Credit Opinion: Crédit Logement

Transcription

1 Credit Opinion: Crédit Logement Global Credit Research - 18 Apr 2013 Paris, France Ratings Category Moody's Rating Outlook Stable Issuer Rating Aa3 Subordinate -Dom Curr A1 Pref. Stock Non-cumulative -Dom Curr A3 (hyb) Contacts Analyst Phone Stephane Herndl/Paris Benjamin Serra/Paris Carola Schuler/Frankfurt am Main Key Indicators Crédit Logement EUR mln [1]2011 [1]2010 [1]2009 [1]2008 [1]2007 CAGR / 5 Yr. Avg. Total assets 9,881 9,477 11,810 11,671 11, Off-balance sheet guaranteed loan portfolio 223, , , , , Tier 1 capital 5,383 5,355 5,329 5,112 4, Mutual Guarantee Fund 3,519 3,232 2,867 2,688 2, Net income, group share [1] As of December 31. Opinion SUMMARY RATING RATIONALE Credit Logement's Aa3 long-term issuer rating reflects (1) its key role and dominant market position within the French banking sector, as the leading provider of home-loan guarantees ("prets cautionnes"); (2) its prudent underwriting and very strong loss-absorption capacity, which would enable the institution to withstand significant performance stresses in its guaranteed loan portfolio; and (3) the inherent correlation between its intrinsic financial strength and the credit quality of its investment portfolio. However, we acknowledge that Credit Logement's implementation of stricter counterparty limits and the collateralisation of some deposits as of 2013 will significantly reduce investment risks. Rating Drivers - Credit Logement has an established leadership position and long track record as an efficient provider of guarantees for French residential home-loans - The French home-loan market's structure is a strong credit driver supporting Credit Logement's financial strength; however, the weak macroeconomic environment will exert pressure on default rates and the housing market has weakened in recent years - Credit Logement's strong capital base, portfolio performance and loss-absorption capacity imply that it is well positioned to withstand deterioration in the performance of its home loans

2 positioned to withstand deterioration in the performance of its home loans - Credit Logement's role as service provider for its partner banks drives low recurring profitability levels, offset by the institution's ability to externalise losses to the contributors to the Mutual Guarantee Fund (MGF), during stress periods - Adequate financial flexibility, reflecting the balance of high subordinated debt levels and shareholder commitments to support Credit Logement's solvency Rating Outlook The outlook is stable on all ratings and reflects Credit Logement's strong franchise and our view that the institution is well positioned to withstand potential deterioration in the performance of its guaranteed loan portfolio. The stable outlook on Credit Logement's ratings is also driven by our expectation that the credit quality of the investment portfolio will be resilient over the next months, as reflected by the stable outlook on the ratings of most of Credit Logement's counterparties within its portfolio. What Could Change the Rating - Up An improvement in the intrinsic financial strength of Credit Logement could develop following a reduction of the risks in its guaranteed loan portfolio, or a material improvement in its loss-absorption capacity. What Could Change the Rating - Down Severe deterioration of the French housing market's performance or Credit Logement's guaranteed home-loan portfolio could exert pressure on its intrinsic financial strength. The institution's intrinsic financial strength could also come under pressure if its loss-absorption capacity or franchise value deteriorates. In addition, deterioration of the credit quality of its asset exposures or an adverse change in its investment policy could also exert negative pressure on Credit Logement's intrinsic financial strength. DETAILED RATING CONSIDERATIONS Unless noted otherwise, data in this report is sourced from company reports and our Banking Financial Metrics. Given the activities and the structure of the institution, we considered factors specific to mortgage insurers as set under "Moody's Global Methodology for Rating Mortgage Insurers" published in December FRANCHISE VALUE - DOMINANT MARKET POSITION IN THE FRENCH HOME-LOAN MARKET We view Credit Logement's franchise as a primary credit strength, given (1) its established leadership position as a provider of home-loan guarantees; and (2) its strong value proposition for French banks active in domestic home financing. Credit Logement writes guarantees on housing loans originated through the retail networks of its partner banks, which are also mainly its shareholders. Its main partners are traditional banks that have extensive recourse to Credit Logement. The proportion of business originated by French mutualist groups has been historically lower, given that these institutions also have their internal housing loan guarantors; however, we note that the new business flows stemming from these networks have increased in recent years. Credit Logement continues to exhibit a dominant franchise as an efficient provider of housing guarantees and as a recognised player in credit monitoring and loan recovery. During 2011, Credit Logement's share of new guarantees written on home loans accounted for 53% of all new home-loan guarantee (or 33% of all home loans originated in 2011, including traditional mortgage loans). Based on outstanding amounts, at end-2011 Credit Logement guaranteed 26% of the domestic home loans in France. Credit Logement relies on the distribution networks of most of the French banks to write guarantees on home loans, facilitating a very strong and diversified distribution channel. The concentration of Credit Logement's portfolio on the Paris region and the south-east of France is above average, with around 60% of home-loan guarantees overall. However, the higher concentration on these affluent regions reflects (1) the importance of these regions in the French housing market, as they accounted for more than 40% of the French market, based on outstanding amounts; and (2) Credit Logement's focus on the premium segments of the French home-loan market. As such, this higher-than-average concentration does not constrain the ratings.

