Idea of the Week: Societe Generale exits from Russia – is their AT1 perp worth buying now?

• The sale of Societe Generale's Russian subsidiaries makes Societe Generale the first EU bank to completely cut Russian exposure.

• 2021 was a solid year for SOCGEN as net banking income was driven by strong momentum in all its businesses.

• The impact of the disposal of Rosbank and the Group’s Russian insurance activities on CET 1 ratio is expected to be around 20 bps, which is much lower than initially expected.

• We continue to remain positive on the recommendation of SOCGEN 6.125% Perpetual Corp (SGD) due to the low impact from its Russian exposure.

• The SOCGEN 6.125% perp has the highest initial spread compared to peers, which makes it more likely that it will be called on its call date.

• The SOCGEN 6.125% perp are trading an attractive levels with an indicative ask yield to next call of 4.56% with 1.97 years to its next call date on 16 April 2024.

A large cloud of uncertainty loomed over EU banks as they contemplate on cutting their Russian exposure. When Russia invaded Ukraine, prices of major EU banks fell as investors were worried how sanctions on Russia will impact the businesses of EU banks operating in Russia. 

On 11 April 2022, Societe Generale announced the sale of its entire stake in their Russian subsidiary, Rosbank and the Group’s Russian insurance subsidiaries to Interros Capital. This marks the first EU bank to exit completely from Russia. In the article, we will discuss the disposal of Rosbank and highlight our recommendations.

About Societe Generale

Societe Generale (“SOCGEN”) is headquartered in France, and operates in three main banking segments - French Retail Banking (“FRB”), International Retail Banking operations, Insurance and Financial Services (“IRB”) and Global Banking and Investor Solutions (“GBI”).

The FRB segment consists of the retail banking of Societe Generale, Credit du Nord group and Boursorama Bank in France. Credit du Nord is a large regional bank while Boursorama Bank is an online banking leader in the country. The IRB segment operates outside of France with networks in Africa, Russia and Central and Eastern Europe. Lastly, the GBI segment is made up of asset management, corporate and investment banking and private banking activities.

According to S&P Global Market Intelligence, SOCGEN had EUR 1,465.95b of total assets, making it the 6th largest bank in Europe and 18th worldwide when ranked by total assets. SOCGEN is rated by the three main credit agencies – S&P (‘A’ with a stable outlook), Moodys’ (‘A1’ with a stable outlook) and Fitch (‘A-‘ with a stable outlook).

FY21 financial highlights

For full year financial results ending 31 December 2021 (“FY21”), the Group reported net banking income of EUR 25.8b, a 16.7% increase from FY20. 2021 was a solid year for SOCGEN as net banking income was driven by strong momentum in all its businesses. In its French Retail Banking segment (“FRB”), net banking income increased by 4.8% to EUR 7.8b due to the recovery of net interest income and fee income. International Retail Banking & Financial Services (“IRB”) improved by 9.9% to EUR 8.1b while Global Banking & Investor Solutions (“GBI”) increased by 25.2%. GBI turned a strong performance as market conditions were favourable in the Equities market. The Equities division reported its strongest earnings since 2009 and is largely driven by favourable market conditions as well as the successful repositioning of the Investment Solutions product offering.

As a result, net income of the Group was EUR 5.6b in FY21, rebounding strongly from the pandemic. Cost-to-income ratio for the group have decreased due to strategic transformations for the Group. Strategic transformations such as the merger between its retail banking networks, Societe Generale and Credit du Nord, will help push down the Group’s cost-to-income ratio. We expect all of its segments to continue to report positive jaws effect, where income growth rate is higher than its expense growth rate.

Disposal of Rosbank in Russia

When Russia invaded Ukraine in late February this year, sanctions imposed on Russia included cutting off major Russian banks from SWIFT. International banks were also affected as a result as they were unable to carry out transactions or businesses with Russian banks, impeding payment flows in Russia. Banks scrambled to disclose the amount of exposure to Russia and Ukraine in order to calm investors during this period of uncertainty. Among the banks that disclosed their exposure to Russia, Italian and French banks have the most exposure. Overall, EU bank’s exposure to Russia is relatively low (compared to total revenues) and manageable.

Table 1: EU banks’ exposure to Russia

Among SGD bank issuers, Societe Generale had one of the largest exposure to Russia amounting to EUR 18.6 billion of which EUR 15.4 billion are accounted for at its subsidiary Rosbank. In 2021, activities located in Russia generated 2.8% of Group net banking income and 2.7% of Group net earnings.

Initially in March 2022, a few days after the Russian invasion of Ukraine, SOCGEN estimated that in the worst case scenario where its Russian subsidiary will be stripped off, it will have a -50 basis points (“bps”) impact to their CET1 ratio. Subsequently on 11 April 2022, SOCGEN announced the sale of its entire stake in Rosbank and the Group’s Russian insurance subsidiaries to Interros Capital. SOCGEN’s exit from Russia makes it the first EU bank to exit completely from Russia while other EU banks with exposures contemplate on their exit.

