DBRS Confirms Crédit Logement’s Issuer Rating at AA (low); Stable Trend

DBRS Ratings Limited (DBRS) has today confirmed Crédit Logement’s (CL or the Company) issuer rating (IA) at AA (low) with a Stable trend. DBRS has also confirmed the A (high) Issuer Rating of Crédit Logement Assurance. These rating actions follow a detailed review of the Company’s performance and outlook.

Crédit Logement is a home loan guarantee company with a leading position in the French home loan guarantee market where it has a market share of about 50% of guarantees on French home loans, and an important position in overall home lending in France with a share of about 30% of all home loans. A key factor in the confirmation of the rating is DBRS’s assessment of the strength of CL’s franchise, with its leading position in the home loan guarantee market and its important position in overall home lending in France. A further rating driver is CL’s low risk profile which reflects the value of CL’s guarantee that attracts low risk borrowers, combined with CL’s relatively conservative underwriting and its expertise in managing distressed 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, including 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’s 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 maintains its leading markets shares. 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 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 4.6 billion at end-2015, up EUR 431 million since end-2014, CL’s Fund provides a sizeable cushion against adverse developments in the home loan market and the economy. Under the guarantee, CL is ultimately obligated to repay the partner for the loan, if a borrower misses three payments and a recovery solution is not found; in this event CL then owns the loan and is responsible for the recovery and collection process. In evaluating CL’s resources, DBRS also considers the benefit of the Company’s strong owners, who are predominantly the largest banks in France and are committed to support CL, including a commitment to provide resources totaling EUR 2.9 billion to the Fund, and they also 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 housing market, the economy and interest rates. In 2015, the Company reported net profit of EUR 236 million (of which about EUR 100 million net one-offs), and DBRS notes that a large part of the Company’s profits would often be distributed to the shareholders, although this was not the case in 2015, 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.
CL has a 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 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 (at end-2015 CL reported non-performing loans of 0.79% of gross loans, well below the 1.73% for the French market), even in a prolonged downturn. While the average probability of default was up to 0.31% in 2015, stable from 2014 but above the 0.24% in 2013 and 0.25% in 2012, DBRS expects CL’s probability of default to continue at or slightly below this level in 2016, given the very low interest rates and the modest economic growth in France. 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. 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 securities portfolio has reduced in size and is now a comparatively small component.

DBRS considers that the Company faces limited liquidity risk. Although there is the potential for a mismatch between the liquidity of its resources/investments and the required payments of claims from its partners on its guarantees, DBRS believes that the Company’s use of models and scenarios to test the adequacy of its liquidity is prudent. One key characteristic that would 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 only has minimal funding needs, 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 Company’s resources are 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 characteristic of the Fund, and this ensures that the resources of the fund are available to support the guarantee in an increasingly adverse environment. Additionally, in case of a 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 agreement to support CL. 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 16.89%, slightly up from 16.12% in 2014. DBRS anticipates that, in case of increased expected losses, given the obligation to deduct them from capital, CL will continue to have the necessary resources to meet regulatory requirements.

RATING DRIVERS
While upward pressure on the ratings is unlikely due to continuing regulatory challenges and the high level of the assigned rating, significantly higher equity capital and higher ratings of CL’s owners could bring positive pressure.

The rating could come under downward pressure 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, any weakening in risk management (processes, underwriting policies) would also put downward pressure on the rating.

Notes:
All figures are in EUR unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (December 2015). Other applicable methodologies include the DBRS Criteria: Support Assessments for Banks and Banking Organisations (March 2016), DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2016), and the Master European Residential Mortgage-Backed Securities (RMBS) Rating Methodology. These can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include Crédit Logement’s annual report, company confidential disclosures, and the input of the European RMBS team. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating included participation by the rated entity or any related third party. DBRS had access to accounts, management and other relevant internal documents for the rated entity or a related third party.

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.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks 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 Yeterian
Rating Committee Chair: Elisabeth Rudman
Initial Rating Date: June 5, 2014
Most Recent Rating Update: September 29, 2015

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