societe generale · loss given failure (lgf) analysis. sg's baseline credit assessment (bca)...

FINANCIAL INSTITUTIONS

CREDIT OPINION23 May 2016

Update

RATINGSSociete Generale

Domicile Paris, France

Long Term Rating A2

Type LT Bank Deposits - FgnCurr

Outlook Stable

Please see the ratings section at the end of this reportfor more information.The ratings and outlook shownreflect information as of the publication date.

Contacts

Alessandro Roccati 44-20-7772-1603Senior Vice [email protected]

Andrea Usai 4420-7772-1058Senior Vice [email protected]

Yana Ruvinskaya 44-20-7772-1618Associate [email protected]

Laurie Mayers 44-20-7772-5582Associate [email protected]

Robert Young [email protected]

Societe GeneraleQuaterly Update

Summary Rating RationaleWe rate Societe Generale's (SG) long-term deposit and senior unsecured debt ratingsA2 with a stable outlook. SG's debt and deposit ratings are underpinned by the bank'sstandalone credit strength, reflected in the BCA and take into account our advancedLoss Given Failure (LGF) analysis. SG's Baseline Credit Assessment (BCA) of baa2 reflectsthe bank's strong franchises, good geographical diversification and broad spread ofpredominantly retail banking activities, according to its universal bank model and capturesSG's enhanced capital ratios and improved liquidity and funding positions. These factors arepartially offset by SG's exposures to the weak and volatile economic environment in Russiaand Romania and the bank's sizeable capital markets activities and its high, albeit improving,reliance on and use of more confidence sensitive wholesale funding.

Credit Strengths and Challenges

» The firm's BCA is supported by its `Strong' macro profile. Franchise value is strong indomestic retail and corporate banking but weak in Russia.

» Credit risk expected to stabilise in France and in Russia. Market risk appetite has reduced.

» Improved capital and leverage levels converging towards those of its global peers withlarge capital market activities

» Profitability is improving but tail risk remains in Russia

» Funding and liquidity profiles are approaching international peers'

» Large volume of deposits and senior and subordinated debt resulting in deposit andsenior debt ratings benefiting from a very low loss-given-failure rate and two-notch upliftfrom the BCA

» Moderate probability of government support resulting in one-notch uplift from BCA fordebt and deposits

Rating OutlookThe outlook on deposit and senior long term debt rating is stable. SG's BCA incorporatesour expectations of weak economic growth within major European economies, resultingin broadly flat revenues, and of weakening economic environment in Russia, resulting ina decrease in revenues and high loan loss provisions in the region.The outlook on seniorunsecured debt and deposits is also underpinned by the current liability structure, whichresults in two notches of uplift reflecting low loss-given-failure, and one notch reflecting themoderate probability of government support.

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MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.

2 23 May 2016 Societe Generale: Quaterly Update

Factors that Could Lead to an UpgradeUpwards pressure could develop on the ratings following further structural improvements in the bank's funding and liquidity profile anda further reduction in the weight of capital markets-related activity within the group. A positive change in the bank's BCA would likelyaffect all ratings.

SG's senior unsecured debt and deposit ratings currently receive two notch uplift under our Advanced LGF analysis; these ratings couldbenefit from a further one notch uplift if SG were to substantially increase long-term debt.

Factors that Could Lead to a DowngradeDownwards pressure might develop on the ratings as a result of: deteriorating funding or liquidity conditions; risk-management failuresor material unexpected losses; worsening macroeconomic conditions; or a significant deterioration of the performance and stability ofthe Russian businesses. A downward movement in SG's BCA would likely result in downgrades to all ratings.

Our advanced LGF analysis indicates that only a large reduction in the amount of SG's senior unsecured debt would lead to a loweruplift for SG's senior unsecured debt creditors, other factors being equal.

Key Indicators

Exhibit 1

Societe Generale (Consolidated Financials) [1]12-152 12-142 12-133 12-123 12-113 Avg.

