Please pass the popcorn Sterling!
Moody's downgrades long-term ratings to Aa3 on normalised systemic support, Outlook negative, BFSR remains on review to consider impact of funding challenges on credit profile
Further to the review initiated on 15 June, 2011
Paris, September 14, 2011 -- Moody's Investors Service has announced an extension of its review of the C+ standalone Bank Financial Strength Rating (BFSR) of Societe Generale SA (SocGen), equivalent to a standalone Baseline Credit Assessment (BCA) of A2 on the long-term ratings scale, originally announced on 15 June, 2011. While Moody's concluded that SocGen's capital base currently provides an adequate cushion to support its Greek, Portuguese, and Irish exposures, Moody's announced that it will extend its review for downgrade of the C+ BFSR to consider the implications of the potentially persistent fragility in the bank financing markets, given its continued reliance on wholesale funding.
As announced in our press release of 15 June 2011, however, Moody's review also encompassed a re-consideration of systemic support assumptions factored into SocGen's long-term debt and deposit ratings under our Joint-Default Approach (JDA). Moody's has today concluded this aspect of the review by downgrading SocGen's debt and deposit ratings by one notch to Aa3 from Aa2. The outlook on the long-term debt ratings is negative. Moody's anticipates that the impact of our review on the BFSR would be limited to a one-notch downgrade, which would not in itself impact the long-term ratings given our revised support assumptions for SocGen, which anticipate increased uplift at a lower standalone rating level. However, a conclusion with a negative outlook on the BFSR would lead to a renewed negative outlook on the long-term ratings. Given this possibility, we are maintaining our negative outlook on the long-term ratings during the review of the BFSR.
The Prime-1 short-term ratings have been affirmed.
Moody's will publish separate press releases on other institutions covered by the review announced on 15 June, 2011.
In its press release of 15 June, 2011, Moody's announced a review of the BFSRs and long-term ratings of three French banking groups (BNP Paribas, Credit Agricole SA and SocGen) because of concerns about the potential inconsistency between their ratings and their exposures to the Greek economy (Greece is rated Ca, outlook developing), either through their holdings of government bonds or the credit they had extended to the Greek private sector.
In the case of SocGen, the review included a reconsideration of the three notches of systemic support included in its long-term debt and deposit ratings. Given the shift in the European-wide public policy environment, Moody's concluded in its review that the exceptional uplift previously applied to SocGen is no longer appropriate. As a result Moody's now applies the same assumptions for systemic support to SocGen as to BNPP and CASA, also considered highly likely to receive such support, resulting in two notches of uplift from its A2 standalone BCA.
Consequently, Moody's has downgraded its long-term debt and deposit ratings to Aa3 from Aa2.
Moody's believes that SocGen has a level of capital, consistent with its BFSR, that can absorb potential losses it is likely to incur over time on its Greek government bonds and to remain capitalized at a level consistent with its BFSR even if the creditworthiness of Irish and Portuguese government bonds were to deteriorate further. This assessment incorporates loss assumptions that are significantly higher than the impairments the bank has already recognised.
However, during the review, Moody's concerns about the structural challenges to banks' funding and liquidity profiles increased, in light of worsening of refinancing conditions, and have prompted an extension of the review. The continuing review will focus directly on these funding and liquidity challenges for SocGen which, given the current environment, could become long-term constraints to the performance of its franchise.
Limited Impact Of Greek And Other Sovereign Exposures On Overall Risk Profile
Since the start of the review for downgrade, SocGen, along with many other financial institutions, has expressed its intention to participate in a proposed restructuring of Greek debt. This led to its recognition of
EUR395 million in impairments in the second quarter of 2011 (1). SocGen was able to comfortably absorb this amount, as it reported net earnings of EUR747 million for the quarter and continues to build its capital ratios. However, at 30 June 2011, SocGen still had net exposures to Greek government bonds of EUR1.9 billion (2), virtually all of which have been impaired.
