October 27, 2017 / 5:49 PM / a year ago

Fitch Affirms Federation des caisses Desjardins du Quebec at 'AA-'/'F1+'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, October 27 (Fitch) Fitch Ratings has today affirmed Federation des caisses Desjardins du Quebec's (FCDQ) Long-and Short-term Issuer Default Ratings at 'AA-' and 'F1+', respectively. This rating action follows Fitch's periodic review of the Canadian Banks Peer Group, which includes Bank of Montreal (BMO), Bank of Nova Scotia (BNS), Canadian Imperial Bank of Commerce (CIBC), Federation des caisses Desjardins du Quebec's (FCDQ), National Bank of Canada (NBC), Royal Bank of Canada (RBC) and Toronto-Dominion Bank (TD). Company-specific rating rationales for the other banks are published separately. For additional information on Canadian Banks Peer Review, please see "Fitch Affirms Canadian Banks; Fundamentals Outweigh Persistent Housing Risks" at 'www.fitchratings.com'. Desjardins Group comprises the Desjardins caisse network in Quebec and Ontario (the caisses), FCDQ and its subsidiaries (including Capital Desjardins Inc. ), the Federation des caisses populaires de l'Ontario Inc. and the Desjardins Security Fund. FCDQ is the issuing entity that issues debt on behalf of the caisse network. FCDQ's caisses and the Ontario federation have committed to maintaining a minimum Tier 1a capital at FCDQ of 8% of its risk weighted assets. The Federation currently meets this requirement as well as the internal targets set. Given FCDQ's ability to call on its own member caisses for capital support and the fact that the Desjardins Security Fund may be used to support individual caisses, Fitch's assessment is primarily based on Desjardin Group's consolidated operating performance and balance sheet, which includes the following: assets, liabilities and capital within the caisse network. Moreover, Fitch believes there is strong cohesion and centralized oversight of the group. For instance, capital management is a function covering all Desjardins Group operations, including those of FCDQ. Further, the law requires FCDQ to regularly inspect and annually audit the caisses, in order to protect member assets and support the caisse officers in the execution of their functions. In accordance with Fitch's Global Bank Rating Criteria - Banking Structures Backed by Mutual Support Mechanisms (Annex 4), Fitch has assigned a group rating to Desjardins Group (DESJ). Fitch has assigned DESJ a Long-and-Short-term IDR of 'AA-'/'F1+', Viability Rating (VR) of 'aa-', Support Rating(SR) of '2' and a Support Rating Floor(SRF) of 'BBB-'. A full list of rating actions follows at the end of this rating action commentary. KEY RATING DRIVERS IDRs, VR SENIOR DEBT DESJ's ratings reflect its strong asset quality and dominant retail franchise in the province of Quebec, which have supported consistent earnings performance relative to its cooperative structure. The Group's ratings are also supported by the high level of capital it holds, something Fitch views as necessary given its limited access to third-party capital and geographic concentration in Quebec. DESJ's ratings also reflect its sizable wealth management and insurance operations, accounting for approximately 40% of operating income by Fitch's estimates. Additionally, the Canadian Mortgage and Housing Corporation (CMHC) insurance plays an important role in supporting the balance sheets of all Canadian banks. DESJ's credit quality remains very strong and supportive of its relatively high rating. At the end of DESJ's June 30, 2017 (2Q17 differs from the rest of the Canadian peer group's quarter end), its ratio of gross impaired loans to total loans was 0.28% compared to a peer average of 0.5%. This is one of the lowest levels of gross impaired loans to total loans globally. Fitch believes the Group has continued its relatively conservative risk appetite and maintained focus on its primary borrower -Quebec homeowners. This strategy has historically led to lower and less volatile credit losses compared to its domestic and foreign peers over time. Fitch still expects some plateauing or cooling of the Canadian housing market, which should adversely impact all Canadian banks' asset quality, including DESJ's. However, offsetting this concern is that Quebec has been a slower growth province, and has not participated as much in the housing price run-up compared to areas such as Vancouver and Toronto. DESJ's residential mortgage loan portfolio is 97% comprised to Quebec. Moreover, Fitch's views the comparatively good average loan-to-value (LTV) ratio for the conventional mortgage portfolio of just over 50% as of 2Q17 as strong mitigating potentially lower home values in the