Total Assets (EUR million) 1159470.0 1107984.0 1058569.0 1027228.0 1181251.0 -0.54

Total Assets (USD million) 1259526.8 1340719.5 1458646.6 1354288.7 1533435.0 -4.84

Tangible Common Equity (EUR million) 41963.6 38130.0 35416.7 37429.8 31146.0 7.74

Tangible Common Equity (USD million) 45584.9 46139.3 48802.2 49347.2 40432.0 3.04

Problem Loans / Gross Loans (%) 6.1 7.0 7.6 7.2 6.9 7.05

Tangible Common Equity / Risk Weighted Assets (%) 11.8 10.8 10.3 11.5 8.9 11.36

Problem Loans / (Tangible Common Equity + Loan Loss Reserve) (%) 42.9 47.8 52.8 50.5 57.8 50.45

Net Interest Margin (%) 0.8 0.9 1.0 1.0 1.1 1.05

PPI / Average RWA (%) 1.9 1.9 2.2 2.3 2.0 1.96

Net Income / Tangible Assets (%) 0.3 0.3 0.3 0.3 0.1 0.25

Cost / Income Ratio (%) 72.0 71.0 69.6 68.5 70.9 70.45

Market Funds / Tangible Banking Assets (%) 49.7 52.5 55.6 52.4 58.2 53.75

Liquid Banking Assets / Tangible Banking Assets (%) 45.0 47.2 49.3 46.4 30.7 43.75

Gross loans / Due to customers (%) 109.0 111.2 115.2 110.4 117.4 112.65

[1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel III - fully-loaded or transitional phase-in; IFRS [3] Basel II; IFRS [4] Compound Annual Growth Rate basedon IFRS reporting periods [5] IFRS reporting periods have been used for average calculation [6] Basel III - fully-loaded or transitional phase-in & IFRS reporting periods have been used foraverage calculationSource: Moody's Financial Metrics

Detailed Rating ConsiderationsTHE FIRM'S BCA IS SUPPORTED BY ITS 'STRONG' MACRO PROFILE. FRANCHISE VALUE IS STRONG, PARTICULARLY INDOMESTIC RETAIL BANKING BUT WEAK IN RUSSIA.

SG's `Strong' macro profile is mainly driven by its exposure to France (`Strong+` macro profile, 43% of its exposures at default),and United States (`Very Strong-`, 13%) but partly offset by the firm's exposures to Eastern Europe (8%) and Russia (2%), whichhave weaker macro profiles. French banks benefit from operating in a country with a large and broadly diversified economy, arobust institutional framework and a very low susceptibility to event risk. Nevertheless, France's medium and long-term economicperformance will continue to be constrained by weak economic growth that coupled with institutional and political constraints, poses



for the material reduction in the government's high debt burden. The French banking sector is relatively concentrated, with severalbanks benefiting from high retail market share in their core regions.

We recognize SG's broad and diversified businesses and reflect it by assigning a one-notch positive qualitative adjustment to the BCAfor “Business Diversification” which offsets a one-notch negative qualitative adjustment for “Opacity and Complexity”, in line withother firms with material capital markets activities.

We consider SG's domestic retail franchise as generally strong: SG benefits from a good position in French retail banking and in thesmall and medium enterprise (SME) segment, benefiting from the integrated solutions offered by the investment banking division.

The group's international retail activities are in three main regions: Central and Eastern Europe, Russia and Africa. Russian activities(€14.5 billion exposures at default at end-March 2016, representing 2% of group total), are currently under pressure due to a weakeconomic environment. Our stress test shows that even in an adverse scenario, the negative impact on SG's capital is manageable.However, the potential volatility of the economy in the country and the heightened geopolitical risk mean that SG's exposures toRussia remains a key although decreasing risk (SG disclosed €2.5 billion equity and €0.7 billion of intra-group funding (subordinatedloan) to SG's Russian subsidiaries at end- March 2016).

The Financial Services to Corporates and Insurance divisions' performance is solid. SG's bancassurance business sells a range of productsto its client base, including in-house life insurance and mutual funds, which form an important part of the savings base in France. Someareas of Specialised Financial Services represent a risk, notably consumer credit in Italy; however, this exposure is contained in thecontext of the group loan book.

The Global Banking and Investor Solutions (GBIS) division provides capital markets, financing & advisory and asset managementservices. We consider SG as a tier-two global investment bank due to its multi-specialist business model with a focus on cross-assetsolutions (structured equity and fixed income solutions) and flow equity derivatives. SG has strong expertise in structured products(with a global leadership in equity derivatives), exchange traded funds (under the Lyxor brand), commodities, research and marketmaking. The group has recently announced a new focus on post trade services and a plan to expand its bond origination and tradingbusiness with existing European clients. Capital markets activities bring elements of volatility, confidence sensitivity and complexitythat reduce the value we attribute to these franchises.

Societe' Generale Americas Securities (SGAS) is a core operating subsidiary through which SG conducts its institutional equities andfixed-income brokerage and futures commission merchant activities in the United States. SGAS's Baa2 and Prime-2 ratings reflect ourview that SGAS is an integrated and strategically important operating subsidiary of SG.

