Fitch Affirms Caisse Centrale DesJardins' Ratings; Outlook Remains Stable

Fitch Ratings has affirmed the ratings for Caisse Centrale Desjardins (CCD) and Capital Desjardins (CD) Inc. The Rating Outlook is Stable. This affirmation is reflective of CCD's strong capital position, solid asset quality and steady earnings.

This rating action follows a periodic review of the Canadian Banking sector. Fitch will publish the main findings of this review in a report 'Canadian Banks: Nearing a Tipping Point' available at www.fitchratings.com in the near future.

KEY RATING DRIVERS - IDRS, VR's, AND SENIOR DEBT

The ratings of CCD and CD reflect their central position within the Desjardins Group (DESJ) - CCD and CD are the issuing entities of DESJ.

The Group's main differentiating factor is its high Tier 1 capital ratio which was 15.3% under Basel III at the end of third quarter 2014 (3Q'14). This compares very favorably to an average of 10.7% for the other Canadian banks included in the sector review (Royal Bank of Canada, Toronto-Dominion, Bank of Montreal, National Bank of Canada, CIBC, and Bank of Nova Scotia) as of the same time period.

Fitch views this strong capital position as a notable mitigant to the concerns inherent in the Group's significant geographic concentration in the province of Quebec, its loan portfolio concentrated in residential mortgages and a legal structure that may limit its ability to access the equity markets compared to peers. 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.

Credit quality for CCD remains relatively strong compared to its Canadian peers. As highlighted by Fitch over recent periods, there will likely be some plateauing or cooling of the Canadian housing market, which will adversely impact all Canadian banks' asset quality, including CCD. Partially mitigating Fitch's view of this risk for CCD is the group's aforementioned high capital ratios, the high level of insured mortgages at roughly 35% of all mortgages, and the comparatively good average loan-to-value (LTV) ratio for the mortgage portfolio of 55% as of 3Q'14.

The company's profitability is somewhat constrained by relatively high operating expenses, owing in part to the business model and structure of the Group. Given its large caisse (credit union) network, CCD has a higher cost structure than other Canadian and global peer banks, which weighs on overall profitability of the Group. While CCD has worked to consolidate its caisses, its cost structure will likely remain high over the near- to intermediate-term.

Although CCD's overall returns are lower than peers, Fitch notes that this reflects the company's cooperative structure. Fitch recognizes that 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 (ROA). As such, Fitch observes that CCD's average annual ROA over the last few years has approximated under 0.70%, which is satisfactory, but lower than many similarly rated banks. Fitch notes that more aggressive expense management could potentially aid an increase in profitability over a medium-term time horizon.

Fitch notes that another aspect that could potentially boost the Group's profitability is its growing insurance (including life, health, and property and casualty lines) as well as wealth management presence in Canada.

In January 2015, CCD closed on its purchase of State Farm Canada's businesses in property and casualty (P&C) and life insurance, as well as its Canadian mutual fund, loan, and living benefits companies. As a result, DESJ has become the second largest P&C insurance provider in Canada. This transaction also increases DESJ's geographic diversification of earnings and risk while providing an advantage of scale and strengthens its position among life and health insurers in Canada. Previously the smallest segment, the P&C business has increased its contribution to earnings to over 12% year-to-date 2014 from approximately 8%-9% in FY11 and FY10. The affirmation and maintenance of the Stable Outlook reflect Fitch's views that the transaction is neutral to CCD's ratings at this time.

RATING SENSITIVITIES - IDRS, VRs, and SENIOR DEBT

Given the already high ratings of the Group, Fitch notes that there is very limited upside to current ratings.

Fitch notes that CCD's Rating Outlook remains Stable. This Outlook encompasses Fitch's views that CCD's earnings will remain somewhat consistent over a medium-term time horizon and that it will maintain relatively high capital ratios.

CCD's ratings are sensitive to the growth of DESJ's insurance business lines, primarily through acquisition. If insurance acquisitions, such as the State Farm transaction, are not integrated effectively or efficiently, negative rating pressure could be placed on CCD's current rating or Outlook. This could be measured through metrics such as customer and/or agent retention over the long term.