near-to-medium term. DESJ continues to hold a relatively high level of Tier 1 capital, in line with Fitch's expectations. Its Tier 1A capital ratio was 17.1% under Basel III at 2Q17, up from 15.9% a year prior and well-above its target of 15%. The peer median, excluding DESJ, at June 30 2017 was 11.1%. Fitch views the company's strong capital position as a significant mitigant to risks associated with the Group having a relatively higher level of geographic concentration in the province of Quebec and its loan portfolio concentration of residential mortgages. Moreover, as a cooperative, DESJ's access to the equity markets is relatively limited compared to peers, which warrants a higher level of capital. Today's affirmation and Stable Outlook reflects Fitch's expectation that DESJ will consistently maintain capital ratios at a relatively higher level than peers over the long term due to its unique organizational structure and business model. DESJ's generates reasonable returns relative to the company's risk profile. Given its cooperative structure, DESJ's average annual and quarterly returns typically runs well-below many similarly rated banks and peers. For instance, DESJ had operating profit to risk-weighted assets ratio of 2.2% through 2Q17. The peer median excluding DESJ was 3.0% through a comparable time frame. However, Fitch recognizes the ultimate strategy of a company with a cooperative structure differs from a typical corporation in that it does not look to maximize shareholder return or return on assets. Therefore, less emphasis is placed on the level of earnings on a relative basis and more emphasis is placed on DESJ's relative earnings consistency. DESJ continues generate a large part of its operating revenue and net income from its insurance operations. Its property and casualty (P&C) business segment accounted for 25% of operating income through 2Q17, although its impact to the bottom line was less than 10% due to costs related to the ongoing integration of State Farm Canada as well as weather-related claims during the first half of the year. Similar to other areas of DESJ, Fitch views the management of the P&C segment as strong and expects performance to remain a net positive contributor to earnings over the rating horizon. This expectation is incorporated into today's rating action. Liquidity and liquidity risk management are strong. The Group has maintained a Basel III liquidity coverage ratio (LCR) in excess of 120% and enjoys dominant market share for retail deposits in Quebec. At 2Q17, DESJ had 41.9% in personal savings account market share in the province. Moreover, it has also found sustained success in the global capital markets for its debt at good pricing. While DESJ, as well as its Canadian bank peers, continues to rely heavily on wholesale funding relative to similarly sized and rated banks in the United States, DESJ's liquidity risk management practices reasonably mitigate related risks, in Fitch's view. SUPPORT RATING AND SUPPORT RATING FLOOR DESJ's SR of '2' and SRF of 'BBB-' reflect Fitch's view that the likelihood of support remains high for Canadian Banks. This is due to their systemic importance in the country, overall significant concentration of Canadian banking assets amongst the institutions noted above (accounting for over 90% of total banking assets), large size of the banking sector with banking assets at 2.1x Canada's GDP, and the Canadian banks' position as key providers of financial services to its local economy. In Fitch's view, Canadian banking authorities through the CDIC Act, have wide latitude to resolve a troubled bank including re-capitalizing an institution, creating a bridge bank, or imposing losses on creditors. Nonetheless, bail-in initiatives demonstrate the Canadian government's progress to reduce the propensity of state support for banks going forward. In Fitch's view, Canadian banking authorities, through the CDIC Act, have wide latitude to resolve a troubled bank including re-capitalizing an institution, creating a bridge bank, or imposing losses on creditors. Nonetheless, bail-in initiatives demonstrate the Canadian government's progress to reduce the propensity of state support for banks going forward. Fitch recognizes that the government's willingness to provide support for D-SIFI's in Canada has decreased as demonstrated by the Department of Finance's recent Resolution Framework, which has received parliamentary approval. The proposal seeks to protect tax payers from the risk of a large financial institution failing with guidelines recently published by OSFI for issuing non-viability contingent capital (NVCC) instruments and defining securities that could be used for "bail-in". In Fitch's view, the bail-in proposal enhances resolution powers given to regulatory authorities under the CDIC Act. