Idea of the Week: It is not always rosy for the banks.

In a year where the majority of the banks saw rising interest rates benefitting their net interest margin, SOCGEN did not manage to enjoy such benefits. For the twelve months ended 31 December 2022 (“FY22”), SOCGEN saw its reported Group net income falling to EUR 2.0b as compared to EUR 5.6b in FY21. From the disposal of Russian assets alone, SOCGEN saw losses amounting to EUR 3.3b arising from the write-down of Russian assets. Although impairments owing to an overall deterioration of the economic outlook rose (EUR 1.6b in FY22 versus EUR 0.7b in FY21), the write-down of Russian assets still accounted for a larger proportion of the losses SOCGEN faced. 

Putting the Russian assets aside, it is fair to say that SOCGEN did see some improvements in its earnings across its businesses. Net banking income rose to EUR 28.0b in FY22, as compared to EUR 25.8b in FY21 – an increase of ~8.76%. On the other hand, net interest income (“NII”) rose to EUR 11.3b in FY22 from EUR 10.7b in FY21 – an increase of ~5.30%. 

While it might have been a silver lining to see overall profits in a year of massive write-downs, SOCGEN’s profitability had been disappointing. Most banks saw an uptick in performance owing to the rapidly rising interest rates, which mostly benefitted their net interest margin allowing for strong earnings in 2022. For SOCGEN, it is clear to see there is a high passthrough of the rates to the consumer deposits, where SOCGEN is unable to take much profit and take advantage of the rising interest rates.

For the European banks, the average increase in NII was about 18.6% across the region, with some of the bigger names like Barclays PLC and HSBC Holdings PLC attaining more than 30% growth in NII. SOCGEN’s 5.3% growth in NII pales severely in comparison, although it is not the only bank facing this situation. Other French banks, e.g. BNP Paribas and Credit Agricole, similarly face limited growth in NII due to legislations in France restricting their ability to capitalise on the rising interest rates.

In France, the government limit the maximum rate that a bank may implement on its mortgages – known as the mortgage usury rate. While the rate sees adjustment quarterly, the adjustments are minimal as compared to the aggressive rate hikes by the European Central Bank (“ECB”). As seen in the chart below, rate hikes by the ECB had been far more rapid than the existing usury rate.

Other than mortgage regulations limiting their net interest margin, French banks see a higher cost of funding in their deposits than other countries. This is due to the presence of government-regulated savings accounts which adjusts semi-annually to the existing inflation and interest rates. As a result, despite ECB still holding negative interest rates in the first half of 2022, Livret A Savings account, the most popular account made available to everyone in France, already saw increasing rates due to inflation. While the government-regulated savings accounts tend to have a limit in place, for example, Livret A Savings only allows for a maximum deposit of EUR 22,950 per pax, such accounts ultimately increase the pass-through rate of interest rates to consumers.

As such, with limits placed on mortgage loans and quick-to-adjust savings accounts, French banks were unable to benefit from the widening net interest margin that other banks saw. For SOCGEN, despite the French government stepping in to indicate a need to adjust the usury rate more frequently, it remains unlikely for it to benefit much from the current interest rates environment. 

The outlook for SOCGEN, if anything, is mild. A targeted 3% growth reflects continued stability in its operations, especially considering its significant reliance on France for its income does not allow for a sudden breakthrough in results. With this in mind, we are more optimistic about its regional development beyond France which should provide SOCGEN with more opportunities – allowing it to take advantage of wider net interest margins. We should see a similar performance for SOCGEN in 2023 as compared to 2022, with the exclusion of the Russian assets write-down.

Credit Quality

SOCGEN’s CET1 ratio is at 13.49% as of 31 December 2022, falling from 13.71% as of 31 December 2021 due to the write-down of Russian assets. It indicated that its CET1 remains well above the required amount by 420 basis points. The liquidity coverage ratio stands at 141% in 2022, a drop from the 149% recorded in 2021 but still sufficient over the regulatory requirement. Its liquidity reserves increased to EUR 279b as of December 2022, from EUR 229b as of December 2021.

The cost of risk for SOCGEN was at 28 basis points in 2022, in which it anticipates the cost of risk to normalise between the range of 30 to 35 basis points moving forward. Non-performing loans (“NPL”) ratio had seen an overall falling trend across the past five years, where the NPL ratio fell slightly to 2.8% as of December 2022 as compared to 2.9% as of December 2021.

Overall, SOCGEN remains well-capitalised even after it decides to exit Russia. It continues to sustain a substantial buffer over the respective regulatory limits placed on its capital. While the cost of risk is expected to increase slightly, SOCGEN’s careful management of non-performing assets should minimise the impact of the cost of risk.

