DBRS Maintains Crédit Logement S.A. IA at AA (low); Issuer Rating Remains Under Review Neg.

DBRS Ratings Limited (DBRS) has today maintained Crédit Logement’s (CL or the Company) intrinsic assessment (IA) at AA (low). The Company’s Issuer Rating remains at AA Under Review with Negative Implications (URN), with the URN reflecting the action taken on 20th May 2015 to review the systemic support assumptions of 38 European Banking Groups. The Short-Term Debt & Deposit rating remains R-1 (middle) with a Stable trend.

DBRS has today maintained CL’s IA at AA (low) following a detailed review of the Bank’s performance and outlook.

In maintaining the Group’s IA at AA (low), DBRS considers CL’s very strong franchise with its leading position in the home loan guarantee market and its important position in overall home lending in France. A further key rating driver is CL’s low risk profile. This profile reflects the value of CL’s guarantee that attracts low risk borrowers combined with CL’s relatively conservative underwriting and its expertise in managing nonperforming borrowers. Resources to support CL’s guarantees even under very adverse scenarios include not only its substantial Mutual Guarantee Fund, but also the commitment of its shareholder-partners that include the major French banks, as well as the additional internal resources on CL’s balance sheet. Consistently positive earnings indicate the resiliency of CL’s business model and its operational capabilities. Potential challenges to this assessment could arise from any weakening of CL’s resources that back its guarantees, including the strength of its main shareholder-partners.

Furthermore, in DBRS view, the Company’s very strong franchise reflects the knowledge, expertise and capabilities that CL has developed since its inception in 1975. With a very wide distribution through its partners’ networks, CL provides about 50% of guarantees on French home loans and holds a market share of about 30% of all home loans in France. As a guarantor of home loans, CL plays a key role in facilitating lending for homes through its efficient approval process and its second underwriting behind its partners’ first underwriting. In offering an alternative to obtaining a mortgage, CL’s generally attractive pricing and guarantee features enable it to attract lower risk home loan borrowers that contributes to its low credit risk profile. For its partners, CL also brings expertise and economies of scale to the approval process and to the process of remedial action and recovery for home loans whose borrowers fall behind in their payments. While most of its guarantees are provided to home loan borrowers through its largest partners, a range of smaller banks also benefits from CL’s guarantees. Given its extensive role, it can also provide a broad perspective on trends in the French home loan market.

CL’s financial guarantee is based on the pooling risk across home loan borrowers, who pay a contribution of about 1% into the Mutual Guarantee Fund (the Fund). If the borrower repays the loan and the guarantee is ended, CL repays the borrower their guarantee contribution less the expected loss on the outstanding pool of guarantees, which is determined on a quarterly basis. Totaling about EUR 4.1 billion at end-2014 up EUR 190 million since end-2013, CL’s Fund provides a sizeable cushion against adverse developments in the home loan market and the economy. Under the guarantee, CL is obligated to repay the partner for the loan, if a borrower misses three payments; in this event CL then owns the loan and is responsible for the recovery and collection process. In evaluating CL’s resources, DBRS considers the benefit of CL’s diverse strong owners that are predominantly the largest banks in France and are committed to support CL. The owners are committed to provide resources for the Fund about equal to the current size of the Fund. In addition, they own EUR 1.7 billion of CL’s subordinated debt. At present, the major shareholders are Crédit Agricole-LCL which owns 33.0%, Société Générale-Crédit du Nord 16.5%, BNP Paribas 16.5%, and Banque Populaire Caisse D’Epargne-Crédit Foncier de France 15.5%.

The Company benefits from its consistently positive earnings that reflect its sound financial fundamentals and its goal of being profitable, but not maximizing its profits. Earnings tend to fluctuate with the pace of new guarantees and conditions in the French housing market, the economy and interest rates. Average net profit varies between about EUR 70 million and EUR 120 million, and a large part would typically be distributed to the shareholders except in 2014 and 2012. Revenues come from the fees paid by borrowers, about 0.25% to 0.30% of the loan; typically, one third of the fee covers origination costs and two thirds of this fee is spread over the life of the guarantee. In addition, net interest income is generated by CL’s investment portfolio.

An important factor in the IA is CL’s low risk profile, which is dominated by the credit risk in its guarantees. This profile is inherent in the Company’s approach to providing its guarantee. Utilising its expertise, including underwriting and pricing models, it provides guarantees to lower risk borrowers through its attractive pricing and other features. Even with relatively strict underwriting guidelines for its partners, CL still declines around 20% of the files that it is presented with. As a result, CL’s credit performance is much better than the French average (CL reported 0.79% NPLs which is below 1.73% for the French market at end-2014), even in a prolonged downturn. While the average probability of default was up to 0.30% in 2014, back to level similar to that of 2010 (compared to 0.24% in 2013 and 0.25% in 2012), it stabilized in 1H15. DBRS expects CL’s probability of default to continue to stabilise given an economic growth in France that is projected to gain momentum in 2015 and 2016 (supported by the depreciation of the EUR vs. USD, the drop in oil price, and the ECB measures), and very low interest rates. CL’s success in recovery is supported by its knowledge of the borrowers from the approval process, but also its expertise and economies of scale. It has been appropriately reinforced in 2014 to leverage that expertise in a more difficult environment. The Company’s investment portfolio also has relatively low risk, as it is predominantly in the form of deposits with major French banks that are also supported by collateral arrangements. CL’s reduced securities portfolio is a comparatively small component.