We view the 2016 plan as credit neutral for bondholders: the plan leverages off of SG's existing business model built around threecore businesses, each one of them currently representing around one third of the group risk-weighted assets: French Retail Banking,International Retail Banking & Financial Services, and Global Banking & Investor Solutions. Under the plan, SG will maintain a balancedcapital allocation, with RWA allocated to domestic and international retail accounting for c.60% of group RWA, while RWA's allocatedto capital market activities will be capped at 20%. In detail, in 2016 SG will focus on: the digital transformation of French RetailBanking and the development of its international retail banking activities; the improvement of its operating efficiency (around €1.1billion of additional savings planned by end-2017) mainly in Global Banking and Investor Solutions; and achieving capital and leveragetargets.

CREDIT RISK EXPECTED TO STABILIZE IN FRANCE AND IN RUSSIA. MARKET RISK APPETITE HAS REDUCED

The main risk to which SG is exposed to is credit risk, representing 82% of RWAs, while market and operational risks represented theremaining RWAs of 18% at end-March 2016. Credit risk mainly relates to the firm lending activities in France, Central Eastern Europe(CEE) and Russia. Market risk derives from its capital markets activities, which represent around one fifth of group RWA and revenues.

SG's customer loan book of €467 billion (including repos) at end-March 2016 is exposed to country risks and sector concentration risks.Exposures to a few relatively large corporates in its financing activities and notable industry concentrations to the financial servicessector in the capital market activities also affect SG's risk positioning. Legacy assets are small: €2.7 billion or around 1% of the groupgross loans.



SG's asset quality was stable during the quarter with €23.4 billion problem loans, equal to 5.5% of gross customer loans (excludinglegacy assets and including repos). Despite the improvement, problem loans remain higher than most domestic players due to thefirm's exposure to Eastern Europe and Russia and its large presence in the mid-corporate French market. High levels of doubtful loansalso reflects protracted workout practices, in common with other French banks, which are partly mitigated by collateral and provisions.At end-2015, the coverage ratio - excluding collateral - was at 64%, including specific and portfolio-based provisions.

SG's cost of risk decreased in Q1 2016 when compared to 2015 full-year (to 46bps from 52bps), benefiting from lower provisions inretail banking that more than offset the increase of additional provisions in the oil and gas wholesale sector. In Russia, the cost of riskdecreased by 40% compared to Q1 2015 to an annualised LLC of around 274bps. We expect a stabilisation of the cost of risk in boththe domestic and international retail loan books for the rest of the year.

Market risk significantly decreased over the last two years: the bank's risk appetite as measured by the average VaR was €20 millionat end-March 2016, in line with €20 million in 2015FY. At end-March 2016, market risk absorbed €18.4 billion RWA, or 5% of groupRWAs. Operational risk absorbed €44 billion RWA, or 13% of group RWAs, a moderate level, when compared to the global firms withcapital markets activities.

We believe that the firm's market risk appetite has reduced, and its risk systems have been overhauled in recent years, followingthe financial crisis and in response to the rogue trader fraud in 2007. However, securities and client trading assets of €163 billion atend-2015 remain higher than some of SG's peers (as a percentage of the total cash balance sheet) due to the large and liquid equitytrading assets portfolio and the large securities book due to Basel 3 liquidity requirements.

Our Asset Risk score of baa3 indicates that, overall, asset risk remains a modest weakness for SG's BCA. We reflect within our score thestricter accountancy regime in France in relation to problem loans, the group's exposures to Russia and the market risk, counterpartycredit risk and operational risk stemming from its capital market activities.

IMPROVED CAPITAL AND LEVERAGE LEVELS CONVERGING TOWARDS THOSE OF ITS GLOBAL PEERS WITH LARGECAPITAL MARKET ACTIVITIES

We view positively the improved reported capital and leverage ratios at end-March 2016. We expect further moderate improvementsin the remaining quarters of 2016, supported by solid capital generation. SG's fully-loaded CET1 ratio was 11.1% at end-March 2016,in line with its European peers.. The firm reported a Basel III leverage ratio (including legacy Additional Tier 1) of 4.0%, in line withthe 4-4.5% target for 2016. SG's target to issue €1.5 billion AT1 securities per year over the next two years should further improve itsleverage ratio, in our view.

SG targets to maintain a management buffer of 100-150 bps against a 1 January 2019 SREP requirement of 10.5%, including thefully-applied Global Systemically Important Banks (G-SIB) resulting in a Basel III fully-applied CET1 ratio of 11.0% as at end-2016 and11.5-12% as at end-2018 and a Basel II leverage ratio of 4%-4.5%, respectively.