3 As a monoline institution and a service provider to its shareholders, Credit Logement has a stable but low earnings generation capacity. The flexible mechanisms prevailing for the disbursement from the MGF of contributions made previously by borrowers nonetheless provides the institution with very strong loss-absorption capacity in case of stress and mitigates its low earnings-generation capacity, in our view. In recent years, Credit Logement has tried to diversify its business model. This includes developing a wider range of guarantee products to meet the needs of specific niches, as well as managing the late arrears and recovery for third parties. For the latter, Credit Logement provides its expertise to other banks but does not bear any credit risk. These activities provides additional earnings diversification, although currently the diversification is limited. RISK PROFILE - HOUSING MARKET STRUCTURE SUPPORTS BUSINESS AND RISK PROFILE, ALBEIT WITH HIGHER LOSS SEVERITY GIVEN THE RECENT HOUSE PRICE EVOLUTION We consider that the structure of the French home-loan market is a strong credit driver supporting Credit Logement's financial strength. This reflects (1) the attractiveness of home-loan guarantees vis-a-vis traditional mortgage loans; and (2) the generally sound market-origination criteria. However, the weak macroeconomic environment - which drives rises in unemployment - will exert pressure on default rates, in our view. In addition, housing conditions have weakened in recent years, following a prolonged period of steep rise in property prices. This may ultimately result in a higher loss severity, including on Credit Logement's portfolio of guaranteed homeloans, if borrowers default. -- Strong demand for home-loan guarantees Based on the 2011 study on domestic home financing from the French banking regulator, more than 60% of the home loans originated in 2011 benefited from a guarantee, while the remainder was issued in the form of traditional mortgage home loans. The high penetration rate of home-loan guarantees is boosted by the relatively low demand for mortgages in France, due to the comparably costly and slow process of registering mortgage deeds and foreclosures. In addition, the evolution of the French covered bond frameworks now places guaranteed home loans on a par with residential mortgage loans for the domestic banks' issuance of covered bonds. The cover pool of covered bonds issued under the Société de Financement a l'habitat (SFH) framework can comprise up to 100% of guaranteed loans, whereas the portion of these loans is capped at 35% of the cover pool for covered bonds issued under the Société de Crédit Foncier (SCF) framework. We expect that this marginally improves the attractiveness of guaranteed loans compared with residential mortgages. -- Sound origination criteria and creditor-friendly domestic home-loan market French home loans are underpinned by generally sound underwriting standards, as evidenced by the market practice that households' debt service typically should not exceed one-third of household's disposable income. In addition, the structure of the market supports home-loan performance, reflecting (1) the very high proportion of fixed-rate home-loans that are immune to interest-rate changes; and (2) the social welfare system in France. Most French home loans are amortising and lenders have full recourse on the assets of the borrowers, if the sale of the property is insufficient to cover credit losses. We understand that given the very low interest-rate environment, many borrowers have re-negotiated the terms of their home loans. While potentially detrimental to the interest margins of the partner banks, the lower interest rates on home loans is positive for Credit Logement as it ultimately results in either (1) a lower default probability, through lower debt service for households; or (2) a lower loss severity in case of default, through the higher loan amortisation. -- Housing market conditions in France will be affected by the weak macroeconomic environment, resulting in higher credit losses We consider that potential losses on home loans have the potential to rise. This reflects (1) the structural rise in unemployment, which can only be temporarily compensated by unemployment benefits, and that will likely prompt higher default rates; and (2) our expectation of a higher loss severity on defaulted loans, because of the expected contraction in house prices in France overall in 2013 and possibly beyond, following a period of steep house price appreciation. For more details, please refer to our Banking System Outlook for France, published in March 2013, and to our Special Comment "French Banks: Ability to Absorb Moderate House Price Correction, but Risks Increase" dated June 2011.

