DBRS Confirms Desjardins Group at AA; Trend Remains Negative

DBRS Limited (DBRS) confirmed the ratings of Desjardins Group (Desjardins or the Group) as well as the Fédération des caisses Desjardins du Québec (FCDQ) Long-Term Issuer Rating of AA and Short-Term Issuer Rating of R-1 (high). Desjardins’ Long-Term Issuer Rating is composed of an Intrinsic Assessment (IA) of AA (low) and a Support Assessment (SA) of SA2 based on expectations that the Government of Canada (rated AAA with a Stable trend by DBRS) would assist the province of Québec (rated A (high) with a Stable trend by DBRS) in providing support to Desjardins, which has been designated as systemically important in Québec by the provincial regulatory authority. The SA2 designation results in a one-notch lift to the Long-Term Issuer Rating. The trend on Desjardins’ short-term ratings as well as the Long-Term Issuer Rating, Long-Term Senior Debt, Long-Term Deposits and older-style subordinated debt remains Negative.

Desjardins’ ratings are driven by its dominant franchise and brand recognition in the province of Québec. This position is reflected in its leadership in retail and commercial banking activities as well as its extensive network of automated teller machines, branches and service centers across the province. The Group is also a top-tier insurance provider in Canada and is permitted to distribute insurance products through its network in Québec, unlike chartered banks which are prohibited from using their networks. While competitive pressures are intense and have resulted in a minor loss of market share in certain categories, DBRS expects Desjardins to retain its leadership position in Québec.

The maintenance of the Negative trends reflects DBRS’s view that anticipated changes in Canadian legislation and regulation mean that the potential for timely support for systemically important financial institutions is declining and is likely to eventually result in a change in DBRS’s Support Assessment for Desjardins systemic support to SA3 from SA2. The legislation enacting the bank recapitalization or bail-in regime for the six large Canadian banks is moving forward. For Desjardins, Québec’s 2016 budget includes proposed amendments to existing laws governing cooperative institutions, specifically with regard to recovery and resolution mechanism. If adopted, the proposed changes could result in a reduction in DBRS’s assessment of systemic support for Desjardins from the provincial authorities. Specifically, the proposed amendments, expected to be discussed at the provincial parliament in September 2017, restrict caisses from leaving the Fédération, allows for the issuance of shares to non-members, enables caisses in difficulty to be merged such that creditors and depositors are protected and requires submission of a turnaround plan to be approved by the regulator, Autorité des marchés financiers.

DBRS views positively Desjardins’ low risk business model that generates relatively stable recurring earnings derived through revenues that are diversified across product categories, but concentrated in Québec. By virtue of its solid insurance franchise, almost 60% of operating revenues are non-interest income based. The proportion of revenues derived from non-interest income was the highest for Desjardins compared with Canada’s large banks at Q2 2017. This results in more stable earnings for Desjardins, which in turn supports the Group’s ratings. DBRS believes that Desjardins’ earnings are sufficient to absorb normal credit losses, but views the high operating cost structure as a constraint on the ratings.

DBRS assesses Desjardin’s asset quality as solid, given the predominance of asset-backed mortgage lending resulting in low levels of net write-offs (20 to 23 basis points), on an absolute basis and also in comparison to the big banks, together with a record of stable and low impaired loans ratio over the last five years. Net write-offs for Desjardins are high compared with peers in the cooperative sector, although DBRS believes that this is likely because of the high incidence of personal bankruptcies in Québec as opposed to lower underwriting standards. DBRS also notes that, unlike Toronto and Vancouver, Montréal (Québec’s most populous city) has not experienced abnormal house price increases, implying comparatively lower exposure for Desjardins to housing-related risks.

In DBRS’s opinion, Desjardins has a diverse funding mix, the majority of which is derived through sticky retail deposits sourced from a broad-based network of caisses and service centres across Québec. To supplement its retail funding base, Desjardins maintains an active wholesale funding program in Canada, the United States and Europe, where it issues covered bonds (including Canadian mortgage bonds), medium-term notes and short-term paper, typically with maturities ranging between two and ten years. DBRS views refinance risk as low and Desjardins’ liquidity position as sufficient to meet normal outflows.

DBRS believes that Desjardins’ capital position is solid and that the cushion available to absorb losses is sufficient, particularly considering the Group’s low risk exposures; however, given Desjardins’ cooperative structure, limited sources of new capital are viewed as a constraint on the ratings. In its assessment, DBRS notes Desjardins’ ability to source emergency capital through its caisses network.

The Grid Summary Grades for Desjardins are as follows: Franchise Strength – Very Strong/Strong; Earnings Power – Strong; Risk Profile – Strong; Funding & Liquidity – Strong; Capitalization –Strong.

RATING DRIVERS
Though unlikely over the intermediate term, positive rating pressure would be driven by greater geographic diversification, sustained improvement in the efficiency ratio or a reduction in loan losses in the consumer lending portfolio. Ratings could be negatively affected by reduced assessment of the likelihood of systemic support, material deterioration of asset quality or a sustained decline in earnings-generation capacity.

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

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 the Global Methodology for Rating Banks and Banking Organisations (May 2017) and Global Methodology for Rating Life and P&C Insurance Companies and Insurance Organizations (December 2016), which can be found on our website under Methodologies.

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

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

Lead Analyst: Sohail Ahmer, Vice President – Global FIG
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer

Initial Rating Date: 5 June 1997
Most Recent Rating Update: 17 August 2017

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

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