Our assigned Capital score of baa2 reflects our expectation that the capital and leverage position will moderately increase over themedium term.

PROFITABILITY IS IMPROVING BUT TAIL RISK REMAINS IN RUSSIA

Results in 2015 showed a positive trend in underlying profitability, driven by higher revenues in French Retail Banking and GlobalBanking and Investor Solutions divisions that more than offset rise in operating costs and cost of risk: SG reported a Moody's adjustednet income of €3.5 billion with an adjusted return on risk-weighted assets of 1% and return on equity of around 8%.

In Q1 2016, SG reported a Moody’s adjusted net income of €829 million, excluding €95 million of revaluation of the bank’s ownfinancial liabilities. We estimate an adjusted annualized return on risk-weighted assets of 0.9% and return on equity of around 7% forthe quarter. The good revenue performance in the French Retail and International Retail and Financial Services divisions more thanoffset weak revenues in the Global Banking and Investor Solutions division. Operating costs were under control (-0.5%, excluding €218million Euribor fine refund and adjusted for IFIRC 21 levy accounting), in line with the bank’s cost reduction plan, aiming at achievingaround €1.1 billion of additional savings by end-2017.



In 2016, we expect continued revenue pressure in Corporate and Investment Banking activities and moderate losses in Russia, due tothe weak economic environment. SG announced it might not be able to achieve the 10% ROE target in 2016 given regulatory pressure,persistent low interest rates environment, and challenging market conditions.

Our baa2 score for Profitability reflects these factors and is in line with SG's BCA.

FUNDING AND LIQUIDITY PROFILES ARE APPROACHING INTERNATIONAL PEERS’

Our “Funding Structure” score of b1 reflects the bank's high reliance on large amounts of wholesale funding.

We view SG's funding profile as weaker than those of some large international peers, as the firm's reliance on confidence-sensitivewholesale funding remains elevated, at €223 billion, or 32% of its funded balance sheet at end-March 2016, driven by large trading andinvestment portfolios. SG's wholesale funding profile was broadly stable in Q1 2016, with short-term wholesale funding (including theportion of long-term debt maturing within the next 12 months), representing 38% of total wholesale funding.

SG’s liquidity reserves were broadly flat over the quarter and in line with those of most of its international peers. At Q1 2016, SGreported a €166 billion liquidity buffer which covered 207% of short-term funding, inclusive of the long-term debt maturing within thenext 12 months. The bank’s liquidity coverage ratio (LCR) was 139%, which is well-above future requirements. Our “Liquid Resources”score of a1 reflects our view that SG has large liquidity buffers.

Notching ConsiderationsLOSS GIVEN FAILURE

SG is subject to the EU Bank Recovery and Resolution Directive, which we consider to be an Operational Resolution Regime. Inaccordance with our methodology we apply our advanced Loss Given Failure analysis, considering the risks faced by the different debtand deposit classes across the liability structure should the bank enter resolution. We assume residual tangible common equity of3% and losses post-failure of 8% of tangible banking assets, a 25% run-off in "junior" wholesale deposits, a 5% run-off in preferreddeposits, and assign a 25% probability to deposits being preferred to senior unsecured debt. These are in line with our standardassumptions.

Under these assumptions, SG's deposits are likely to face very low loss-given-failure, due to the loss absorption provided bysubordinated debt and, potentially, by senior unsecured debt should deposits be treated preferentially in a resolution, as well as thevolume of deposits themselves. This results in a Preliminary Rating Assessment (PRA) two notches above the BCA. For SG's seniorunsecured debt, our LGF analysis also shows a very low loss-given-failure resulting from a combination of its own volume and theamount of debt subordinated to it. This results in a PRA of two notches above the BCA.

For SG's junior securities our LGF analysis shows a high loss-given-failure, given the small volume of debt and limited protection frommore subordinated instruments and residual equity. We also incorporate additional notching for junior subordinated and preferenceshare instruments reflecting coupon suspension risk ahead of failure.

See the "Notching/Loss Given Failure and Government Support" table in the scorecard below for complete notching details on all ofSG's liabilities.

GOVERNMENT SUPPORT

The implementation of the BRRD has led us to reconsider the potential for government support to benefit certain creditors. We believethat there is a moderate likelihood of government support for SG's senior debt and deposits in the event of its failure resulting ina one notch uplift from the PRA for government support positioning our ratings at A2. This probability reflects the bank's systemicimportance in France including its significant share of retail and corporate deposits and its interconnectedness with other financialinstitutions. We continue to believe that the probability of government support for more junior securities is low and therefore do notincorporate any uplift in our ratings.