The residual risk to the group from these exposures is modest, however, in Moody's view. Holdings of other non-investment-grade peripheral European countries government bonds are not a significant concern, given total exposures including the trading book of only EUR400 million to Ireland and EUR600 million to Portugal, and these amounts have since declined slightly further (3). Italian and Spanish government bond holdings are larger at EUR5.0 billion and EUR2.3 billion respectively.
SocGen's exposures to the Greek private sector credit are larger but also modest overall, and lie chiefly at its subsidiary General Bank of Greece (Geniki; E / Caa1 / B1, on review for possible downgrade), which had gross loans of EUR4.3 billion at 30 June 2011. These loans are of generally poor quality, and the bank has provisioned EUR1.0 billion, 24% of the loan book, with a cost of risk in the first half of 2011 of around 9% annualized (4). SocGen's exposure to Ireland and Portugal private sector credit are smaller, at EUR2.8 billion and EUR0.9bn respectively at end-2010, according to European Banking Authority disclosures.
In its review, and in the context of a stress test covering SocGen's global loan book and structured finance exposures, Moody's considered a severe case scenario for certain government bond holdings, using haircuts significantly higher than the impairments the bank has already
recognized: 60% for Greece, 50% for Ireland, 50% for Portugal, 10% for Spain and 7% for Italy. Taking into account the impairments already made against some Greek bonds, we believe resultant pretax losses would total around EUR1.6 billion, about 3.4% of SocGen's core Tier 1 capital after tax or 32bps of risk-weighted assets, with further mitigation possible via reduced dividends. Loss assumptions for private sector credit were based upon those previously published by Moody's, see "European Banking Credit Loss Assumptions", published on 2 August, 2010.
For the group overall, the potential impact of these exposures is diluted considerably and even at the level of SocGen's international retail banking operations, which include Geniki, the bank has been consistently profitable as earnings elsewhere offset the Greek losses. Moody's therefore considers SocGen to be sufficiently profitable and capitalized that it can absorb further potential related losses. The bank has strong franchises, good geographical diversification and a broad spread of business activities. Moody's also takes into account the bank's legacy positions in structured credit products, as well as weaknesses in risk management that were exposed by the trading fraud discovered in early
2008 (and the subsequent improvements in risk management), in addition to the volatile nature of SocGen's capital markets business, which in common with those of many other banks, is characterised by a certain complexity and opacity of risk profile, as well as a relatively confidence-sensitive customer base.
CONTINUED REVIEW OF BFSR TO FOCUS ON FUNDING PROFILE
Nevertheless, SocGen's wholesale funding, the majority of which is short-term, is still high in absolute terms and may pose a vulnerability given considerable market tension. During the summer, concerns over sovereign exposures and the health of sovereign balance sheets grew significantly. This was most manifest in the behaviour of US money market funds, which are an important source of short-term US dollars for SocGen.
These funds became particularly risk-averse, resulting in reduced availability and shorter tenors for this type of financing. For more details, see Moody's Special Comment, "EU Banks: Stronger Liquidity and Central Bank Actions Mitigate Recent Volatility but Longer-Term Concerns Remain".
Moody's notes that SocGen has substantial holdings of central bank eligible assets, which it reports to be around EUR79 billion, and EUR26 billion of other liquid assets at end-August. In addition, SocGen has full access to Eurosystem central bank liquidity in major currencies. As such Moody's believes that SocGen can withstand the short-term credit negative impact of the contraction in dollar funding, and euro funding remains plentiful. Even so, the amount of the bank's wholesale funding requirements makes it vulnerable to a deterioration in market sentiment.
At end--2010, from a strictly accounting view, debt securities and interbank borrowings totalled EUR216 billion, or 25% of its total balance sheet excluding insurance technical reserves and derivatives, 64% of which falls due within three months, and 79%, within one year (5).