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES CD's subordinated debt is notched one level below DESJ's VR for loss severity. This is in accordance with Fitch's criteria and assessment of the instruments non-performance and loss severity risk profiles, which have thus been affirmed due to the affirmation of the VR. RATING SENSITIVITIES IDRs, VR AND SENIOR DEBT DESJ is one of the highest rating banking groups in Fitch's global bank rated universe. Therefore, there is limited upside to its current ratings. Today's rating action incorporates Fitch's view that uncertainties remain on what the impact of recent mortgage reform announcements will be to the broader mortgage market. As such, a faster price correction that is prolonged and/or a slowdown in the housing market will likely impact earnings growth for all the banks. Further, these changes would also affect the broader economy through the link between housing wealth and consumer consumption, and the real estate sector, which are important drivers of GDP growth. Fitch notes that the Canadian banks' ratings are sensitive to negative pressures in the housing market. Modest rating pressure could ensue should DESJ's credit performance deteriorate, evidenced by impaired loan and losses trending to levels above its 10 year average of approximately 0.40% and 0.22%, respectively. Fitch notes that this could potentially become more severe should macroeconomic risks continue, such as unexpected increases in interest rates, a severe housing price correction as well as macroeconomic weakness in the overall Canadian economy that leads to a material rise in unemployment. DESJ's Stable Outlook encompasses Fitch's expectation that its earnings will remain consistent over the rating time horizon and is able to adequately augment capital such that capital ratios are maintained well above Canadian bank peers. To the extent that the company experiences large operational losses or makes a large scale acquisition such that Tier 1a capital is brought to a level closer to peers, Fitch would likely take negative rating action. Fitch expects the Canadian P&C market to continue to consolidate and that DESJ will have a notable gain in its 3Q17 results from the sale of Western Financial Group during the quarter. While Fitch expects DESJ to be a participant in the P&C consolidation over the long term, Fitch also expects acquisitions to be reasonable in price and within DESJ's core competencies. To the extent that DESJ partakes in M&A activity that does not fit these attributes and/or results in earnings and capital metrics that are not commensurate with expectations, Fitch could take negative rating action. SUPPORT RATING AND SUPPORT RATING FLOOR The SR of '2' incorporates Fitch's expectation that there could be some level of support for the Canadian Banks going forward although it has been weakened given bail-in legislation. Although Canadian authorities have taken steps to improve resolution powers and tools, they maintain a flexible approach to bank resolution. Fitch's assessment of continuing support for Canadian D-SIFI's has to some extent relied upon resolution powers granted regulators under the CDIC ACT as well as the potential size, structure, and feasibility of NVCC and TLAC implementation. Further, continued regulatory action to ensure sufficient contingent capital has been implemented for all Canadian banks. Therefore, SRs and SRFs are sensitive to the implementation of TLAC requirements. To the extent that these are deemed more than sufficient to recapitalize a non-viable bank, SRs and SRFs may be lowered. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES The subordinated debt ratings are primarily sensitive to any change in DESJ's VR. Fitch has affirmed the following ratings: Federation des caisses Desjardins du Quebec --Long-term IDR at 'AA-'; Outlook Stable; --Short-term IDR at 'F1+'; --Senior unsecured debt 'AA-' --Support at '2'; --Support Floor at 'BBB-' Capital Desjardins, Inc. --Subordinated debt at 'A+' Fitch has assigned the following ratings Desjardins Group --Long-term IDR at 'AA-'; Outlook Stable; --Short-term IDR at 'F1+'; --Viability Rating at 'aa-' --Support at '2'; --Support Floor at 'BBB-'. Contact: Primary Analyst Bain K. Rumohr, CFA +1-312-368-3153 Fitch Ratings, Inc. 70 West Madison Street Chicago, IL 60602 Secondary Analyst Doriana Gamboa Senior Director +1-212-612-0865 Committee Chairperson Sean Pattap Senior Director +1-212-908-0642 Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com. 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