COUNTERPARTY RISK ASSESSMENT (CRA)

CR Assessments are opinions of how counterparty obligations are likely to be treated if a bank fails and are distinct from debt anddeposit ratings in that they (1) consider only the risk of default rather than both the likelihood of default and the expected financial losssuffered in the event of default and (2) apply to counterparty obligations and contractual commitments rather than debt or depositinstruments. The CR assessment is an opinion of the counterparty risk related to a bank's covered bonds, contractual performanceobligations (servicing), derivatives (e.g., swaps), letters of credit, guarantees and liquidity facilities.

The CR Assessment is positioned at A1(cr)/P-1(cr). The CR Assessment is positioned four notches above SG's BCA of baa2, based on thecushion against default provided to the senior obligations represented by the CR Assessment by subordinated instruments. The maindifference with our Advanced LGF approach used to determine instrument ratings is that the CR Assessment captures the probabilityof default on certain senior obligations, rather than expected loss, therefore we focus purely on subordination and take no account ofthe volume of the instrument class. SG's CR Assessment also benefits from one notch of government support in line with the moderatesupport assumption incorporated in the group's long term debt and deposit ratings.

About Moody's Bank Scorecard

Our Scorecard is designed to capture, express and explain in summary form our Rating Committee's judgment. When read inconjunction with our research, a fulsome presentation of our judgment is expressed. As a result, the output of our Scorecardmay materially differ from that suggested by raw data alone (though it has been calibrated to avoid the frequent need for strongdivergence). The Scorecard output and the individual scores are discussed in rating committees and may be adjusted up or down toreflect conditions specific to each rated entity.



Rating Methodology and Scorecard Factors

Exhibit 2

Societe GeneraleMacro FactorsWeighted Macro Profile Strong 100%

Financial ProfileFactor Historic Ratio Macro

Adjusted ScoreCredit Trend Assigned Score Key driver #1 Key driver #2

SolvencyAsset RiskProblem Loans / Gross Loans 6.9% ba1 ← → baa3 Quality of assets Market risk

CapitalTCE / RWA 11.8% baa2 ↑ baa2 Capital retention Stress capital

resilienceProfitabilityNet Income / Tangible Assets 0.3% ba3 ↑ ↑ baa2 Return on assets Loan loss

chargecoverage

Combined Solvency Score ba1 baa2LiquidityFunding StructureMarket Funds / Tangible BankingAssets

49.7% b1 ← → b1 Term structure

Liquid ResourcesLiquid Banking Assets / TangibleBanking Assets

45.0% a1 ← → a1 Stock ofliquid assets

Combined Liquidity Score baa3 baa3Financial Profile baa2Business Diversification 1Opacity and Complexity -1Corporate Behavior 0Total Qualitative Adjustments 0Sovereign or Affiliate constraint: Aa2Scorecard Calculated BCA range baa1-baa3Assigned BCA baa2Affiliate Support notching 0Adjusted BCA baa2

Instrument Class Loss GivenFailure

notching

Additional notching PreliminaryRating

Assessment

GovernmentSupport notching

Local Currencyrating

ForeignCurrency

ratingCounterparty Risk Assessment 3 0 a2 (cr) 1 A1 (cr) --Deposits 2 0 a3 1 A2 A2Senior unsecured bank debt 2 0 a3 1 A2 A2Dated subordinated bank debt -1 0 baa3 0 Baa3 Baa3Junior subordinated bank debt -1 -1 ba1 0 (P) Ba1 Ba1 (hyb)Non-cumulative bank preferenceshares

-1 -2 ba2 0 Ba2 (hyb) Ba2 (hyb)

Source: Moody's Financial Metrics



Ratings

Exhibit 3Category Moody's RatingSOCIETE GENERALE

Outlook StableBank Deposits A2/P-1Baseline Credit Assessment baa2Adjusted Baseline Credit Assessment baa2Counterparty Risk Assessment A1(cr)/P-1(cr)Senior Unsecured A2Subordinate Baa3Jr Subordinate Ba1 (hyb)Pref. Stock Non-cumulative Ba2 (hyb)Commercial Paper P-1Other Short Term (P)P-1

Source: Moody's Investors Service



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REPORT NUMBER 1026985

societe generale · loss given failure (lgf) analysis. sg's baseline credit assessment (bca)...

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