4 CAPITAL ADEQUACY - STRONG REFLECTING THE SOUND PERFORMANCE OF THE PORTFOLIO AND THE INSTITUTION'S VERY STRONG LOSS-ABSORPTION CAPACITY Credit Logement is well positioned to withstand the aforementioned expected deterioration in the performance of home loans, and we consider that its capital adequacy is a strong, positive rating driver. Our assessment is underpinned by our view that Credit Logement has (1) prudent underwriting and sound risk management, which supports the strong asset quality of its guaranteed loan portfolio; and (2) very strong loss-absorption capacity, because of existing capital buffers and its ability to externalise credit losses. Credit Logement guarantees loans that are originated by the retail arms of French banks, which are also mainly its shareholders. At origination, loans are booked onto the partner banks' balance sheets, which also collect interest and principal repayment flows. Credit Logement's guarantee can be called by partner banks if arrears occur on the guaranteed home loan. If an end-borrower defaults, the corresponding loan is repaid in full to the partner bank and transferred onto the balance sheet of Credit Logement, which subsequently takes over the late-arrears management and recovery process. At end-2011, Credit Logement had outstanding home-loan guarantees of EUR224 billion, equivalent to a significant multiple of its existing Tier 1 capital of EUR5.4 billion for the same period. However, we consider Credit Logement's capital adequacy to be sound. The quality of loans that Credit Logement guarantees is strong, reflected by the ratio of NPLs on its balance sheet to total guaranteed loans (0.21% at year end-2011). We believe this results from the generally strong origination criteria in the French home-loan market, which we consider are even stronger at Credit Logement because of the double due-diligence process at origination and Credit Logement's veto power. Its strong asset quality also reflects its efficient arrears management. In our view, the institution has sufficient shock absorbers to withstand a period of stress on its guaranteed loan portfolio and the MGF allows for the externalisation of potential losses. The MGF, which is composed of cash payments made by households when they take out a loan guaranteed by Credit Logement, is used to repay late arrears and repayment of NPLs that are transferred onto Credit Logement's balance sheet. It is also used to cover potential ultimate credit losses (write-offs). At year-end 2011, Credit Logement's MGF stood at EUR3.5 billion, equivalent to 1.6% of outstanding guarantees. We believe that under severe stress, Credit Logement would have the ability to use the entire MGF to absorb losses. Although MGF contributions are currently repaid in part to the end-borrower once the corresponding loans are repaid in full, Credit Logement would not have to make any repayment, if it anticipated a material increase in future credit losses. The other capital instruments and subordinated debt also provide meaningful loss-absorption capacity, given (1) their nominal size, with EUR1.5 billion of capital and EUR4.4 of subordinated instruments at end-2011, which together accounted for almost 2.6% of outstanding guarantees for the same period); and (2) the very low risk that a significant reduction in capital or a loss absorption by subordinated instruments would result in deterioration of the institution's funding and liquidity profile. Credit Logement does not rely on wholesale funding, apart from long-dated subordinated and hybrid debt that we consider as a loss absorbing. Credit Logement benefits from a written support commitment from its shareholders, which would provide the institution with the means to beef up its capital as it originates new business and grows its portfolio of guaranteed loans. However, we consider that the shareholders' ability to provide support would be challenged if Credit Logement faced very high losses on its guaranteed loan portfolio. If this scenario occured, we expect that the shareholders would also likely be faced with the same stress, thereby limiting their ability to provide support, especially given their relatively weaker financial strength, as reflected by their current weighted average rating (A2) relative to that of Credit Logement. PROFITABILITY - WHILE LOW, COMPENSATED