FINANCIAL INSTITUTIONS ISSUER IN-DEPTH 1 March 2017 RATINGS BNP Paribas LT Bank Deposits: A1 Senior Unsecured: A1 Junior Senior Unsecured: Baa2 Subordinate: Baa2 Short-term: Prime-1 BCA: baa1 Outlook: Stable Société Générale LT Bank Deposits: A2 Senior Unsecured: A2 Junior Senior Unsecured: Baa3 Subordinate: Baa3 Short-term: Prime-1 BCA: baa2 Outlook: Stable Contacts Andrea Usai 44-20-7772-1058 Senior Vice President [email protected]Yana Ruvinskaya 44-20-7772-1618 Associate Analyst [email protected]Michael Eberhardt, CFA 44-20-7772-8611 VP-Sr Credit Officer [email protected]Laurie Mayers 44-20-7772-5582 Associate Managing Director [email protected]Robert Young 212-553-4122 MD-Financial Institutions [email protected]BNP Paribas and Société Générale BNPP has greater capacity to absorb shocks than SG, despite similar capitalisation SUMMARY Over the last few years, both BNP Paribas (BNPP, A1/A1 stable, baa1 1 ) and Société Générale (SG, A2/A2 stable, baa2) have strengthened their solvency and liquidity as well as refocused their business models on activities that consume less capital. Our assessment of the banks' capitalisation is broadly similar and their stable outlooks reflect good capacity to withstand earnings and funding shocks. However, we believe that BNPP’s comparatively stronger profitability and funding profile give it greater capacity to absorb shocks, resulting in a standalone baseline credit assessment (BCA) one notch higher than SG. » BNPP’s capital markets activities are proportionally smaller than SG’s, giving it greater capacity to mitigate earnings shocks and tail risk. Both banks have sizeable capital markets operations and are committed to Corporate and Institutional Banking (CIB), but BNPP’s larger proportion of more stable retail and commercial banking profits gives it greater capacity to absorb earnings shocks from declining CIB activity in the event of a sudden change in market conditions. » BNPP’s stronger, more stable profitability gives it greater capacity than SG to generate capital through retained earnings. In recent years, both banks have had solid earnings from well diversified operations, providing good capacity to absorb unexpected losses. However, BNPP has maintained a stronger track record of profitability and earnings stability, except in 2014 when it accounted for a large regulatory fine. » We assess the banks' capitalisation as broadly similar and adequate for their risk profiles. Both banks had Basel III fully loaded common equity tier 1 (CET1) ratios of 11.5% at end-2016 and have been improving their CET1 and leverage ratios, mainly through retained profits. We also consider how the banks' capital positions will evolve, how they would withstand stress loss scenarios, and the banks’ ability to meet higher capital requirements, if required, through profit retention or other management actions. » BNPP sources less funding from confidence-sensitive wholesale markets than SG, making it less vulnerable to market stresses despite a smaller liquidity buffer. Given its size and degree of interconnectedness, BNPP will have to build a larger buffer of more expensive loss-absorbing capital than SG in coming years 2 , increasing its funding costs. However, the overall funding stocks of the two banks should remain broadly unchanged, as we expect they will replace existing debt with instruments meeting new regulatory standards. SG has higher overall refinancing risk, although its larger liquidity stock than BNPP makes it more resilient to short-term liquidity stresses.
BNP Paribas and Société GénéraleBNPP has greater capacity to absorb shocks than SG, despitesimilar capitalisation
SUMMARYOver the last few years, both BNP Paribas (BNPP, A1/A1 stable, baa11) and Société Générale(SG, A2/A2 stable, baa2) have strengthened their solvency and liquidity as well as refocusedtheir business models on activities that consume less capital. Our assessment of the banks'capitalisation is broadly similar and their stable outlooks reflect good capacity to withstandearnings and funding shocks. However, we believe that BNPP’s comparatively strongerprofitability and funding profile give it greater capacity to absorb shocks, resulting in astandalone baseline credit assessment (BCA) one notch higher than SG.
» BNPP’s capital markets activities are proportionally smaller than SG’s, giving itgreater capacity to mitigate earnings shocks and tail risk. Both banks have sizeablecapital markets operations and are committed to Corporate and Institutional Banking(CIB), but BNPP’s larger proportion of more stable retail and commercial banking profitsgives it greater capacity to absorb earnings shocks from declining CIB activity in theevent of a sudden change in market conditions.
