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

DBRS Limited (Morningstar DBRS) confirmed the credit ratings of Desjardins Group (Desjardins or the Group) and the Fédération des caisses Desjardins du Québec (FCDQ), including the Long-Term Issuer Ratings at AA and Short-Term Issuer Ratings at R-1 (high). The trends on all credit ratings are Stable. Desjardins' Long-Term Issuer 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) would assist the Province of Québec (Québec; rated AA (low) with a Stable trend) 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 credit rating of AA.

KEY CREDIT RATING CONSIDERATIONS
The credit ratings and Stable trends reflect Desjardins' strong franchise in Québec, where it has dominant market shares across a number of businesses. 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 good levels of 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 credit ratings also consider Desjardins' material exposure in its loan book to small and medium-size enterprises (SME) and the agriculture sector with a significant concentration in Québec, as well as its relatively high cost structure in comparison to the large Canadian banks.

While Morningstar DBRS 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, Morningstar DBRS would upgrade the credit ratings if Desjardins continues building the scale and diversity of its franchise, resulting in a sustainable improvement in earnings, while maintaining a similar risk profile.

Conversely, Morningstar DBRS would downgrade the credit ratings if there was a reduction in the assessment of the likelihood of systemic support, material losses in the loan portfolio, or if there was a sustained decline in earnings-generation capacity.

CREDIT RATING RATIONALE
Franchise Combined Building Block (BB) Assessment: Strong
Desjardins is the sixth-largest banking institution in Canada by total assets (as of Q1 2024) 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 both). 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: Good/Moderate
Desjardins generates good levels of 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 2024, Desjardins reported net income of $774 million, compared with $264 million for the same period in 2023, supported largely by higher noninterest income as well as an increase in net interest income. Strong revenue was partially offset by higher operating expenses and provision for credit losses. Net interest margin (as calculated by Morningstar DBRS) expanded by 2 basis points (bps) year over year (YOY) to 1.70% in Q1 2024, while the share of noninterest income in total revenue increased to about 55% in Q1 2024 from 47% in the same period of 2023. Desjardins' high operating cost structure remains a constraint on the credit ratings, although the operating efficiency ratio decreased to about 65% in Q1 2024 from 80% in the same period of 2023. Morningstar DBRS notes that the Group is taking measures to improve its productivity index (i.e., efficiency ratio) in the Personal and Business Services Segment, including reducing the number of full-time employees and downsizing the distribution network.

Risk Combined Building Block (BB) Assessment: Strong
The Group's risk profile is strong. More than 70% of the loan book comprises retail loans, most of which are residential mortgages and have historically generated low losses. However, the Group's commercial loans are skewed toward small and medium-size enterprises, which typically have fewer resources to cope with economic downturns. Gross loans and acceptances grew 6.6% YOY in Q1 2024, on the back of 4.1% and 14.3% expansions in residential mortgages and commercial loans, respectively. In a challenging operating environment, gross impaired loans increased by 29 bps YOY to 0.8% of gross loans in Q1 2024, largely driven by credit cards and commercial loans primarily in the real estate, agriculture, and health care sectors. Nevertheless, loan losses remained minimal with a net write-offs ratio of 4 bps in Q1 2024. As with other banking organizations, Morningstar DBRS expects Desjardins' credit quality to continue deteriorating modestly in 2024 as the macroeconomic outlook remains tilted toward the downside or if interest rates remain higher for longer than currently expected.

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. Term deposits continued to grow about 15.5% YOY to $158.4 million in Q1 2024 as members locked in higher yields. As a result, these deposits represented about 56% of total deposits as at Q1 2024. Desjardins' personal deposits are supplemented by its 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, the Group enjoys high liquidity levels in line with peers with a liquidity coverage ratio of 152% for Q1 2024, and a net stable funding ratio of 125%, both well above the regulatory minimums.

Capitalisation Combined Building Block (BB) Assessment: Strong
Morningstar DBRS 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. Nevertheless, Desjardins' capital levels are significantly higher than those of Canada's large banks, while its risk profile is not materially different. As of Q1 2024, Desjardins reported Tier 1A and TLAC ratios at 21% and 29.8%, respectively, well above the regulatory requirements of 9.5% and 21.5%, respectively.

Further details on the Scorecard Indicators and Building Block Assessments can be found at: https://dbrs.morningstar.com/research/436112.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Environmental (E) Factors
Morningstar DBRS views that Climate and Weather Risks are relevant to, but do not affect, the credit ratings or trends assigned to Desjardins. As part of its property and casualty (P&C) product offering, Desjardins is exposed to weather-related losses from natural catastrophic events, such as wind, wildfire, hail, flooding, and other extreme weather events. These events can lead to earnings volatility, which Morningstar DBRS considered when assessing the Group's earnings. This factor is new and was not relevant in the last rating action. This factor more appropriately reflects the Group's sizable P&C Insurance business that holds top-tier market shares in Québec and ranks among the top five in Canada.

Social (S) Factors
Morningstar DBRS views that the Social Impact of Products and Services ESG subfactor was relevant to the credit ratings but does not affect the assigned credit 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.

There were no Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 4, 2024) https://dbrs.morningstar.com/research/433881. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.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 dbrs.morningstar.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.

Morningstar DBRS did have 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.

These credit ratings are 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 conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are monitored.

For further information on Morningstar DBRS 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 Morningstar DBRS 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: John Mackerey, Senior Vice President, Sector Lead
Initial Rating Date: June 5, 1997

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

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