DBRS: BNPP’s 2Q14 Loss, but Solid Underlying; Internal Control System Reinforced

Summary
• Net loss of EUR 4.3 billion, driven by EUR 5.8 billion net penalties related to the settlement with the U.S. authorities that was announced on June 30, 2014.
• Strength of underlying net income evident in resilient revenue generation across all business segments and lower cost of risk than initially anticipated.
• Important changes to the Group’s internal control system in response to the U.S. authorities, also bolsters BNPP’s reputation.
• CRDIV Common Equity Tier 1 (CET1) ratio remains at 10.0% illustrating capacity to absorb shocks.
• DBRS rates BNPP Canada and BNP Paribas Canada Branch’s Long-Term Deposits and Senior Debt at AA with a Negative trend. The ratings of BNPP Canada reflect the strength of its parent, BNP Paribas S.A. (BNPP or the Group), which owns 100% of the shares of BNPP Canada and guarantees its rated debt instruments.

As anticipated, the Group reported a net loss in 2Q14 driven by an exceptional fine related to U.S. dollar clearing violations of U.S. law announced on June 30, 2014. At the same time, the underlying net income trend remains positive. Excluding the penalties and other exceptional items, underlying net income was EUR 1.9 billion in 2Q14, which is up from EUR 1.7 billion in 1Q14 and EUR 1.6 billion in 2Q13.

This upward trend in underlying income is mostly supported by solid revenues, as well as lower operating provisions that compensated for an increase in operating expenses, which reflect the Group’s objectives in expanding in Investment Solutions (IS) and Corporate and Investment Banking (CIB).

BNPP’s powerful underlying franchise is reflected in its largely resilient revenue generation. Revenues held up at EUR 9.6 billion in 2Q14, up +4.0% vs. 2Q13 for the operating divisions at constant scope and exchange rate. This was achieved in spite of still weak demand in France and the low interest rate environment that are putting pressure on earnings. Revenues in Retail Banking that includes Domestic Markets and others retail businesses were up 0.9% YoY at constant scope and exchange rate, illustrating the benefits of being diversified. CIB overall revenues increased by 14.6% YoY to EUR 2.4 billion in 2Q14 at constant scope and exchange rate and excluding the impact of the introduction of Funding Valuation Adjustment (FVA). Good activity in the rates and credit businesses combined with good performance in Asia helped to drive a rebound in CIB revenues, in particular Fixed Income reported a 22.1% increase in revenues vs. 2Q13. Equities and Advisories also reported a good quarter in part thanks to equity derivatives. Improved performance in Corporate Banking was driven by growth in Asia. Investment Solutions (IS), mostly driven by Insurance and Securities Services, reported another good quarter with revenues up 5.0% YoY at constant scope and exchange rate to EUR 1.7 billion. DBRS, Inc. (DBRS) anticipates that the combination of the Group’s franchise strength, growth strategy and cost control will enable the Group to continue to deliver solid underlying earnings as demonstrated in this quarter.

The ability of the Group to absorb credit costs out of underlying earnings remained resilient in 2Q14. BNPP generated gross operating income, or income before provisions and taxes (IBPT), of EUR 3.0 billion. While revenues are holding up, provisioning expenses of about EUR 0.9 billion in 2Q14 were significantly down by 18.1% relative to 2Q13, as CIB, the Europe-Mediterranean and Personal Finance business lines reported a decline, while others showed stability. This resulted in an improved capacity to absorb those expenses, as provisions absorbed just 28% of IBPT in 2Q14 below 30.9% in 2013. DBRS views this level as very manageable. Contributing to the improving position, the cost of risk improved, as the Group’s credit cost was down to 53 basis points (bps) in 2Q14 from 68 bps in 1Q14, and 64 bps in 2Q13. The cost of risk was generally down in CIB and Personal Finance. In the Europe-Mediterranean business line, the Group had provided for the difficult situation in Eastern Europe in 1Q14. Doubtful loans and commitments in 2Q14, as well as the non-performing loan (NPL) ratio at 4.5%, are unchanged compared to end-2013, with a coverage ratio of 83%.

DBRS’s current high rating level for BNPP incorporate very limited tolerance for any further risk management and control issues. In this quarter, BNPP conjointly announced with its results significant changes to the Group’s internal control system, which DBRS view positively. This was done in answer to the U.S. authorities, but should also bolster BNPP’s reputation. Changes include the vertical integration of the Group Compliance and Group Legal functions to ensure independence and resource autonomy, and the creation of two Group Committees: the “Group Supervisory and Control Committee” to coordinate and ensure consistency between the Compliance, Legal, Risk Management and Inspection Generale (Internal Audit) departments, and the “Group Conduct Committee” that includes persons from outside the Group. Enforcing those changes, new Deputy Chief Operating Officer, Head of Group Risk Management, Head of Group Compliance, and Head of the Inspection Generale were appointed. Additional recurring operating costs, which the Group expects to be in the range of EUR 100 to 150 million a year, are largely absorbable.

DBRS views BNPP’s current capital level as adequate given the Group’s plans. With 10.0% CRDIV Common Equity Tier 1 (CET1) ratio only down 60 bps since last quarter despite the 100 bps impact of the penalties paid in 2Q14. Fully loaded Basel III CRDIV leverage ratio is estimated at 3.5%. The Group’s 2014 MLT funding programme is fully completed.

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