BY THE FLEXIBILITY OF THE MGF REPAYMENT RATE Credit Logement's recurring profitability levels are low, reflecting its role as service provider for its partner banks that are also its shareholders. This, in turn, causes low recurring capital-generation capacity. However, the institution's ability to externalise losses to the MGF contributors, during stress periods, mitigates low net profits and we therefore do not consider low profitability as a constraint on the institution's intrinsic financial strength. As a service provider to its shareholders, Credit Logement is not a profit maximiser. The institution has two main revenue sources (1) commissions on the "prêts cautionnés" paid by individual borrowers, and which are capitalised and released through its income statement throughout the life of the guarantee; and (2) income from the placement of its free capital funds. Its earnings generation capacity is therefore driven by its pricing policy and business volumes on its main activity, and by interest-rate movements. At end-2011, operating income was split

5 business volumes on its main activity, and by interest-rate movements. At end-2011, operating income was split equally between net interest income and commission income, while other sources of income were marginal. We do not consider low recurring earnings generation capacity as a rating constraint for Credit Logement. This reflects our view that (1) Credit Logement's first line of defence is its MGF; and (2) its operating income is relatively predictable. Credit Logement allocates credit losses on guaranteed home loans in priority, which allows for the externalisation of losses, whilst the stability of its activity and the gradual release of commissions through its income statement throughout the life of the guarantees supports income predictability. ADEQUATE FINANCIAL FLEXIBILITY REFLECTS THE BALANCE OF HIGH SUBORDINATED DEBT LEVELS AND SHAREHOLDER COMMITMENTS TO SUPPORT ITS SOLVENCY Although Credit Logement does not have any outstanding senior unsecured instruments, its financial leverage is high, at around 75% at end-2011 (leverage defined as the ratio of financial and operating debt to the sum of financial and operating debt and capital, excluding the MGF). The currently high amount of outstanding subordinated debt instruments outstanding, which were issued in the past to beef up the institution's solvency, could constrain the institution's ability to find additional capital resources outside of the group, in case of need. However, we consider that Credit Logement would be able to find financial resources to fund the growth of its activity. Indeed, its shareholders are committed to maintain its solvency and to replenish the MGF. At end- 2011,Credit Logement reported that the commitment to replenish the MGF amounted to EUR3.3 billion. This commitment to maintain Credit Logement's solvency has allowed the institution to consolidate its capital buffers and maintain adequate loss-absorption capacity, as evidenced by the EUR1.7 billion of outstanding deeply subordinated loans (prês subordonnés) issued to Credit Logement's shareholders at end-2011, out of the total of EUR4.4 billion of subordinated debt at the same period. However, we consider that the ability of the shareholders to provide support would be challenged if Credit Logement faces very high losses on its guaranteed loan portfolio. OTHER CONSIDERATIONS -- High correlation between Credit Logement's financial strength and the average credit quality of its investment portfolio Credit Logement's intrinsic financial strength is inherently correlated to the credit quality of its investment portfolio. This reflects (1) the portfolio's relatively large size (EUR8.5 billion of interbank exposures at end-2011, equivalent to more than 160% of Credit Logement's Tier 1 capital); (2) the high concentration by counterparty and industry in the portfolio, as Credit Logement places its treasury assets in the form of deposits at the main French banks; and (3) our view that investment risks embedded in the portfolio have increased because of the deterioration in the counterparties' creditworthiness. The latter element was one of the drivers for our review of Credit Logement's ratings initiated in However, we note that Credit Logement has recently adopted significantly lower counterparty