» BNPP’s stronger, more stable profitability gives it greater capacity than SGto generate capital through retained earnings. In recent years, both banks havehad solid earnings from well diversified operations, providing good capacity to absorbunexpected losses. However, BNPP has maintained a stronger track record of profitabilityand earnings stability, except in 2014 when it accounted for a large regulatory fine.
» We assess the banks' capitalisation as broadly similar and adequate for theirrisk profiles. Both banks had Basel III fully loaded common equity tier 1 (CET1) ratiosof 11.5% at end-2016 and have been improving their CET1 and leverage ratios, mainlythrough retained profits. We also consider how the banks' capital positions will evolve,how they would withstand stress loss scenarios, and the banks’ ability to meet highercapital requirements, if required, through profit retention or other management actions.
» BNPP sources less funding from confidence-sensitive wholesale markets thanSG, making it less vulnerable to market stresses despite a smaller liquiditybuffer. Given its size and degree of interconnectedness, BNPP will have to build a largerbuffer of more expensive loss-absorbing capital than SG in coming years2, increasingits funding costs. However, the overall funding stocks of the two banks should remainbroadly unchanged, as we expect they will replace existing debt with instrumentsmeeting new regulatory standards. SG has higher overall refinancing risk, although itslarger liquidity stock than BNPP makes it more resilient to short-term liquidity stresses.
BNPP has greater capacity to mitigate earnings shocks and tail risk from declines in capital markets operationsBoth BNPP and SG have sizeable corporate and investment banking (CIB) franchises. The banks are also selectively expanding theseoperations, in contrast to some European competitors that have retreated from CIB activities to strengthen their solvency and focus onmore profitable, less-capital consumptive activities.
Despite their larger absolute size and scope, BNPP’s capital markets activities are smaller than SG’s relative to its retail, commercial andcorporate banking businesses, providing the group with greater capacity to mitigate earnings shocks and tail risk from declines in itscapital markets operations: capital markets revenues accounted for only 13% of BNPP’s total revenues in the first half of 2016 comparedwith 23% for SG (Exhibit 1).
Exhibit 1
BNPP Has Lower Reliance on Capital Markets Revenues than SGGlobal Investment Banks: total revenues (X-axis), capital markets revenues (Y-axis) and capital markets revenues over total revenues (%, bubble size)
Source: Moody’s estimates based on company financials.
The global retail and commercial banking operations of BNPP and SG provide each with a large shock-absorbing source of more stablerevenues to help buffer earnings volatility and unexpected losses from their CIB activities. Exhibit 2 shows that pre-tax earnings fromnon-capital markets activities for the period 2010 through H1 2016 have been proportionally higher for BNPP than SG. This is despiteBNPP accounting for a large one-off regulatory fine of €6.5 billion in 2014. BNPP's higher proportion of stable and recurring revenuesfrom non-capital markets operations than SG make its earnings and capital more resilient to changes in market conditions.
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.
2 1 March 2017 BNP Paribas and Société Générale: BNPP has greater capacity to absorb shocks than SG, despite similar capitalisation
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Exhibit 2
BNPP Has a Higher Proportion of ‘Shock-Absorbing’ Non-CIB Earnings than SGGlobal Investment Banks: capital markets vs non-capital markets earnings (2010 – H1 2016)
Note: SG’s capital markets pre-tax earnings also include Securities Services and Financial & AdvisorySource: Moody’s based on company data.
BNPP also has greater capacity to build additional capital through retained earningsBNPP and SG operate universal banking business models with sizeable domestic and international retail and commercial bankingoperations as well as CIB franchises. The banks’ healthy historical profitability rests on their well-established domestic businesses andhighly diversified operations, both by product and geography. The greater the revenue pool from diverse, non-capital markets activities,the greater the ability of a bank to generate internal capital and absorb earnings shocks or unexpected losses from its CIB activities.
Of the two banks, BNPP has consistently been the more profitable, excepting 2014 when it accounted for a large one-off regulatory fineof €6.5 billion (Exhibit 3).
Exhibit 3
BNPP’s Profitability Has Historically Proven Stronger than SG’sBNPP and SG: net income over tangible assets
Source: Moody’s calculations based on banks’ published financials.
