Fitch: Societe Generale 2Q15 Results Solid; Higher Capital Targets
SG reported EUR1.7bn pre-tax profit for 2Q15, adjusted for a EUR312m gain from changes in the fair value of own debt and for a EUR30m gain for debit and credit valuation adjustments. Adjusted pre-tax profit was up 36% yoy and 9% qoq (when adjusted for the EUR289m contribution to the eurozone's single resolution fund and other bank levies that were booked in 1Q15 for the full year). SG generated a stable 8.8% return on equity (ROE) in 2Q15 excluding the abovementioned non-recurring items.
SG's 2Q15 ROE would have been above its 10% FY16 target, were it not for the EUR200m provision for litigations. However, we expect profitability in 2H15 to reflect seasonally weaker quarters. This means that control on operating expenses and continued growth in its foreign and in non-retail banking businesses will be key to achieving its ROE target in quarters when global markets revenue are weaker.
SG's GBIS business was the main driver of the bank's operating profit in 2Q15 with EUR859m, equal to 42% of total operating profit excluding the corporate centre. Results were particularly strong in SG's global markets and investor services business, where revenue was up 9% yoy at constant scope and exchange rates. SG continued to report satisfactory returns in this business, with a 23% ROE in 1H15. Revenue in equities sales and trading was up by a significant 61% yoy (down only 6% qoq compared with a strong 1Q15), with good momentum in Europe and Asia, particularly in equity derivatives. Similar to most peers, higher foreign exchange volumes only partly offset lower demand in rates and credit products for SG, and revenue in fixed income sales and trading was down 15% yoy.
SG's financing and advisory business benefited from increased origination volumes and outstanding loans. Revenue growth, 16% yoy in 2Q15 at constant scope and exchange rates, outpaced operating expenses' (1% yoy), translating into a satisfactory 55% cost-income ratio in 2Q15. We expect particularly low LICs in recent quarters to normalise at some point; SG expects them to represent around 25bp of the gross loan book through the cycle (11bp in 1H15).
Net income generated by SG's domestic banking businesses increased 12% yoy to EUR399m, excluding PEL/CEL provisioning impact (the PEL/CEL provision affects banks in France every quarter and is linked to interest rate mismatch arising from regulated savings and credits). Lower LICs for corporate clients largely drove the increase; they represented 38bp of customer loans in 2Q15 on an annualised basis (43bp in 1H15), below the bank's 45bp-50bp target through the cycle. In addition, the improvement in SG's revenue in the recent quarters was confirmed, as it rose 2% yoy on higher fees and resilient net interest income (0.7% yoy). While overall revenue growth in this business should remain limited due to low interest rates and only gradual pick up in loan demand from corporates, we expect the bank to deliver satisfactory returns (16% return on allocated equity in 1H15, above its 14% target). Growth momentum for financial commissions should continue, notably due to life insurance products becoming comparatively more attractive to clients after regulated savings rates were cut to modest levels in August 2015. Outstanding housing loans continued to grow and were up 2% qoq at end-2Q15.
Operating profit in the international retail banking and financial services (IRBFS) businesses was up 0.7% to EUR520m at constant scope and exchange rates. Both the financial services and insurance parts of IRBFS continued to post robust recurring operating profit at EUR169m (15% growth yoy at constant scope and exchange rates) and EUR131m (6% growth yoy at constant scope and exchange rates) respectively.
The international retail banking business continued to be a moderate drag on SG's profitability. SG generated robust performance in the Czech Republic (EUR109m operating profit in 2Q15, although down 7% at constant scope and exchange rate due to higher expenses) and in the Africa and Mediterranean basin (EUR86m, up 9% at constant scope and exchange rate), the two main drivers of the business' profitability. Performance has been gradually improving in Romania, as the bank generated a EUR18m operating profit compared with a EUR54m operating loss for FY14, although it will take time for risk-adjusted performance to become satisfactory. The cost-income ratio for the Romanian operations was acceptable at 59% but LICs still depleted around two-thirds of the pre-impairment operating profit in 2Q15.
In Russia, SG reported a EUR45m net loss in 2Q15, which is smaller than the EUR91m loss in 1Q15. The negative contribution from its Russian business is likely to remain at least for the rest of 2015, but we believe the overall impact should remain manageable for the group. Revenue was down 25% yoy in 1H15 at constant scope and exchange rates due to lower business volumes, although it rebounded slightly qoq (8%). The loan book declined 15% yoy at constant scope and exchange rates, and we expect the group to continue to manage its Russian operations cautiously. LICs remained high and were up 53% yoy in 1H15, to EUR186m. SG further reduced its direct exposure to its Russian subsidiaries by EUR0.4bn in 2Q15, with a total EUR2.7bn in equity and EUR1bn in funding at end-1H15.
SG reported a EUR285m net loss in its corporate centre in 2Q15 excluding gains from changes in the fair value of own debt and from debit valuation adjustments. The loss mainly related to an additional EUR200m provision for litigations, bringing total litigation reserves to EUR1.3bn at end-1H15. As the bank has increased its target CET1 ratio to close to 11% in 2017 and allocates only 10% CET1 capital per business division, the corporate centre could in future report greater losses as it includes the results on unallocated capital.
SG's full-applied CET1 ratio improved 30bp qoq to 10.4% as retained earnings increased and risk-weighted assets (RWA) declined in the bank's global markets business. We expect SG to be able to meet its revised CET1 ratio target (close to 11% by end-2016), due to its satisfactory earnings retention capacity. The revision of its capital targets, which also includes a 4%-4.5% leverage ratio, brings the bank closer in line with its global trading and universal bank peers, and we believe that these targets could be revised further if regulatory requirements increase. SG announced that the planned disposal of its 20% stake in asset manager Amundi should lead to a 20bp improvement in its CET1 ratio by end-2015. SG's CET1 ratio benefits from the treatment of its insurance subsidiaries under the 'Danish compromise', but this benefit is set to diminish, to 15bp, following the sale of Amundi by end-2016.
SG's revised Basel III total capital ratio target (18%) is in line with the bank's plan to use additional Tier 1 (AT1) and Tier 2 instruments to comply with Financial Stability Board's total loss absorbing capacity (TLAC) requirements. SG's leverage ratio improved 10bp to 3.8% at end-2Q15, although this includes legacy AT1 instruments, and we expect the bank's adequate capital generation capacity and leeway in its leverage exposure to help improve the ratio.
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