DBRS Confirms Desjardins Group at AA, Stable Trend

DBRS Limited (DBRS) confirmed the ratings of Desjardins Group (Desjardins or the Group) and the Fédération des caisses Desjardins du Québec’s (FCDQ) Long-Term Issuer Ratings at AA and Short-Term Issuer Ratings at R-1 (high). DBRS also confirmed the Long-Term Senior Debt rating for Capital Desjardins Inc. (CDI) at A (high). The trends on all ratings are Stable. Desjardins’s rating is comprised of an Intrinsic Assessment of AA (low) and a Support Assessment (SA) of SA2, which is 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 Positive trend by DBRS) in providing support to Desjardins, which has been designated as a domestic systemically important financial institution in Québec. The SA2 designation results in a one-notch uplift to the Long-Term Issuer Rating, resulting in a final rating of AA. Under the Autorité des marchés financiers’ (AMF) Bail-in Regime for Desjardins, DBRS expects to eventually remove the uplift from systemic support once the Group has achieved a sufficient total loss absorbing capacity (TLAC), which would offset the removal of systemic support.

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. Furthermore, the Group’s insurance business holds top-tier market shares in Québec and ranks among the top five in Canada. Desjardins’s co-operative business model generates relatively low-risk exposures and stable earnings. However, with the majority of the loan book residing in Québec, there is a significant concentration risk. Furthermore, in comparison to Canada’s large banks, Desjardins’s relatively high cost structure is a constraint on its ratings.

RATING DRIVERS
DBRS views Desjardins as well placed in its current rating category. Over the longer term, positive ratings pressure would be driven by a significant increase in geographic diversification and a sustained improvement in the cost to income ratio. Conversely, a reduction in the assessment of the likelihood of systemic support, material losses in the loan portfolio because of unforeseen weakness in the risk management process, or a sustained decline in earnings-generation capacity, could impact ratings negatively. Although unexpected, any adverse impact to Desjardins’s franchise strength or funding profile stemming from the data breach could also have negative ratings implications.

RATING RATIONALE
Desjardins’ ratings are underpinned by its dominant franchise and brand recognition in Québec. The Group has leading market shares in retail, commercial banking and insurance activities, which are distributed through an expansive network of branches, service centers and automated teller machines across the province. Desjardins is permitted to distribute insurance products through its network in Québec, unlike chartered banks, which are prohibited from using their networks. This is an important differentiator and source of franchise strength for Desjardins. In 2018, the Group updated its corporate governance structure in favour of greater participation across the caisses network. This structure also allows for access to a wider pool of candidates with relevant skills and experience for the Board of Directors of Desjardins, which DBRS views positively.

In June 2019, the Group reported a significant data breach in which personal information of approximately 2.9 million members had been stolen from its network by an employee. The breach contained important personal information on members’ first and last names, dates of birth, social insurance numbers, addresses, phone numbers and email addresses, but did not contain account-specific information such as passwords, security questions and personal identification numbers. It remains unknown whether this information was sold to third parties. Desjardins has managed this situation through timely communication with its stakeholders and by providing loss insurance to its affected members free of cost. DBRS will continue to monitor the situation closely to assess any implications for the Group’s franchise and funding profile. To date, this breach does not appear to have materially impacted Desjardins franchise, deposits or funding.

Desjardins generates relatively stable earnings from its generally lower-risk business mix, which DBRS views positively. Though the retail business is concentrated in Québec, Desjardins benefits from diverse revenue sources, including retail banking, wealth management, commercial/corporate banking, institutional asset management, trust services, capital markets/investment banking and insurance (life and general). The insurance segments, which include wealth management, are key contributors to the Group’s diversification and are an important source of earnings for Desjardins, though they can add some volatility to earnings. This was the case in Q1 2019 when Group net income declined by 20% year over year to $401 million because of adverse performance in the property and casualty (P&C) insurance segment. In 2018, Desjardins generated net income of $2.3 billion, 46% of which came from the insurance segments.

Desjardins maintains sound asset quality, given its solid underwriting and the predominance of mortgage loans and other collateralized lending, which results in low levels of provisioning and write-offs. The level of gross impaired loans to gross loans remains manageable at 0.58% in Q1 2019. The majority of Desjardins’s residential and commercial mortgage exposure is concentrated in Québec. While this exposes Desjardins to concentration risk, DBRS notes that the provincial economy has performed well. Furthermore, compared with Toronto and Vancouver, Montréal (Quebec’s most populous city) is less exposed to real estate-related risks given less robust home price appreciation in recent years. The Group’s wholesale credit risk exposures remain well diversified. However, DBRS is cautious of the impact of recent escalations in trade disputes between Canada, the United States and China on this portion of the loan portfolio.

Desjardins maintains a diverse funding mix that is largely comprised of stable retail deposits, which are sourced from its broad network of caisses and service centres across Québec. This is supplemented by Desjardins’ active participation in the Canadian, U.S., and European wholesale funding markets where it issues covered bonds, securitization notes, medium-term notes and short-term paper. While the Group’s proportion of high-quality liquid assets to total assets of 7.6% at Q1 2019 was significantly below that of Canada’s big banks, DBRS considers Desjardins’ liquidity position to be commensurate with its low-risk balance sheet and more limited capital markets/investment banking activities.

DBRS views Desjardins’s capital position as strong and the available cushion as sufficiently strong to absorb potential losses, considering the Group’s lower risk exposures. As a cooperative institution, Desjardins is limited in its ability to raise fresh capital, although it can source emergency capital through its caisses network. In March 2019, the AMF finalized the Bail-In regime for Desjardins. As a result, Desjardins can now issue bail-inable debt (senior and subordinated), which improves its regulatory capital position. Given its existing capital and likely maturing senior debt, it is expected that the Group will exceed its 21.5% TLAC ratio requirements prior to the April 1, 2022, deadline.

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

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

The applicable methodologies are Global Methodology for Rating Banks and Banking Organisations (June 2019) 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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