Banks. Societe Generale S.A. France. Full Rating Report. Key Rating Drivers. Rating Sensitivities. Ratings

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1 France Full Rating Report Ratings Long-Term IDR Short-Term IDR Viability Rating A F1 Support Rating 5 Support Rating Floor NF Derivative Counterparty Rating A+(dcr) Compagnie Generale de Location d Equipements Long-Term IDR A Short-Term IDR F1 Support Rating 1 Sovereign Risk Long-Term IDR Outlooks Long-Term IDRs Sovereign Long-Term IDR Financial Data a AA 31 Dec 17 Stable Stable 31 Dec 16 Total assets (USDbn) 1,529 1,457 Total assets (EURbn) 1,275 1,382 Total equity (EURbn) Operating profit (EURm) 5,29 6,172 Published net income 3,43 4,338 (EURm) Operating profit/riskweighted assets (%) Impaired loans/gross loans (%) Fitch Core Capital/riskweighted assets (%) Fully applied Basel III CET1 ratio (%) Loans/customer deposits (%) Related Research - Ratings Navigator (October 217) European GTUBs Quarterly Update (January 218) Fitch 218 Outlook: Global Trading and Universal Banks (December 217) Analysts Christian Scarafia christian.scarafia@fitchratings.com Luis Garrido, CFA luis.garrido@fitchratings.com Rafael Quina, CFA rafael.quina@fitchratings.com Key Rating Drivers Diversified Universal Bank: s (SG) ratings reflect the bank s sound company profile, which benefits from franchise strengths across selected products and geographies that result in well-diversified and resilient earnings. SG has a broad retail and corporate banking network across France, several countries in central and eastern Europe (CEE) and Africa, as well as Russia, a leading global equity derivatives franchise and a sound presence in euro-denominated debt capital markets. Asset Quality Weaker than Peers: SG s asset quality remains weaker than peers, despite material improvements since end-213. Impaired loans represented 5% of gross loans at end- 217, reflecting higher-risk pockets than Global Trading and Universal Bank (GTUB) peers in SG s domestic retail portfolios and certain international retail markets, as well as slower writeoff practices in France aiming to maximise recoveries. Loan impairment charges (LICs) can therefore accrue through time, which in our view exposes the group to unexpected shocks. Sound Profitability: SG s earnings are sound and resilient thanks to the group s diversification. Market activities and exposure to emerging economies introduce some earnings volatility, which has been well managed. Product and geographical diversification provides cross-selling opportunities and results in stronger revenue per client. Delivering cost savings will be important to improve operating profit. We expect French retail revenue to stabilise in 218 as the proportion of renegotiated housing loans falls to negligible levels. Strong Internal Capital Generation: SG s strong internal capital generation mitigates the group s adequate regulatory capital ratios, which are at the lower end of GTUB peers. SG targets a 12% fully loaded common equity Tier 1 (CET1) ratio by end-22 and expects to operate with a CET1 ratio of about 11.5% by end-218, about 2pp above its expected endstate regulatory capital requirement. We expect internal capital generation to be sufficient to fund organic growth and potential bolt-on acquisitions. Diversified Funding: SG has a well-diversified funding, consisting mainly of customer deposits. The group has an established access to wholesale capital markets. Subsidiaries are increasingly self-funded. The bank s buffer of unencumbered liquid assets is equal to about 29% of unsecured short-term wholesale funding. Senior Preferred Debt Uplift: Long-term senior preferred debt, deposits and derivative counterparties are rated one notch above SG s Long-Term Issuer Default Rating (IDR) because of their preferential status over the bank s large buffer of additional Tier 1, Tier 2 and senior non-preferred debt, which was about 8.5% of risk-weighted assets (RWAs) at end-217. Rating Sensitivities Weaker Earnings: A structural deterioration in profitability that weakens the bank s internal capital generation would put pressure on the ratings, as would higher gross impaired loans or a material change in risk appetite. Sizeable litigation losses could result in a downgrade if they durably reduce capitalisation without a credible plan to restore it to current levels. Limited Upside: An upgrade would be contingent on a substantial strengthening of the bank s company profile and a material improvement in asset quality while maintaining sustainable earnings, sound capitalisation and an unchanged risk appetite. 6

