Fitch Affirms Caisse Centrale Desjardins' Ratings; Outlook Remains Stable.
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), Caisse Centrale Desjardins (CCD), National Bank of Canada (NBC), Royal Bank of Canada (RBC) and Toronto-Dominion Bank (TD).
Company specific rating rationales for the other banks will be published separately. For further discussion of the Canadian Banks sector, please refer to the special report titled 'Canadian Bank Peer Review' at www.fitchratings.com.
CCD is a financial services cooperative whose members are the Federation des caisses Desjardins du Quebec (FCDQ) and its caisses; CCD also has auxiliary members which include federations from Ontario (and their member caisses), New-Brunswick and Manitoba. As a result, CCD is regulated by the Autorite des Marches Financiers (AMF). CCD must maintain capital in accordance with standards determined by FCDQ and approved by the AMF.
Under a formal equity maintenance agreement, FCDQ and the Ontario federation have committed to maintaining minimum Tier 1a capital at CCD of 8.0% of its risk weighted assets and its leverage ratio 50bps higher than minimum regulatory requirements.
Given this ability of FCDQ to call on its own member caisses to support CCD, Fitch's assessment is primarily based on Desjardin Group's consolidated operating performance and balance sheet, which includes: assets, liabilities and capital within the caisse network.
On Oct. 27, 2016, CCD announced that the boards of directors of the FCDQ and CCD convened a special meeting of their members on Nov. 28, 2016 to submit to them the proposal to amalgamate FCDQ with CCD. In the event that such amalgamation by-laws are adopted, the amalgamation would become effective shortly after obtaining the necessary regulatory approvals, particularly from the Autorite des marches financiers (AMF). Management and the boards of FCDQ and CCD expect the amalgamation to be effective on Jan. 1, 2017.
When the amalgamation is complete, CCD will continue its existence within FCDQ. FCDQ will enjoy all of the rights and be liable for all of the obligations of CCD, in addition to its own rights and obligations. FCDQ will also have the capacity and powers devolved to CCD including the ability to call on the caisse network for capital in case the need arises.
In Fitch's view the amalgamation will not result in any interruption of CCD's activities. Furthermore, FCDDQ will become the issuer under debt issuance programs for CCD's securities and will honor any security issued by CCD. FCDQ will also be CCD's successor in dealings with clearing houses and payment associations. Given the above commentary and the fact that Fitch already heavily weighs its analysis of CCD on consolidated financial information, Fitch does not expect any impact on current ratings due to the amalgamation. When the amalgamation is complete, Fitch would expect to withdraw the ratings of CCD and assign ratings to FCDQ and its debt issuances.
KEY RATING DRIVERS
The ratings for CCD and CD reflect their central position within the Desjardins Group (DESJ). CCD and CD are the debt issuing entities for DESJ. Therefore, Fitch's ratings for the entities are primarily based on DESJ's consolidated operating performance and balance sheet.
The Group's ratings reflect solid and consistent earnings performance relative to its cooperative structure. Performance is supported by strong asset quality and a dominant retail franchise in Quebec.
The Group continues to hold a relatively high level of Tier 1 capital, in line with Fitch's expectations. Its Tier 1 capital ratio was 15.9% under Basel III at June 30, 2016 (2Q16) compared to a peer average of 10.5%. 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, the Group'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.
The Group continues to integrate the acquisition of State Farm Canada. Financial results from the transaction thus far have been in line with expectations and the P&C business segment accounted for 13% of surplus earnings before member dividends through 2Q16. Fitch notes that results within the segment have been adversely impacted by the Fort McMurray fire that occurred in the first half of 2016. The company estimates that damages, after reinsurance, could amount to $41 million before taxes, a reasonable level in Fitch's view.
Fitch continues to view the transaction as neutral to DESJ's rating even as it has increased the Group's geographic diversification of earnings and risk while providing an advantage of scale and strengthens its position among P&C, life and health insurers in Canada. Similar to other areas of the Group, 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.
DESJ's continues to generate reasonable returns relative to the company's risk profile and cooperative structure. DESJ's average annual and quarterly return on assets (ROA) typically runs well below many similarly rated banks. 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.
Profitability is somewhat constrained by relatively high expense base which is driven by the Group's business model. Given its large caisse network, DESJ has a higher cost structure than other Canadian and global peer banks, which weighs on overall profitability of the group. Like many banks globally, in the current low rate environment, management has taken a more aggressive stance on expenses that could aid profitability over the long term. DESJ has worked to consolidate its caisses (or branches) as well as centralized many Group functions in order to improve efficiencies. Fitch notes that the proposed amalgamation will provide opportunities for cost saves as intercompany transactions will be reduced as will quarterly and annual filings. However, Fitch expects its cost structure to remain relatively high over the near to intermediate term. This expectation is embedded within the current rating and outlook.