limits and has introduced a mechanism to collateralise some of its deposits. We believe that these measures - likely to be fully effective by end-june will result in a significant reduction of the risks linked to this portfolio, through (1) higher portfolio granularity on unsecured deposits; and/or (2) a reduction of the loss severity on collateralised deposits, if any counterparty defaults. Currently, the credit enhancement resulting from the adoption of the aforementioned measures mitigates the impact of the deterioration of the creditworthiness of the counterparties, in our view. However, we also consider that future deterioration of the counterparties' credit quality could exert further pressure on Credit Logement's intrinsic financial strength. -- Prudent ALM and liquidity management With regards to asset-liability management, Credit Logement has adopted strict limits and liquidity is invested based on the type of funding and its duration, in order to reduce mismatches. Credit Logement's market risk is also very limited. It is not active in the derivative product nor forward financial instrument markets and only has very marginal risks on equities. Credit Logement's market risk is limited to interest-rate risk, which it has historically prudently managed. In 2011, Credit Logement's net present value's sensitivity to a drop in rates of 200 bps amounted to 11.4% of its share capital over 10 years.

6 -- Low risk of other debtors registering a mortgage on loans guaranteed by Credit Logement Credit Logement benefits from a negative pledge on the loans it guarantees, but only registers a mortgage on the property in case of foreclosure. As such, it is exposed to the risk of a debtor registering a mortgage in breach of this negative pledge, especially given that Credit Logement is able to register a mortgage only after the partner bank makes a guarantee claim, which can take up to three months. However, we consider that this risk is mitigated by the prudent management of NPLs, and Credit Logement's ability to file a mortgage-lien by way of court, which is much more rapid. This prudent management is evidenced by Credit Logement's strong track record regarding the negative pledge risk. -- Expansion outside of France has been limited to date, but requires solid understanding of market structures Since September as a result of its partnership with Crédit Agricole Financement Suisse - a subsidiary of Crédit Agricole S.A. (A2 stable, BFSR D/BCA ba2, stable) - Credit Logement guarantees CHF-denominated housing loans taken out by households of Swiss nationality, or from countries within the European Economic and Monetary Union, domiciled in Switzerland. At present, this activity remains marginal relative to the overall production and outstanding amounts (year-end 2011: EUR36 million); as such it does not materially alter Credit Logement's risk profile. However, the factors underpinning Swiss borrowers' solvency are relevant, such as the dynamics of the borrowers' default rates (local social safety net, stability of the local labour markets, etc.) and the trends affecting the valuation of properties. Notching Considerations The dated subordinated instruments are rated one notch below the institution's long-term issuer rating, to reflect their subordination in case of liquidation. Conversely, Credit Logement's hybrid instruments are rated three notches below its long-term issuer rating, to reflect (1) their deeply subordinated claim in liquidation; and (2) the mandatory coupon-skip mechanism tied to a capital deficiency event, or a regulatory notification trigger. Rating Factors Crédit Logement Financial Strength Rating Scorecard [1] Aa A Baa Ba Score [2]Adjusted Score Factor 1: Market Position (45%) Baa Aa Avg. NIW as a % of Total Industry NIW 33.4% Prime Loans (% of RIF) 100.0% Client Concentration 69.0% Geographical Concentration 60.0% Factor 2: Housing Market Attributes (25%) Aa Aa Demand for Mortgage Insurance x Generic Loan Attributes x Housing Conditions x Factor 3: Capital Adequacy (30%) B Aa Adjusted Risk-to-Capital Ratio x Factor 4: Profitability (15%) Baa A Return on Capital (after-tax) x Combined Ratio Factor 5: Financial Flexibility (10%) Caa A Cash Flow Coverage Adjusted Financial Leverage x Total Leverage x Aggregate profile B Aa3

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