BNPP and SG were less affected than many other large global banks by the subprime mortgage crisis of 2008-09, and had comparativelylimited exposures to other distressed asset classes such as commercial real estate. This in part reflects the two banks’ conservative riskappetite and credit risk management compared with global peers. At the same time, they have taken steps to optimise their businessmodels to improve their return on assets and reallocated capital towards those activities generating a higher return on capital. The banksalso have been able to strengthen regulatory capitalisation to meet more stringent risk requirements.
3 1 March 2017 BNP Paribas and Société Générale: BNPP has greater capacity to absorb shocks than SG, despite similar capitalisation
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Moreover, BNPP and SG carry a much smaller burden of legacy matters, such as non-core assets or high-profile litigations, than manyof their international peers. A relative lack of extraordinary charges against earnings places BNPP and SG at an advantage in the currentenvironment of low interest rates and muted economic growth in Europe, and both have reported a better return on average assets thanmany European peers, though still lagging some in the broader global investment bank (GIB) peer group (Exhibit 4).
Exhibit 4
Profitability of BNPP and SG Compares Favourably with European Peers…Global Investment Banks: return on average assets (group level)
Source: Moody’s Investors Service, data from Factset and company reports
BNPP and SG have also outperformed peers on earnings stability (Exhibit 5), a key aspect of our profitability assessment. BNPP is strongerthan SG on this measure over the period 2007 to H1 2016, which includes the 2008-09 financial crisis. However, BNPP’s earnings volatilitywas slightly higher than SG’s post financial crisis, partly driven by the large financial fine of around €6.5 billion it paid in 2014.
Exhibit 5
… and They Also Have Low Earnings VolatilityGlobal Investment Banks: earnings volatility
Note: Capital markets earnings based on firm LOB disclosures including sales/trading and investment banking (origination and advisory) but excluding other corporate banking activitieswhere possible. Where disclosed, legacy unit losses from capital markets have been allocated to capital markets segment. Corporate overhead segments are included in non-capitalmarkets segment. Earnings are adjusted for own credit gains/losses (DVAs). HSBC’s baseline credit assessment shown (a1) represents the intrinsic standalone financial strength of the group(HSBC Holdings plc) and is currently on negative outlook. RBS (ba1) is currently on positive outlook, BCS (baa2) is currently on negative outlook. Societe Generale’s GIB Pre-tax Incomealso includes Securities Services and Financial & Advisory, Barclays’ GIB Pre-Tax Income also includes Corporate Lending and Transactional Banking. DB’s GIB pre-tax income also includesTrade Finance and Cash Management services and other Loan products.Source: Moody’s calculations based on banks’ published financials.
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BNPP and SG have similar capitalisationWe assess that BNPP and SG have broadly similar capitalisation levels, which are adequate for their risk profiles when also taking intoaccount their leverage ratios and exposures to losses under stress. Both banks had Basel III fully loaded common equity tier 1 (CET1) ratiosof 11.5% at end-2016, which have been improving in recent years, together with their leverage ratios, mainly owing to retained profits(Exhibit 6). Our capital assessments consider the banks' current capital positions and how we expect these to evolve over time, as wellas other factors, such as our assessment of stress losses and the banks’ ability to meet increasing capital requirements through profitretention or other management actions, if required.
BNPP and SG have announced similar target CET1 ratios of 12% by 2018. For BNPP this would be 1.75% higher than its 10.25% fullyloaded CET1 Supervisory Review and Evaluation Process (SREP) requirement at 1 January 2019; the latter includes a 2% G-SIB buffer toaccount for its size. SG’s 2018 target CET1 ratio would be 2.5% above its fully loaded CET1 9.5% SREP requirement, which includes alower 1% G-SIB buffer owing to its smaller size and regulators’ lower assessment of systemic risk. However, we note that SG had morecapital headroom (excess of capital over regulatory requirement) than BNPP at the end of 2016. In addition, SG already meets its 2019Total Loss Absorbing Capacity requirements.
Exhibit 6
Capitalisation and Leverage Have Been Improving, Mainly Owing to Retained ProfitsBNPP and SG: Basel III fully loaded CET1 and leverage ratios
Source: Company reports.
