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Fitch: SG's Q213 Underlying Profit Up, Balance Sheet Strengthening

Ratings says that Societe Generale's (SG; A/Stable/a-) Q213 results showed improvement in almost all its businesses. At the same time, SG reported a 70bp increase in its Basel III 'fully applied' common equity Tier 1 (CET1) ratio, which reached 9.4% at end-June 2013, a level more in line with its peers among the global and trading universal banks.

SG reported a EUR1.4bn pre-tax profit in Q213, adjusted for fair value of own debt changes (EUR53m gain) and CVA/DVA accounting impacts (EUR106m loss), representing an improvement both yoy (+50%) and qoq (+14%). Cost cutting more than offset sluggish revenue in some businesses, and loan impairment charges (LICs, excluding those relating to the disposal of legacy assets) declined to 67bp of customer loans in Q213 on an annualised basis (75bp in Q212).

SG's French retail banking business remains one of the bank's two main contributors to operating profit, along with corporate and investment banking (CIB), each accounting for roughly one-third of the group's Q213 operating profit, excluding the EUR155m operating loss reported in the corporate centre. The business continued to generate sound profitability in Q213 (with a 15% return on Basel 2.5 capital in Q213 on an annualised basis). Fitch considers revenue is likely to remain sluggish in French retail activities for all domestic banks in the coming quarters given the low demand for credit and the low interest rate environment (revenue was up only 1.6% in Q213 yoy). Although operating profit declined by 9% yoy on higher LICs (+29% yoy) they appear to be stabilising (down by 9% qoq to 58bp of customer loans in Q213 on an annualised basis versus 65bp in both Q412 and Q113). Fitch believes that any rise in LICs should remain manageable.

SG's CIB business includes its core activities (capital markets, and financing and advisory) and its legacy assets portfolio. The business posted solid underlying results in Q213 (EUR0.5bn operating profit or a 20% pre-tax return on Basel 2.5 capital on an annualised basis), while further downsizing its legacy portfolio at acceptable costs (EUR43m net loss for the quarter). The capital markets division posted higher revenue yoy (+27%) in its two businesses (equities and fixed-income), but lower revenue qoq (-16%) as Q1 was seasonally strong. The equities business reported particularly strong results in Q213 (EUR0.7bn revenue or +42% yoy and only -3% qoq) due to sustained customer activity, notably in equity derivatives and structured products where SG maintains leading positions. Like most of its European peers with a strong focus on Europe, SG's fixed-income revenue was down qoq (-29%), lagging its US peers, which benefited from better domestic market activity than in Europe.

SG's financing and advisory business continues to benefit from the bank's strong franchise in euro corporate bonds, although declining lending and issuance volumes weighed on revenue compared with the previous quarter (-15%). The legacy assets portfolio reached EUR6.1bn at end-June 2013, and was mainly investment grade. Fitch expects this portfolio to be more or less break-even in the coming quarters.

SG's international retail banking (IRB) business continued to generate weak earnings in Q213 (6% return on Basel 2.5 capital on an annualised basis), but confirmed the improvement seen in the previous quarter. Fitch expects that it will take some time for SG to deliver strong profitability in this business, and SG's efforts to improve operating efficiency should help operating profit. LICs also continued to decrease (-23% yoy), although the latter still absorbs the bulk of pre-impairment operating profit in some countries, such as Romania (EUR1m operating profit in Q213) and Russia (EUR17m operating profit, albeit up from EUR26m operating loss in Q212). SG's IRB has the largest presence in the Czech Republic, which drives the division's operating profit (EUR126m in Q213).

SG's specialised financial services and insurance business continued to provide good earnings diversification, as the division generated one-fifth of the bank's Q213 operating profit (excluding the loss in the corporate centre). The division, whose operating profit rose by 15% yoy on higher revenue and lower LICs, generated an adequate 16% return on Basel 2.5 capital in Q213 on an annualised basis. Moreover, LICs appear to be under control. The contribution of SG's wealth management business to the bank's operating profit remained small in Q213, at 5%, and largely came from private banking activities.

SG reported an increase in its Basel III 'fully applied' CET1 ratio, closing the gap with its European peers. The rise was due mainly to retained earnings, lower risk-weighted assets (including legacy assets sales) and CVA reduction. SG effectively reached its 9.5% target six months ahead of plan, and Fitch expects the bank to strengthen its capital ratios further through earnings retention and further legacy assets deleveraging. The bank announced that it expected to report a Basel III leverage ratio above 3% by end-2013, which is in line with most of its global and trading universal bank peers.

SG's liquidity is adequate. Its Basel III LCR ratio was above 100%. Its liquidity buffer covered 136% of the bank's short-term wholesale funding maturing within one-year; the cash and deposit with central bank part of the buffer covered 71% of short-term wholesale funding maturing within one year (up from 51% at end-Q113).



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