SOCGEN’s income statement is expected to take a hit of ~EUR 3.1b when the sale is completed, from the write-off of the net book value of the Russian subsidiaries (~EUR 2b) and an exceptional non-cash item of ~EUR 1.1b. The impact of the disposal of Rosbank and the Group’s Russian insurance activities on CET 1 ratio is expected to be around 20 bps, which is much lower than initially expected from SOCGEN.

In FY21, SOCGEN’s CET1 ratio was 13.7%, which was 470 bps above regulatory requirements. Even with a deduction of 20bps to CET1 ratio, SOCGEN still sits comfortably above regulatory requirements of 9.09% and well above their target CET1 ratio of 200 to 250 bps above requirements.

As the events in Russia and Ukraine offers much uncertainty over the impact of the sanctions imposed on Russia, we think the sale of SOCGEN’s Russian subsidiary offers much needed clarity moving forward. We find a 20 bps hit to CET1 ratio is fairly manageable as the Group still remains well capitalised even with the deduction. 

Outlook

Net earnings from SOCGEN is expected to take a slight hit from the write-off of Rosbank. The impact from the disposal of Rosbank is expected to be offset by the growth in SOCGEN’s existing businesses as the Group builds on the commercial momentum already embedded in its businesses. The Group’s cost of risk was 13 bps in 2021 compared to 64 bps in 2020 during the height of the pandemic. We do not expect cost of risk to increase substantially and SOCGEN guided for cost of risk to be below 30 bps for 2022. 

The ECB recently announced that it will conclude its net purchases under its APP in 3Q22. Any rate hikes will only happen after that and it will be gradual, which is a stark contrast to the Federal Reserve who is looking to hike rates aggressively this year. As such, interest rate-related pressure on bank income will likely persist for this year. We think the bank’s interest income to increase during the tail end of 2022 when the ECB decides to hike rates.

Solvency and liquidity profile

We find SOCGEN to be well-capitalised to take a hit on its solvency ratio following the disposal of Rosbank. For FY21, SOCGEN has a CET1 ratio of 13.7%, which is 470 bps above regulatory requirements and the Group also guided for a target of CET1 ratio between 200 – 250 bps above requirements. We find the impact of 20 bps from the sale of Rosbank to be largely manageable and marginal to SOCGEN’s solvency and earnings as Russia only accounted for 2.7% of net group earnings. Although CET1 ratio is expected to take a hit of 20bps, we like the sale of Rosbank for the reason that it clears the air of uncertainty around SOCGEN’s Russian exposure. Additionally, SOCGEN initially guided for an impact of 50 bps from the write off of Rosbank, a 20 bps impact is lower than previously guided and we think the impact will be minimal to the Group’s solvency.

The Group’s liquidity is also stable with a liquidity coverage ratio of 131% in 4Q21. SOCGEN had a total of EUR 229b of liquid asset buffer, of which EUR 168m were Central Bank deposits, EUR 58b was high quality liquid asset securities and EUR 3b was Central Bank eligible assets.

Table 2: CET1 ratios of EU banks

Recommendation

We continue to remain positive on the recommendation of SOCGEN 6.125% Perpetual Corp (SGD) due to the low impact from its Russian exposure. Additionally, among other SGD denominated AT1 perps (Table 3), the SOCGEN 6.125% perp has the highest initial spread compared to peers, which makes it more likely that it will be called on its call date.

Table 3: Reset rates of AT1 instruments

The SOCGEN 6.125% perp is trading at attractive levels when compared to other SGD AT1 instruments (Figure 1). The SOCGEN 6.125% perp has an indicative ask yield to next call of 4.56% with 1.97 years to its next call date on 16 April 2024. The perpetual resets on 16 April 2024 and every 5 years thereafter. If not called, the distribution rate will reset at the prevailing 5Y SGD Swap Offer Rate (“SOR”) + 4.207%. The notes may be written down in the event of a Capital Ratio Event, which occurs when the Common Equity Tier 1 ratio falls below 5.125% on a consolidated basis.

Table 4: SGD AT1 notes

Conclusion

Following the Russian invasion in Ukraine, banks and companies are looking to reduce their Russian exposure completely. The sale of Rosbank could subsequently lead to other major EU banks to speed up their exit from Russia. 2021 was as all round good year for SOCGEN as revenue growth as driven by momentum in all businesses. Looking ahead, we expect net earnings to have a slight decline from the write-off of Rosbank but offset by the continued growth in its businesses. We find the impact of 20 bps from the sale of Rosbank to be largely manageable and marginal to SOCGEN’s solvency and earnings as Russia only accounted for 2.7% of net group earnings. We continue to remain positive on the recommendation of SOCGEN 6.125% Perpetual Corp (SGD) due to the low impact from its Russian exposure. The SOCGEN 6.125% perp has a high initial spread, which makes it more likely that it will be called on its call date.

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds positions in CS 5.625% Perpetual Corp (SGD), UBS 5.875% Perpetual Corp (SGD), HSBC 4.700% Perpetual Corp (SGD) and HSBC 6.250% Perpetual Corp (USD) and the analyst who produced this report hold a NIL position in the abovementioned securities.

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