DBRS Confirms Desjardins Group at AA, Negative Trend

DBRS Limited (DBRS) confirmed the ratings of Desjardins Group (Desjardins or the Group) as well as the Fédération des caisses Desjardins du Québec’s (FCDQ) Long-Term Issuer Ratings at AA and Short-Term Issuer Ratings at R-1 (high). Desjardins is assigned an Intrinsic Assessment 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 (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, resulting in a final rating of AA. 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.

The Negative trends reflect DBRS’s view that changes in legislation regarding bank recapitalization or a bail-in regime in Québec could imply a reduction in the potential for timely support for systemically important financial institutions, which would likely lead to a change in DBRS’s SA for Desjardins to SA3 from SA2. The legislation enacting the bank recapitalization or bail-in regime for the six large Canadian banks was finalized in 2018 (DBRS Takes Rating Actions on Six Canadian Banking Groups after Finalization of Bail-In Regime). For Desjardins, the Québec government passed legislation (Bill 141) in June 2018 that provides the basis on which the Autorité des marchés financiers (AMF) will issue guidelines for Desjardins with respect to recapitalization and bail-in. DBRS will assess its current Negative trend on the ratings once the AMF publishes its bail-in regime applicable to Desjardins.

KEY RATING CONSIDERATIONS
The ratings for Desjardins are primarily driven by the strength of its franchise based on its dominant position as a retail and commercial co-operative financial institution in Québec. In addition to which, the Group’s insurance businesses hold a top-tier market share in Québec and rank among the top five in Canada. Desjardins also holds the unique advantage of being able to sell insurance products through its branches, something Canada’s federally regulated banks are restricted from doing. Desjardins’ cooperative business model incentivizes low-risk exposures, resulting in relatively stable recurring earnings. However, with the majority of the loan book residing in Québec, there is significant concentration risk. Also, in comparison to Canada’s large banks, Desjardins’ relatively high cost structure constrains its ratings.

RATING DRIVERS
Though unlikely over the intermediate term, positive ratings pressure would be driven by an improvement in productivity and earnings without a material weakening of the risk profile. Continued diversification by product and geography would also be viewed positively. Conversely, a reduction in assessment of likelihood of systemic support, material losses in the loan portfolio because of unforeseen weakness in the underwriting and/or risk management process, or a sustained decline in earnings-generation capacity could impact ratings negatively.

RATING RATIONALE
Desjardins’ ratings are driven by its dominant franchise and brand recognition in 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 centres 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 remain intense, DBRS expects Desjardins to retain its leadership position in Québec.

DBRS views positively Desjardins’ low risk business model that generates relatively stable recurring earnings derived through revenues that are diversified across product categories. Though concentrated in Québec, Desjardins benefits from diverse sources of revenues, including retail banking, wealth management, insurance (life and general), commercial/corporate banking, institutional asset management, trust services and capital markets/investment banking. Desjardins reported Q2 2018 adjusted net income of $548 million, a quarter-over-quarter increase of 9%. The net interest margin was stable at 1.83%, while net loans grew 3.2% sequentially.

DBRS assesses Desjardins’ asset quality as solid, given the predominance of asset-backed mortgage lending, resulting in low levels of provisions for credit losses to average net loans (19 to 24 basis points) on an absolute basis and also in comparison to the big banks. While the ratio of gross impaired loans to gross loans deteriorated to 0.51% in Q2 2018 from 0.28% in Q2 2017, DBRS notes that this is related to recognition of impaired loans under IFRS 9 and that net write-offs to average net loans remained low at 0.20% in Q2 2018. The majority of Desjardins’ residential and commercial mortgage exposure is concentrated in Québec. Though this exposes Desjardins to potential losses in the event of a sustained deterioration in the provincial economy, DBRS 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 real estate-related risks.

In DBRS’s opinion, Desjardins has a diverse funding mix. At Q2 2018, 69% of funding was 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 notes that the proportion of high-quality liquid assets to total assets (8.1% at F2017 for Desjardins) was significantly below the proportion for Canada’s big banks (13% to 18% at F2017). However, DBRS concludes that given Desjardins’ low-risk balance sheet and limited investment banking activities, its liquidity position is sound.

DBRS views Desjardins’ capital position as solid and the available cushion as sufficiently strong to absorb potential losses, 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; and Capitalisation – Strong.

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 on the issuer page at www.dbrs.com.

The applicable methodologies are the Global Methodology for Rating Banks and Banking Organisations (July 2018) and Global Methodology for Rating Life and P&C Insurance Companies and Insurance Organizations (January 2018), which can be found on our website under Methodologies.

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: Michael Driscoll, Managing Director, Head of NA FIG

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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