Achieving the target 12% CET1 ratio would bring BNPP and SG almost in line with the 12.3% median for their GIB peer group (Exhibit7). However, their sizeable capital markets operations, including large derivatives and repo books, contribute to higher leverage thanother large banks. BNPP and SG have improved their leverage ratios to 4.4% and 4.2%, respectively, at the end of 2016 through retainedprofits, the reduction of leverage exposures, and issuance of additional Tier 1 notes. While these levels are broadly in line with those oftheir European peers and above the minimum of 3%, they remain well below the 5.3% median for the GIB peer group, which includessome large banks in the US, where, unlike in Europe, a large portion of mortgage loans are sold to mortgage financiers, resulting in lowerleverage exposures.
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Exhibit 7
BNPP and SG’s Capital and Leverage Ratios Remain Lower than Medians for Global PeersGlobal Investment Banks: Basel III fully loaded CET1 and leverage ratios, as at end-2016
Note: *UBS and CS leverage ratio reflect Common Equity Tier plus Low Trigger Additional Tier 1 and High-Trigger Additional Tier 1 securities ** Figures as at end-Sep 2016Source: company data.
In coming years, BNPP and SG, together with their global peers, will likely be subject to more stringent regulatory capital standards thatare likely to result in higher risk-weighted assets (RWAs). The enhanced standards will include the fundamental review of the tradingbook, the review of the standardised approach to credit risk, restrictions on the use of internal models for operational risk and low-defaultexposures, as well as the potential implementation of capital floors.
In addition, the introduction of IFRS 9 will require banks to account for future credit losses based on expected lifetime losses, which weexpect will result in higher loan loss provisions that weigh on banks’ profitability and internal capital-generation capacity.
However, the strong and steady profitability of BNPP and SG should enable them to absorb these negative regulatory capital pressuresand continue strengthening their solvency. BNPP and SG’s strong capacity to generate capital through retained earnings is evident in theirCET1 ratio increases of more than 40 basis points (bps) per year since 2013, while maintaining relatively high dividend pay-out ratios.The banks have also demonstrated their ability to strengthen their solvency through management actions, if required: a recent exampleis the ongoing disposal of BNPP’s First Hawaiian Bank (FHB, Aa3/A3 stable, a2).
BNPP has a better funding profile than SG, making it less vulnerable to changes in market conditionsA lower proportion of wholesale funding reduces a bank’s vulnerability to refinancing risk, an advantage BNPP holds relative to SG.Although BNPP held a higher wholesale funding stock (€270 billion) than SG (€204 billion) at end-September 2016 (Exhibit 8), itswholesale funding stock has historically been much smaller relative to its size (Exhibit 9). At end-June 2016 BNPP’s wholesale fundingstock equalled around 42% of its tangible banking assets, making its funding profile better than SG’s, for which we calculated a higherratio of around 52%.
6 1 March 2017 BNP Paribas and Société Générale: BNPP has greater capacity to absorb shocks than SG, despite similar capitalisation
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Exhibit 8
BNPP Has a Larger Wholesale Funding Stock than SG…BNPP and SG: breakdown of wholesale funding
Source: Company reports.
Exhibit 9
…but Has a Lower Relative Reliance on Such FundingBNPP and SG: Market funding over tangible banking assets
Note: The above ratios are calculated using our definition of market funding, which includes: (1) due to financial institutions, (2) short-term borrowings, (3) trading liabilities, excludingderivatives contracts, (4) long-term senior debt, (5) 50% of covered bonds and other secured funding.Source: Moody’s calculations based on banks’ published financials.
Similar to their French and GIB peers, BNPP and SG have large stocks of debt funding both in absolute amount and relative to theirbalance sheets. The two banks’ historical loan to deposit (LTD) ratios of above 100% indicate a structural reliance on wholesale marketfunding, which tends to be more volatile and confidence-sensitive than retail and SME deposits.
Both BNPP and SG have increased their deposit bases in recent years, helped by the declining returns of alternative savings products,which in turn has improved their LTD ratios (Exhibit 10). Since 2014, however, BNPP has outperformed SG on this metric.
