DBRS Morningstar Confirms Desjardins Group at AA, Stable Trend

DBRS Limited (DBRS Morningstar) confirmed the ratings of Desjardins Group (Desjardins or the Group) and the Fédération des caisses Desjardins du Québec’s Long-Term Issuer Ratings at AA and Short-Term Issuer Ratings at R-1 (high). DBRS Morningstar also confirmed the Long-Term Senior Debt rating for Capital Desjardins inc. at A (high). The trends on all ratings are Stable. Desjardins’ rating is composed 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 Morningstar) would assist the Province of Québec (Québec; rated AA (low) with a Stable trend by DBRS Morningstar) 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. DBRS Morningstar expects to remove the uplift from systemic support once the extraordinary measures taken to support the Canadian economy are reduced.

KEY RATING CONSIDERATIONS
The ratings and Stable trends reflect Desjardins’ strong franchise in Québec, where it has dominant market shares. A competitive advantage relative to many financial institutions, the Group’s diversified business model includes a sizeable contribution from its insurance business, which holds top-tier market shares in Québec and ranks among the top five in Canada. Historically, Desjardins’ co-operative business model generates relatively stable earnings from well-managed risk exposures; however, as is the case for Canada’s large banks, the economic impact from the Coronavirus Disease (COVID-19) pandemic will have a negative impact on the Group’s profitability and risk metrics over the intermediate term. The ratings also take into consideration Desjardins’ significant concentration risk, with the majority of loans underwritten in Québec, as well as Desjardins’ relatively high cost structure in comparison to Canada’s large banks.

RATING DRIVERS
Given the current environment, DBRS Morningstar views an upgrade of Desjardins’ ratings as unlikely. Over the longer term, a ratings upgrade would require a significant enhancement in market position along with a sustained improvement in the cost to income ratio and financial performance.

The ratings would be downgraded as a result of a material deterioration in the Group's asset quality or an adverse impact from the coronavirus pandemic, which significantly impacts Desjardins’ financial performance.

RATING RATIONALE
Desjardins is the sixth largest financial institution in Canada by total assets with an expansive branch network in Québec (Canada’s second largest province by population and GDP), where it holds leading market shares for loans and deposits (38% for residential mortgages and 41% for deposits). Furthermore, the Group maintains a sizeable insurance business with a leading franchise in Québec, where it is uniquely positioned to sell insurance products through its branches. This has been an important competitive differentiator for Desjardins. In DBRS Morningstar’s assessment, Desjardins is well positioned to mitigate the impacts from the coronavirus pandemic given its solid underwriting standards, strong funding and liquidity positions, and capital levels that are almost twice those of Canada’s large banks. Furthermore, the Group’s sizeable insurance business and its wealth management franchise provide relatively stable sources of revenues and earnings during this period of volatility.

Desjardins generates relatively stable earnings. Although concentrated in Québec, Desjardins benefits from diverse revenue sources, including retail banking, insurance (life and general), wealth management, commercial/corporate banking, institutional asset management, trust services, and capital markets/investment banking. In Q1 2020, Desjardins reported net income of $285 million, a 29% decline when compared with adjusted net income of $401 million in the previous year. This was mainly due to the impact of higher provision for credit losses (PCL) related to the coronavirus pandemic that increased to $324 million in Q1 2020 from $109 million in Q1 2019. It remains uncertain whether the higher levels of PCL will translate into loan losses; however, Desjardins is well-provisioned and generates sufficient income before provisions and taxes to absorb higher PCL.

The Group’s risk profile remains solid. About 75% of the loan book comprises retail loans, most of which are residential mortgages. These have generated low levels of losses, even during the financial crisis of 2008–09 when Desjardins demonstrated substantially stronger asset quality metrics relative to Canada’s large banks. Although the Group has a smaller proportion of commercial and corporate loans in comparison to Canada’s large banks, its business loans are skewed toward small and medium-size enterprises (SMEs), which are more at risk in the current environment. However, as a consequence of the relatively lower operating costs in Québec, the unprecedented measures put in place by the federal government to provide income support for individuals and businesses should lessen the financial impact on the SME sector. DBRS Morningstar will continue to monitor the quantum and evolution in credit quality of Desjardins’ loan portfolio.

Desjardins maintains a diverse funding mix that is largely composed of stable retail deposits, which are sourced from its 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. Positively, DBRS Morningstar notes that the Group has access to all the emergency liquidity facilities that have been made available by the Bank of Canada and other government agencies.

DBRS Morningstar views Desjardins’ capital position as strong and sufficient to absorb potential losses given the Group’s well-managed 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. However, DBRS Morningstar notes that Desjardins’ capital levels are almost twice those of Canada’s large banks while its risk profile is not materially different. In March 2019, the Autorité des marchés financiers’ finalized the Bail-In Regime for Desjardins. As a result, Desjardins has issued bail-inable debt (senior and subordinated), which has further bolstered its regulatory capital position. Desjardins has already exceeded its regulatory requirement for its total loss-absorbing capacity (TLAC) ratio of 21.5% prior to the regulatory deadline of April 1, 2022. Given its existing capital position and replacement of maturing senior debt with Bail-inable Senior Debt, Desjardins is expected to remain ahead of its TLAC requirement.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organizations (June 8, 2020) https://www.dbrsmorningstar.com/research/362170/global-methodology-for-rating-banks-and-banking-organisations.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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.dbrsmorningstar.com.

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

This rating is endorsed by DBRS Ratings Limited (DBRS Morningstar) for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:

The last rating action on this issuer took place on May 22, 2020, when DBRS Morningstar finalized the provisional rating on the issuer’s NVCC Subordinated Debt.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Lead Analyst: Sohail Ahmer, Vice President
Rating Committee Chair: Michael Driscoll, Managing Director
Initial Rating Date: June 5, 1997.

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

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