DBRS Morningstar Confirms Ratings on Desjardins Group at AA, Stable Trends

DBRS Limited (DBRS Morningstar) confirmed the ratings of Desjardins Group (Desjardins or the Group) and the Fédération des caisses Desjardins du Québec (FCDQ)’s Long-Term Issuer Ratings at AA and Short-Term Issuer Ratings at R-1 (high). The trends on all ratings are Stable. Desjardins’ rating is composed of an Intrinsic Assessment of AA (low) and a Support Assessment of SA2, which is based on the expectation 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.

KEY CREDIT RATING CONSIDERATIONS
The rating confirmations and Stable trends reflect Desjardins’ strong franchise in Québec, where it has dominant market shares. Additionally, the Group’s diversified business model includes a sizable contribution from its insurance business, including a Property and Casualty Insurance business that holds top-tier market shares in Québec and ranks among the top five in Canada. Moreover, Desjardins’ co-operative business model generates relatively stable earnings from its well-managed risk exposures, and its balance sheet fundamentals are sound, including stable funding sources, high liquidity levels, and a very solid capital cushion. 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 with the large Canadian banks.

While DBRS Morningstar is concerned about a potential real estate market correction, particularly in the greater Toronto and Vancouver areas, the majority of Desjardins’ credit exposure is underwritten in Québec, which has experienced a relatively benign credit environment in recent years and has not witnessed the rapid real estate price appreciation seen in some other provinces.

CREDIT RATING DRIVERS
Over the longer term, DBRS Morningstar could upgrade the ratings if Desjardins were to continue building the scale and diversity of its franchise, without a commensurate increase in risk, while sustainably improving profitability metrics.

Conversely, DBRS Morningstar could downgrade the ratings if there were a reduction in the assessment of the likelihood of systemic support; material losses in the loan portfolio, especially from deficiencies in risk management; or a sustained decline in earnings generation capacity.

CREDIT RATING RATIONALE
Franchise Combined Building Block (BB) Assessment: Strong
Desjardins is the seventh-largest banking institution in Canada by total assets (as of Q1 2023) with a large branch network in Québec (Canada’s second-largest province by population and GDP) where it holds leading market shares for both residential mortgage loans and deposits (38% for residential mortgages and 41% for deposits). Furthermore, the Group maintains sizable insurance businesses with leading franchises in Québec, where it is uniquely positioned to sell insurance products through its branches. This has been an important competitive differentiator for Desjardins compared with the large Canadian banks, which are prohibited from selling insurance through their bank branches.

Earnings Combined Building Block (BB) Assessment: Strong/Good
Desjardins generates strong earnings, supported by diverse revenue sources, including retail and commercial banking, insurance (life and general), wealth management, institutional asset management and trust services, and capital markets/investment banking. In Q1 2023, Desjardins Group reported net income of $264 million, down about 30% year over year (YOY) compared with the same period in 2022, which was restated as a result of the adoption of IFRS 17 (Insurance contracts) on January 1, 2023. Higher operating expenses and provision for credit losses were only partly offset by an uptick in noninterest income while net interest income, as calculated by DBRS Morningstar, remained broadly stable. Operating expenses grew about 2.9% YOY in Q1 2023, reflecting greater spending on personnel, technology, and security. Despite an increase in claims in the Property and Casualty Insurance segment, overall noninterest income calculated by DBRS Morningstar grew 1.6% YOY in Q1 2023 on the back of higher net fees and commission as well as net foreign exchange gains.

Risk Combined Building Block (BB) Assessment: Strong
The Group’s risk profile remains solid. More than 70% of the loan book comprises retail loans, most of which are residential mortgages and have historically generated low levels of losses. Although the Group has a relatively small proportion of commercial and corporate loans in comparison to Canada’s large banks, its business loans are skewed toward small and medium-size enterprises, which typically have less resources to cope with economic downturns. Gross loans and acceptances grew 8.2% YOY in Q1 2023 on the back of expansions of 5.5% and 18.3% in residential mortgages and commercial loans, respectively. Meanwhile, gross impaired loans increased marginally by 4 basis points (bps) to 0.5% of gross loans for the same period with minimal loan losses. Nevertheless, as with other banking organizations, DBRS Morningstar expects Desjardins’ credit quality metrics to modestly deteriorate in 2023 amid economic challenges associated with higher interest rates and inflation.

Funding and Liquidity Combined Building Block (BB) Assessment: Strong/Good
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. Reflecting higher market rates, retail term deposits grew about 20% YOY in Q1 2023 as members locked in higher yields following a prolonged low-rate environment. As a result, these deposits represented about 25% of total funding as of Q1 2023 while demand deposits accounted for about 23% for the same period. Personal deposits are 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. Meanwhile, Desjardins enjoys high liquidity levels in line with peers, with a liquidity coverage ratio of 140% for Q1 2023 and a net stable funding ratio of 127%, both well above the regulatory minimums.

Capitalization Combined Building Block (BB) Assessment: Strong
DBRS Morningstar views Desjardins’ capital position as strong and sufficient to absorb losses in a stressed environment. 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 significantly higher than 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. As of Q1 2023, Desjardins reported Tier 1A and TLAC ratios at 19.9% and 29.3%, respectively, comfortably above the regulatory requirements.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/417135.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
General Considerations

Social (S) Factors
DBRS Morningstar views the Social Impact of Products and Services ESG subfactor as relevant to the credit rating but it does not affect the assigned ratings or trends. As a cooperative, Desjardins operates a membership-based community banking model where the social aspect of its activities strengthens its franchise. As a result, this factor is incorporated into the Group’s Franchise Strength grid grades.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at (July 4, 2023) https://www.dbrsmorningstar.com/research/416784.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 22, 2023; https://www.dbrsmorningstar.com/research/415978). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/416784 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

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 credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

This credit rating is endorsed by DBRS Ratings Limited for use in the United Kingdom, and by DBRS Ratings GmbH for use in the European Union, respectively. The following additional regulatory disclosures apply to endorsed credit ratings:

The last credit rating action on this issuer took place on July 14, 2022.

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 credit 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: https://registers.esma.europa.eu/cerep-publication/.

For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

Lead Analyst: Shokhrukh Temurov, Vice President, North American Financial Institutions
Rating Committee Chair: Michael Driscoll, Managing Director, Head of North American Financial Institutions
Initial Rating Date: June 5, 1997

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

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