Moody's expects SocGen to continue to enhance the amount and quality of liquidity, reduce its reliance on the wholesale markets, and lengthen the duration of its borrowings, in anticipation of the challenges posed by the Net Stable Funding Ratio and Liquidity Coverage Ratio to be introduced by Basel III. However, given the likelihood that bank financing conditions will remain fragile and prone to disruption so long as concerns persist over European sovereigns, and the potential for that disruption to become more marked and sustained over time, Moody's is maintaining its review on SocGen's BFSR. The extended review will assess the potential for further, increased disruption to undermine SocGen's business model and creditworthiness given its continued reliance on short-term funding, as well as the potential impact on other credit considerations, notably profitability.
LONG-TERM DEBT AND DEPOSIT RATINGS DOWNGRADED TO Aa3
Moody's regards France as a high support country, in which SocGen plays a major role as an intermediary and to whose banking system it is integral.
In its press release of June 15, 2011, Moody's stated that it would re-assess the systemic support assumptions factored into its long-term ratings on SocGen. The long-term rating incorporated a three-notch uplift from its intrinsic financial strength equivalent on the long-term rating scale (above average for France), compared to the two-notch uplift assigned prior to Moody's downgrade of the financial strength rating on
14 April 2009, and the two-notch uplift assigned to both BNPP and CASA.
Moody's still assesses the probability of systemic support for SocGen in the event of distress as being very high, but now believes that given the shift in the European-wide public policy environment, the exceptional uplift previously applied to SocGen is no longer appropriate and the assumptions of systemic support for SocGen should be in line with those for BNPP and CASA. This has resulted in a downgrade to the long-term debt and deposit ratings to Aa3 from Aa2, and in two notches of uplift from the bank's A2 standalone financial strength equivalent on the long-term scale, from three notches previously.
OUTLOOK FOR LONG-TERM DEBT AND DEPOSIT RATINGS NEGATIVE
The outlooks for the long-term debt and deposit ratings of SocGen are negative. This reflects the application of Moody's JDA. Moody's anticipates that the impact of our review on the BFSR would be limited to a one-notch downgrade to C, which would not in itself impact the long-term ratings, given our revised support assumptions for SocGen, which anticipate increased uplift at a lower standalone rating level.
However, a conclusion with a negative outlook on the BFSR would lead to a renewed negative outlook on the long-term ratings. Given this possibility, we are maintaining our negative outlook on the long-term ratings during the review period.
KEY RATING SENSITIVITIES
Given the current review for downgrade on SocGen's BFSR, an upgrade is unlikely.
Similarly, an upgrade of the long-term deposit and debt ratings is also unlikely in the foreseeable future given the current review for downgrade on the BFSR.
The main factors which could lead to a lower BFSR include:
- a reconsideration of the bank's funding and liquidity profile within the context of its broader business model, and the impact of its current and future funding structure on other credit considerations, chiefly risk management and profitability;
- a prolongation or intensification of challenges to refinancing conditions, resulting in a weaker liquidity and / or funding position in Moody's view;
- increased sovereign risk in the euro area
- an unexpectedly sharp deterioration in the bank's capital markets activities;
- aggressive expansions of riskier activities or an actual failure in risk management;
- further significant asset quality deterioration, in the lending activities or in its structured credit-related exposures;
- increased uncertainty over the bank's ability to strengthen capital and liquidity in advance of Basel 3 requirements or deteriorating market conditions.
A one-notch downgrade of the BFSR -- as could result from our current review -- would not result in a downgrade of the debt and deposit ratings. The latter could however, in theory, be downgraded as a result of a multi-notch downgrade of the BFSR or following a further reduction in Moody's expectation of the probability of systemic support to be extended to SocGen in the case of stress, neither of which Moody's expects.
SUBORDINATED OBLIGATIONS AND HYBRID SECURITIES
The ratings on SocGen's dated subordinated obligations are notched off the bank's fully supported, long-term GLC deposit ratings.
The ratings on the bank's hybrid obligations are notched off SocGen's Adjusted BCA of A2, in accordance with Moody's Guidelines for Rating Bank Hybrid Securities and Subordinated Debt published 17 November 2009.
KEY RATING FACTORS AND SENSITIVITIES FOR OTHER ENTITIES AFFECTED BY THIS RATING ANNOUNCEMENT
For all other entities affected by this rating announcement, please refer to the rationale above.