DBRS Changes Trend on Desjardins Group to Stable from Negative Post-AMF Finalization of Bail-In Regime

DBRS Limited (DBRS) changed the trend to Stable from Negative on the Long-Term and Short-Term Issuer Ratings of AA and R-1 (high), respectively, for Desjardins Group (Desjardins or the Group). DBRS also assigned a new rating of AA (low) with a Stable trend to Fédération des caisses Desjardins du Québec’s Bail-inable Senior Debt as well as changed the trends on its long-term and short-term ratings to Stable from Negative. In addition, DBRS changed the trend on Fédération des caisses Desjardins du Québec’s Subordinated Debt rating to Stable from Negative and subsequently downgraded the rating to A (high) from AA (low) to reflect its structural subordination to the Bail-inable Senior Debt. Lastly, DBRS changed the trend on Capital Desjardins inc.’s (CDI) Long-Term Senior Debt rating to Stable from Negative and subsequently downgraded the rating to A (high) from AA (low) as CDI’s assets comprise subordinated obligations of caisses populaires that are not guaranteed by any other caisse populaire or by any other entity of the Group. These actions result from the Autorité des marchés financiers’ (AMF) publication of its final rules related to the Bail-in Regime for Desjardins, which is designated as a domestic systemically important financial institution in Quebéc.

KEY RATING CONSIDERATIONS
The revision of the trend to Stable from Negative for the affected long-term ratings reflects DBRS’s view that a downgrade of the Group’s existing senior and subordinated debt ratings is now unlikely. It is anticipated that systemic support would still be sufficient to add one notch of support until Desjardins issues adequate amounts of bail-inable debt to meet its total loss-absorbing capacity (TLAC) requirements. Once an adequate level of bail-inable debt has been issued, the likelihood of future systemic support would be much lower. Accordingly, the notch of support would then be withdrawn. However, the bail-inable debt creates an additional buffer that better protects all senior obligations that cannot be bailed in under the regulation; therefore, DBRS does not expect to downgrade any long-term ratings of the Group’s existing senior obligations.

When issued, DBRS will rate the new bail-inable debt at the level of Desjardins’s Intrinsic Assessment (IA), reflecting the risk of being put into resolution.

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. A reduction in the assessment of the 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, would pressure ratings.

RATING RATIONALE
Under the Bail-in Regime, Bail-inable Senior Debt will have preferential treatment during a bail-in compared with all other securities of Desjardins that rank below such debt in the capital structure. DBRS will rate the new Bail-inable Senior Debt at the level of Desjardins’s IA, reflecting the risk of Desjardins being put into resolution. This rating would be one notch below DBRS’s ratings on other senior obligations and deposits of the Group that currently benefit from systemic support. Going forward, these instruments will eventually benefit from the additional layer of Bail-inable Debt in the securities hierarchy. DBRS expects that Desjardins will begin to issue Bail-inable Senior Debt after March 31, 2019. In the event of a bail-in, Bail-inable Senior Debt and any bail-inable securities ranking below it would be converted into contributed capital securities and the terms of the conversion will be determined by the AMF at the point of resolution. These contributed capital securities would rank equally with existing capital shares of the Group. Subsequently, the contributed capital securities and the capital shares would be converted into common shares with the potential for these shares to be listed on a stock exchange.

The new Bail-in Regime in Quebéc reduces the likelihood of systemic support, but bolsters the position of other senior unsecured obligations by creating a new type of senior bank debt that is bail-inable. The likelihood of systemic support does not go away immediately. Instead, DBRS expects that the likelihood of such support will decline as Desjardins builds up its required new bail-inable debt.

DBRS notes that, while the Bail-in Regime does not specifically prohibit the government from bailing out Desjardins, DBRS’s banking methodology requires that systemic support be sufficiently predictable in timeliness and scale to improve the ratings. In DBRS’s view, the Bail-in Regime reduces the timeliness and scale of potential support. As a result, DBRS expects to change the Support Assessment designation of Desjardins to SA3 from SA2 once a larger TLAC buffer is achieved. Currently, the SA2 designation provides a one-notch uplift to Desjardins’s long-term ratings.

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

The applicable methodologies are 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 2019), which can be found on our website under Methodologies & Criteria.

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

For more information on this credit or on this industry, visit www.dbrs.com.

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