimated at 3.6% pro-forma as of April 2014.

DBRS rates Société Générale’s Senior Long-Term Debt & Deposits at AA (low) with a Negative trend.

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