DBRS Confirms Caisse centrale & Desjardins Group at AA Following Methodology Change, Negative Trends

DBRS Limited (DBRS) has today confirmed all ratings of Caisse centrale Desjardins (Caisse central), Capital Desjardins inc. (Capital Desjardins) and Desjardins Group (Desjardins or the Group), including Desjardin’s Long-Term Issuer Rating at AA, as noted in the accompanying table. Trends remain Negative. In taking this action, DBRS is now utilizing the “Global Methodology for Rating Banks and Banking Organisations” (June 2015) and two related criteria: “DBRS Criteria: Support Assessment for Banks and Banking Organisations” (March 2015) (the Support Criteria) and “Rating Bank Capital Securities - Subordinated, Hybrid, Preferred & Contingent Capital” (February 2015). Desjardins’ senior long-term debt rating of AA is composed of an intrinsic assessment of AA (low) and a support assessment of SA2, resulting in a final rating that has a one notch uplift to AA. Desjardins is viewed as a co-operative with a strong mutual support structure.

The Negative trends on Desjardins Group and its related entities reflects the action DBRS took on May 20, 2015, when the trends on seven banking groups in Canada were changed to negative, including Desjardins. This rating action reflects DBRS’s view that anticipated changes in Canadian legislation and regulation mean that the potential for timely systemic support for these systemically important institutions is declining and is likely to eventually result in a change in DBRS’s support assessment from SA2 to SA3 for these institutions. DBRS currently has an SA2 support assessment for Desjardins Group based on DBRS’s view of likely support from the Government of Canada for this institution, which is systemically important for Québec. As DBRS’s view of Canadian government support for the large banks evolves, so too will the potential for support for other deposit-taking institutions. While support continues to be expected from the Province of Québec (the Province), its ability to support is limited as its Issuer Rating of A (high) cannot support a higher rating level for Desjardins. DBRS notes that the Province’s regulator has designated Desjardins a domestic systemically important financial institution.

Caisse centrale, a 95%-owned financial agent of the Desjardins Group, acts as the Group’s treasurer and provides short-term financing, Medium-Term Notes and arranges Subordinated Debt funding. Ratings assigned to Caisse centrale reflect an SA1 support assessment, with Desjardins Group being the supporting entity; the equalization of the ratings considers Caisse centrale’s position as an integral component of the Desjardins Group.

Capital Desjardins, a wholly owned subsidiary within Desjardins, issues securities and uses the proceeds to acquire subordinated notes (Tier 2 capital) of the caisses. The rating reflects an SA1 support assessment, with Desjardins Group being the supporting entity. However, since the supporting securities are subordinated notes issued by the individual caisses ranking behind all other indebtedness of the caisses, including deposit liabilities, this subordination results in the rating being one notch below Desjardins Group’s AA senior debt rating.

The strength of Desjardins’ franchise is evident in its leading market shares in most retail banking business lines in Québec. With a high penetration rate within the Province’s population, this extensive regional franchise gives the Group a strong position relative to both the large banks and smaller regional competitors. Desjardins reports that it has market shares of 43% of personal savings, 36% of residential mortgages, 24% of consumer loans, 24% of commercial and industrial loans and 40% of agricultural loans in the Province. Also indicative of the Group’s strong position, DBRS estimates the 335 caisses (most of which are in Québec) operate about 49% of the branches in Québec (based on the caisses and the nine largest chartered banks). Also important for the Desjardin’s franchise are the Group’s significant Wealth Management and Life and Health Insurance segment and the Property and Casualty Insurance segment provide a meaningful level of diversification by business and geography, as the two businesses have a presence across Canada

In the first nine months of 2015, Desjardins recorded a profit of $1.5 billion before member dividends and non-controlling interests, a 21% increase over the first nine months of 2014. Net interest income increased on higher average interest earning assets offset by a contraction in net interest margins. The margin compression is consistent with most lenders in Canada as a result of the highly competitive and low interest rate environment. Desjardins’ level of non-interest income to operating revenue remains high at 57.5% in the first three quarters of 2015. The efficiency ratio (operating expense-to-operating income) improved to 70.4% in the first three quarters of 2015 from 72.2% for the same period in 2014; the efficiency ratio remains high compared with the banks. One of Desjardins’ stated objectives is to improve efficiency as the high-cost structure limits financial flexibility and offers less of a buffer to absorb credit losses. Loan loss provisions remained acceptable at 13.4% of operating profit in the first nine months of 2015. In the first three quarters of 2015, Desjardins recorded a return on equity of 9.5%; a high single-digit return is considered strong for a co-operative institution.

Desjardins maintains strong asset quality metrics, as indicated by its net write-off rate averaging 21 basis points in recent years (a lagging but good indicator of actual long-term credit costs). Overall asset quality is strong and compares favourably to peer banks, as Desjardins benefits from its relatively larger weighting toward lower-risk residential mortgages (65% at the end of Q3 2015). The other components of the loan portfolio are consumer at 13% and business and government at 22%. Given Desjardins’ material exposure to the residential mortgage market, any slowdown in this market may slow earnings generation, while a downturn in the residential mortgage market could hurt asset quality indicators and ultimately have an impact on provisioning levels. The Group’s risk profile is considered strong.

Desjardins’ funding profile, which is considered strong, is a positive for its rating. Core retail deposits, considered the most stable source of funding, represent a large portion of funding. The funding activities of Caisse centrale and Capital Desjardins contribute to the diversity of the funding profile.

Desjardins’ capitalization is also strong, with a Tier 1A Capital Ratio (comparable to the Basel III Common Equity Tier 1 ratio) of 15.8% (as at September 30, 2015) relative to the AMF minimum capital level of 8% commencing January 2016. Bolstering its capital ratios, the Group’s share of equity increased by 9.7% in the first three quarters of 2015, in part due to the issue of F capital shares. The Group’s quality of Tier 1 is high as it has not utilized innovative capital and has minimal preferred equity. Internal capital generation has been in the high single digits, which is considered strong.

As noted previously, the Negative trends reflect the potential for a reassessment of the likelihood for federal government support. There are various factors that could influence the credit strength of Desjardins and its related entities. Material improvement in the fundamental business, including cost levels and increased diversification by business line have the potential to be positive, while a change in the assessment of support, evidence of weakness in risk management or material deterioration in the economy or housing market that structurally weakens the Group might have negative implications.

Notes:
All figures are in Canadian dollars unless otherwise noted.

Typically, DBRS issuer ratings apply to all general senior unsecured obligations of the issuer in question. In Desjardins Group’s case, the issuer ratings represent DBRS’s opinion on the overall creditworthiness of the Group from a theoretical perspective, as the Group is not a legal entity and cannot issue debt.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are Global Methodology for Rating Banks and Banking Organisations (June 2015), DBRS Criteria: Support Assessment for Banks and Banking Organisations (March 2015) and Rating Bank Capital Securities - Subordinated, Hybrid, Preferred & Contingent Capital (February 2015), which are available on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

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