7 1 March 2017 BNP Paribas and Société Générale: BNPP has greater capacity to absorb shocks than SG, despite similar capitalisation
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Exhibit 10
BNPP and SG’s Loan to Deposit Ratios Have Been Improving but BNPP’s Is LowerBNPP and SG: gross loan-to-deposit ratios
Source: Moody’s calculations based on banks’ financials.
BNPP and SG have had higher LTD ratios than many European peers because a large portion of retail savings in France is disintermediatedvia the widespread use of life insurance contracts and different types of regulated savings accounts (Livret A, Livrets LDD and CEL/PEL3),which all benefit from tax advantages. Although regulated savings accounts are collected directly by the banks, only a small fraction ofthese deposits have historically remained on their balance sheets, with the vast majority transferred to a government agency4
BNPP and SG also require wholesale funding to finance their large stock of trading and investment assets, much of which relates to theirsizeable capital markets businesses. In addition, they hold short-term deposits and other placements from large corporate clients, whichthey maintain in liquid form, and which are therefore not used to finance operating assets.
The banks’ outstanding long-term debt stock is well termed out and diversified by investor type and currency, partly mitigating theassociated refinancing risks. Moreover, both BNPP and SG have sizeable liquidity buffers and can access central bank refinancing, ifrequired, during times of exceptional or prolonged market stress. Nonetheless, we believe that the banks’ creditors remain exposed tothe (gross) refinancing risk of their large remaining wholesale funding stocks.
SG HAS A LARGER LIQUIDITY BUFFER THAN BNPP, REFLECTING ITS HIGHER REFINANCING RISK
In our analysis of bank funding and liquidity, we measure the extent to which banks’ liquidity buffers mitigate the corresponding refinancingrisk in their funding structures. Both BNPP and SG have adequate liquidity owing to their sizeable pools of liquid assets, which are wellin excess of the corresponding short-term liabilities (Exhibit 11). However, SG has a larger liquidity buffer relative to its size than BNPP(Exhibit 12), reflecting its greater stock of wholesale funding relative to the balance sheet. Even so, BNPP has a lower (net) refinancing riskowing to its lower stock of wholesale funding relative to its size, and despite a proportionally smaller liquidity buffer than SG (Exhibit 12).
8 1 March 2017 BNP Paribas and Société Générale: BNPP has greater capacity to absorb shocks than SG, despite similar capitalisation
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Exhibit 11
Both BNPP and SG Have Large Liquidity Pools but BNPP’s Liquid Assets Are Smaller Relative to Its SizeLiquid reserves and liquid assets as % of short-term debt
Notes: BNPP no longer discloses the amount of short-term debt on a quarterly basis.Source: Moody’s calculations based on banks’ published financials.
The benefit of SG’s greater liquidity buffer is increased resilience to short-term liquidity stresses, as evidenced by its liquidity coverageratio (LCR5) of 142% at the end of 2016, compared with 123% for BNPP (Exhibit 13).
Exhibit 12
BNPP and SG: Liquid banking assets over tangible banking assets
Source: Moody's calculation based on banks' published financials.
Exhibit 13BNPP and SG: Liquidity coverage ratios (LCRs)
Source: company data.
9 1 March 2017 BNP Paribas and Société Générale: BNPP has greater capacity to absorb shocks than SG, despite similar capitalisation
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10 1 March 2017 BNP Paribas and Société Générale: BNPP has greater capacity to absorb shocks than SG, despite similar capitalisation
Endnotes1 The bank ratings shown in this report are the banks’ deposit rating, senior unsecured debt rating and baseline credit assessment.
2 Total Loss Absorbing Capacity requirements are calculated based on individual banks’ risk weighted assets.
3 Livret A, Livret de Développement Durable - LDD, Compte Epargne Logement - CEL, and Plan Epargne Logement - PEL are all regulated savings, whichprovide depositors with a tax deduction on interest and whose rate is set by the French Ministry of Finance.
4 Caisse des dépôts and consignations (Aa2 stable). From April 2016, French banks have the option to transfer the full amounts of Livret A and Livret LDDsto the CDC.
5 LCR measures a bank’s ability to withstand market shocks over a 30-day period.
11 1 March 2017 BNP Paribas and Société Générale: BNPP has greater capacity to absorb shocks than SG, despite similar capitalisation
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12 1 March 2017 BNP Paribas and Société Générale: BNPP has greater capacity to absorb shocks than SG, despite similar capitalisation