The Outlook also incorporates Fitch's view that DESJ is fairly well-positioned for when the Canadian housing market plateaus or possibly cools. Fitch believes this market movement would be manageable for DESJ given the aforementioned characteristics of its mortgage portfolio and its high capital ratios.

Fitch does note, however, that 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 Outlook.

KEY RATING DRIVERS - SUPPORT RATINGS AND SUPPORT RATING FLOORS

The affirmation of CCD's SRs and SRFs reflects Fitch's expectation that there remains an extremely high probability of support from the Canadian government ('AAA', Outlook Stable) if required. This expectation reflects Canada's extremely high ability to support its banks especially given its financial flexibility, though propensity is becoming less certain.

Specific to CCD, Fitch's view of the likelihood of support is based mostly on the banks' systemic importance in Canada, significant concentration overall Canadian banking assets amongst the institutions noted above (which account for over 90% of banking assets), the large size of the banking system with banking assets at 2.1x Canada's GDP, and the Canadian Banks' position as key providers of financial services to the Canadian economy. CCD's IDRs and senior debt ratings do not benefit from support because their Viability Ratings (VRs) are all currently above their SRFs.

However, in Fitch's view, there is a clear intention to reduce support for D-SIFIs in Canada, as demonstrated by commentary and actions from Canadian banking regulators seeking to protect taxpayers from the risk of a large financial institution failing. This is further supported by the proposed issuance of non-viable contingent capital (NVCC) instruments, resolution powers given regulatory authorities under the CDIC Act, and other initiatives that demonstrate the Canadian government's progress in reducing the propensity of state support for banks going forward. Fitch believes this increases the likelihood of NVCC and potential senior debt losses if one or more of the Canadian Banks run afoul of solvency assessments.

RATING SENSITVITIES - SUPPORT RATING AND SUPPORT RATING FLOOR

Fitch is classifying Canada as a Path 2 country as defined in its September 2013 report, Bank Support: Likely Rating Paths, and, given the factors noted above, Fitch expects there to be some level of support for CCD going forward, and as such does not expect the SR to be affected.

The SRF ratings are more likely to be impacted and are sensitive to progress made in completing NVCC issuances and any additional regulatory initiatives that may be imposed on the Canadian D-SIFIs. Fitch's assessment of continuing support for Canadian D-SIFIs 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.

Fitch expects that the continued regulatory action to ensure sufficient contingent capital will be implemented for all Canadian banks in the near term, but regardless, Fitch believes that sufficient regulatory progress continues to be made over the ratings time horizon. Therefore, Fitch expects to downgrade CCD's SRFs to 'BBB-' at some point over the next 12 months.

Absent a material in change economic conditions or the companies' stand-alone credit profiles, a downgrade of the SRFs to 'BBB-' would mean no change to CCD's long-term IDR and debt ratings because their viability ratings are all above the SRF.

KEY RATING DRIVERS - SUBORDINATED DEBT SECURITIES

Subordinated debt issued by the CD is notched down from CCD's IDRs in accordance with Fitch's assessment of the instrument's nonperformance 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.

KEY RATING SENSITIVITIES - SUBORDINATED DEBT

The subordinated debt ratings are primarily sensitive to any change in the IDRs of CCD.

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 '1';

--Support Floor at 'A-'.

Capital Desjardins, Inc.

--Subordinated debt at 'A+'.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--Global Financial Institutions Rating Criteria' (January 2014)

--The Evolving Dynamics of Support for Banks' (September 2013)

-- Bank Support: Likely Rating Paths' (September 2013)

--2015 Outlook: Canadian Banks (December 2014)

--Banking Structures Backed by Mutual Support Mechanisms (Dec. 18, 2013)

Applicable Criteria and Related Research:

Banking Structures Backed by Mutual Support Mechanisms
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724995

2015 Outlook: Canadian Banks (Stable RatingOutlook, Negative Sector OutlookRemains for 2015)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=810389

The Evolving Dynamics of Support for Banks
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715000

Global Financial Institutions Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732397

Additional Disclosure

Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=978297

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