Recommendations

Issue	Ask Price	Current Yield	Yield to next call/ reset	First call date/ reset date	Years to first call/ reset	Reset rate	Bond Credit Rating (S&P/ Fitch)
SOCGEN 8.250% Perpetual Corp (SGD)	90.51	9.11%	11.16%	15 Dec 2027	4.18	Prevailing 5-Year SORA OIS + 5.600%	BB/BB+
SOCGEN 6.125% Perpetual Corp (SGD)	79.65	7.69%	39.55%	16 Apr 2024	0.93	Prevailing 5Y SGD SOR + Initial Margin (4.207%)	BB/BB+
BACR 8.300% Perpetual Corp (SGD)	96.00	8.65%	9.54%	15 Dec 2027	4.35	5-year SORA-OIS + the Margin (5.641%)	N.R./BBB-
BACR 7.300% Perpetual Corp (SGD)	91.00	8.02%	9.66%	15 Sep 2028	5.10	5Y SORA OIS + Initial Margin (3.929%)	N.R./BBB-
BNP 5.900% Perpetual Corp (SGD)	94.63	6.24%	7.25%	28 Feb 2028	4.80	5-year SORA OIS Rate + Initial Margin [2.674%]	BBB-/BBB
Source: Bondsupermart, Bloomberg Finance L.P., iFAST Compilations. Data as of 12 May 2023.

SOCGEN offers two SGD AT1 issuances, both of which saw fluctuations in their prices as a result of the recent banking crisis. Between the two, if we had to choose, SOCGEN 8.250% Perpetual Corp (SGD) would be the preferred one considering the higher initial margin at 560 basis points.

For SOCGEN 6.125% Perpetual Corp (SGD), it appears that the market priced in a non-call resulting in the ask price being severely below par. Looking at the initial margin on the reset rate at 4.207%, the cost of new issuance for SOCGEN is much higher. If SOCGEN were to issue a new perpetual, considering its most recent issuance SOCGEN 8.250% Perpetual Corp (SGD), it is likely to be within the range of 8~9%. In comparison, if allowed to reset, SOCGEN 6.125% Perpetual Corp (SGD) based on a 5Y SGD Swap-Offer Rate (“SOR”) at 2.9625% as of 12 May 2023 will likely see a reset rate of 7.1695% instead. Given the impending situation of a rate pause, and potential rate cuts in the following year, interest rates are expected to stabilise from here and a decreasing 5Y SGD SOR will only further drive the case of a non-call.

As such, the market has likely priced in a call on the following reset date for SOCGEN 6.125% Perpetual Corp (SGD) on 16 April 2029. Based on this call date, the yield to call is estimated at 12.18% (assuming it resets with a coupon of 7.1695%), closer to the yield to next reset seen on SOCGEN 8.250% Perpetual Corp (SGD). Years to the following reset date is estimated at 5.93 years.

Comparing against other SGD AT1 issuances of similar years to next call, we prefer BACR 8.300% Perpetual Corp (SGD). Previously we had noted a preference for a higher initial margin on the reset rate, raising the likelihood of redemption of the perpetual notes – and BACR 8.300% Perpetual Corp (SGD) has a relatively similar initial spread as SOCGEN 8.250% Perpetual Corp (SGD). Between the two, Barclays’ outlook is much more optimistic alongside a stronger credit profile. While SOCGEN 8.250% Perpetual Corp (SGD) offers a higher yield to next call at 11.16%, the additional risk might not be worth the additional yield it provides over BACR 8.300% Perpetual Corp (SGD).

Reiterating several important points on AT1 bonds – 1) these are capital instruments designed to absorb losses upon the trigger of an insolvency event and 2) it remains at the bank’s sole discretion to call back the bonds and it should not be assumed that the bond will be called back on its first date. In SOCGEN’s case, investors have to be clear of the non-call risk associated with its AT1 bonds, particularly since SOCGEN 6.125% Perpetual Corp (SGD) has potentially priced in a non-call.

Overall, as it continues to remain profitable, SOCGEN likely requires more time to stabilise amidst this changing interest rate environment for them. While it would be ideal if it could capitalise on the net interest margin outside of France, there is little reason to be optimistic about SOCGEN’s future performance for now. Investors might want to wait and see how the legislation might change for the French banks in 2023, before taking the risk in SOCGEN’s SGD AT1 issuances.

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a position in BACR 8.300% Perpetual Corp (SGD) and the analyst who produced this report holds a NIL position in the abovementioned securities.