DESJ's credit quality remains very strong and supportive of its relatively high rating. The Group's ratio of gross impaired loans to total loans stood at 0.35% compared to a peer average of 0.63%. Fitch believes the Group has maintained a relatively conservative risk appetite and maintained focus on its primary borrower - the homeowner in Quebec. This strategy, has led to lower and less volatile credit losses compared to its domestic and foreign competitors over time.
Business and government loans are up 6% year-over-year, a reasonable level in Fitch's view. These loans made up 22.5% of total loans at 2Q16, essentially flat over the last year. Meanwhile residential mortgages, which continue to account for nearly two-third of the Group's loan portfolio increased 4.8% from 2Q15.
Fitch still expects some plateauing or cooling of the Canadian housing market, which should adversely impact all Canadian banks' asset quality, including DESJ's. Recent announcements on mortgage market reform from the Canadian Finance Minister will likely expedite this process in many parts of the country. Moreover, the potential for risk-sharing of losses on insured mortgages will likely result in some credit quality deterioration at CCD and peers.
However, the Group already has a relatively low level of insured mortgages to total mortgages at 33%. Therefore, Fitch would not expect the credit quality impact to be as meaningful at CCD compared to peers. Moreover, Fitch's views its aforementioned high capital ratios, the comparatively good average loan-to-value (LTV) ratio for the conventional mortgage portfolio of just over 50% as of 2Q16 mitigates. Also 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.
Liquidity and liquidity risk management are strong. The Group has maintained a Basel III liquidity coverage ratio (LCR) in excess of 120%, well-above peers. The company enjoys dominant market share for retail deposits in Quebec. 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.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Subordinated debt issued by the CD is notched down from CCD's Issuer Default Ratings (IDRs) in accordance with Fitch's assessment of the instrument's non-performance and relative loss severity risk profile. Subordinated debt is typically notched down from the issuing entity's Viability Rating (VR). In the absence of a VR, as is the case with CCD, the issuances are notched from the entity's Long-term IDR.
CD's subordinated debt is notched one level below CCD's IDR 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 IDR.
SUPPORT RATING AND SUPPORT RATING FLOOR
The affirmation of the CCD's SR of '2' and SRF of 'BBB-' reflect Fitch's view that the likelihood of support remains high for Canadian Banks due to their systemic importance in the country, significant concentration overall in of Canadian banking assets amongst the institutions noted above, which account for over 90% of total banking assets, the 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 the 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.
Fitch recognizes that the government's willingness to provide support for D-SIFI's in Canada has been reduced demonstrated by Department of Finance consultation paper which outlines the proposed bail-in regime as banking regulators seek to protect tax payers from the risk of a large financial institution failing. This is evidenced by the proposed issuance of non-viability contingent capital (NVCC) instruments, resolution powers given regulatory authorities under the CDIC Act, and other initiatives that demonstrate the Canadian government's progress to reduce the propensity of state support for banks going forward.
VR, IDRs, AND SENIOR DEBT
Given the already high ratings of the group, Fitch continues to believe that there is very limited upside to current ratings.
CCD's Stable Outlook encompasses Fitch's expectation that its earnings will remain consistent over the rating time horizon and able to adequately augment capital such that capital ratios are maintained well above Canadian bank peers.
CCD's ratings continue to be sensitive to the growth of its insurance business lines, namely through its recent acquisition of State Farm Canada, which is still being integrated into CCD's operations. Negative rating pressures could occur if Fitch observes an ineffective integration process. This could be measured through metrics such as customer and/or agent retention over the long term. Moreover, Fitch expects the Canadian P&C market to continue to consolidate. While Fitch expects CCD to be a participant in this consolidation over the long term, Fitch also expects acquisitions to be reasonable in price and CCD's core competencies. To the extent that CCD 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.
As noted, Fitch believes the Group is well-positioned to handle new mortgage market reform as well as a cooling Canadian economy and housing market given the aforementioned characteristics of its mortgage portfolio and its high capital ratios. However, should Fitch's expectations of the slowing of the Canadian housing market change, both nationally and with respect to the province of Quebec, there could be pressure on the Group's ratings or Rating Outlook. Moreover, should Fitch observe a disproportionate impact to CCD's earnings and capital due to mortgage market reform, Fitch could take negative action on CCD's IDR or Rating Outlook.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The subordinated debt ratings are primarily sensitive to any change in the IDRs of CCD.
SUPPORT RATING AND SUPPORT RATING FLOOR
The support rating (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 intend to 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 implementation. Further, continued regulatory action to ensure sufficient contingent capital has been implemented for all Canadian banks.
Fitch has affirmed the following:
Caisse Centrale Desjardins
--Long-term Issuer Default Rating (IDR) at 'AA-'; Outlook Stable;
--Short-term IDR at 'F1+';
--Senior unsecured debt at 'AA-';
--Support at '2';
--Support Floor at 'BBB-'.
Capital Desjardins, Inc.
--Subordinated debt at 'A+'.
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|Date:||Nov 25, 2016|
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