DBRS considers that the Company faces limited liquidity risk. There is the potential for a mismatch between the liquidity of its deposits/investments and required payments of claims from its partners on its guarantees, if these claims were to rise abruptly and persist at a very high level. The Company utilises models and scenarios to test the adequacy of its liquidity. This analysis was validated in May 2011 by the Prudential Supervision Authority. CL also reports that it is compliant with the liquidity ratio validated by the regulators that applies to CL and was put in place in 2011. One key characteristic that could help CL manage its liquidity needs in an extremely stressed environment is its ability to delay payment of a claim for up to two years. This reflects a convention signed between CL and its shareholder-partners. CL does not need funding, as it only provides guarantees. It does raise subordinated debt, but DBRS views that as related to capital, rather than to funding.

DBRS’s credit assessment of the Company also incorporates the evaluation of its capital adequacy under extreme stress in market and economic conditions. From this perspective, DBRS’s analysis indicates that CL has sufficient capital and financial resources, under various adverse run-off scenarios, to support an Intrinsic Assessment of AA (low) based, inter alia, on an evaluation of risk utilising the DBRS European RMBS model. DBRS also considers CL’s track record and its own stress tests. CL’s most recent stress tests indicate that the buffer in place is sufficient to cope with very adverse scenarios, including significant deterioration in the domestic economic environment and the housing market. The ability to reduce or even stop repayments to borrowers from the Fund is an important charactersitic of the Fund that ensures that the resources of the fund are available to support the guarantee in an increasingly adverse environment. Additionally, in case of severe crisis, the bank-partner shareholders are obligated to replenish the Fund. As an adverse scenario unfolds, this commitment provides a second line of defense beyond the Fund’s initial resources. Moreover, this commitment is backed by the strength of CL’s major shareholders and their “joint & several” written agreement to support CL. CL’s additional resources to support its guarantees also include its equity and its subordinated debt. Moreover, the Company is regulated by the Autorité de Contrôle Prudentiel et de Résolution (ACPR) in France and is subject to bank capital requirements. In that context, CL reported a Tier 1 ratio of 16.12% down from 23.98%, mainly due to larger regulatory deductions that took place in 2014 reflecting changes in the allowance rules for expected losses (now only deducted from Tier 1, as opposed to both Tier1 and Tier 2 before) but also an increase in the level of expected losses. The level of equity Tier 2 also decreased, mainly due to early redemptions given their non-eligibility under CRD IV. Given regulatory constraints (deductions for expected losses, but also the grandfathering of the Fund since January 1, 2014), CL needs to continue to demonstrate it can adapt and handle remaining uncertainties regarding regulatory requirements on solvency and liquidity.

While upward pressure on the ratings is unlikely due to continuing regulatory challenges and given the high level of the assigned rating, but significantly higher equity capital and higher ratings of CL’s owners would bring positive pressure. Downward pressure on the IA is not expected, but could result if there was a material decrease in the Company’s capital or significant deterioration in the projected losses on its guarantee portfolio and future business, unless this weakening was offset by actions to bolster the Company’s position. At the same time, the downgrading of a number of CL’s large owners could also pressure the ratings to the extent that their capacity to support was more in doubt.

CL’s ratings remain Under Review with Negative Implications due to DBRS’s review of the systemic support assumptions for a number of European Banks initiated on 20th May 2015. The review reflects DBRS’s view that recent developments in European regulation and legislation mean that there is less certainty about the likelihood of timely systemic support. Currently, CL has a support assessment of SA-2, which results in a one-notch uplift from CL’s IA of AA (low) to the final rating of AA. During the review period, DBRS is considering whether to change the support designation of a number of European banks from SA-2 to SA-3, which is the category for banking organisations where DBRS has no expectation of systemic support or is not confident enough that timely systemic support would be forthcoming in times of need to add a notch for systemic support. Such a conclusion would lead to the removal of any uplift and a downgrade of the senior ratings for any affected banks. The review is expected to be completed in September.

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: Support Assessment for Banks and Banking Organisations, the DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities, and the Master European Residential Mortgage-Backed Securities Rating Methodology and Jurisdictional Addenda (July 2015). These can be found can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

This rating is under review. Generally, the conditions that lead to the assignment of reviews are resolved within a 90 day period. DBRS reviews and ratings are under regular surveillance.

For further information on DBRS historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Vitaline Vincent
Rating Committee Chair: Elisabeth Rudman
Initial Rating Date: June 5, 2014
Most Recent Rating Update: May 20, 2015

Information regarding DBRS ratings, including definitions, policies and methodologies are available on www.dbrs.com.