2 Economic Data (%) f 219f France: Real GDP growth France: Unemployment rate Source: National Institute of Statistics and Economic Studies (INSEE) end-217 data, Fitch forecasts Exposure by Region End-217 Other E Europe MEA 3% APAC 4% LatAm 1% 5% E Europe (EU) 7% N America 13% France 44% Other W Europe 23% Total: EUR872bn. Includes off-balance sheet exposures Earnings Contribution 217 International retail GM & IS Financial advisory AWM 1% 8% 6% 4% 2% % 9% 7% 11% 9% 13% 23% 18% 32% 22% 21% 27% Revenue French retail Financial services Insurance Pre-tax profit AWM: Asset and wealth management (booked in GBIS). GM & IS: global markets and investor services Related Criteria Bank Rating Criteria (March 218) Global Non-Bank Financial Institutions Rating Criteria (March 218) Operating Environment SG mainly operates in very stable and advanced economies, with typically high sovereign ratings, developed and transparent regulatory frameworks, and robust financial markets. Nonetheless, the bank has some exposure to more volatile countries, mainly in CEE and Russia. We expect the recovery in economic conditions in Russia to help sustain the bank s return to profitability in the region. SG s presence in the US and Asia (largely in corporate and investment banking) provides some diversification benefits. We expect France s strong cyclical recovery will help sustain real GDP growth at 2.1% in 218. The high level of unemployment is a weakness for the sovereign rating level, but has been falling. We expect SME lending to be more sensitive to changes in macroeconomic factors, including unemployment. We believe the impact of high unemployment to be contained for housing loans as household indebtedness is modest (58% of GDP) and lending is mainly extended to borrowers in stable employment. Concentrated Banking Market The major French banks are large and banking sector assets are significant at about 3.5x GDP. The sector is concentrated, and the six largest banks account for about 85% of banking sector assets. Three French banks are classified as global systemically important banks (G-SIBs) by the Financial Stability Board. Fitch Ratings considers barriers to entry into the French market as high. French banks have limited flexibility to reduce remuneration rates on deposits, as interest rates paid on widely held regulated savings deposits are defined by the state and are higher than market rates. Remuneration on the Livret A, which acts as a benchmark for other savings products, is at.75%. Company Profile SG is a universal bank and the third-largest French bank by total assets. Retail banking generates about half of revenue and pre-tax profit, both through three brands in France and through operations in several countries in Europe and Africa, as well as Russia. In investment banking, SG has a sound presence in euro-denominated debt capital markets and a leading equity derivatives franchise. Structured equity derivatives account for less than 4% of group revenue. Within International Retail Banking and Financial Services (IBFS), the bank is the 8% shareholder of ALD Automotive, Europe s largest fleet management company by fleet size. The group operates across three divisions: French retail banking, Global Banking and Investor Solutions (GBIS), and IBFS. Sound client, product and geographic diversification have supported resilient profitability, despite pockets of higher risk. The breadth of SG s product offering and geographical presence provides cross-selling opportunities, mainly in corporate and investment banking, and bancassurance. Revenue synergies, as measured by the bank, represented 3% of group revenue in 216. Revenue from sales and trading is typically more volatile, and accounted for a manageable 18% of revenue in 217, which is lower than at peers. Moderate Franchise in French Retail SG s domestic retail franchise generates high revenue per customer, as it focuses on France s wealthier urban areas. The group s deposit and loan market share of about 7% is significantly lower than that of the dominant cooperative banking groups, which limits its pricing power. SG operates in French retail banking through different brands: SG s own network of about 2, branches; Credit du Nord (A/Stable/bbb+), which focuses on small- and medium-sized enterprises through a network of eight regional banks; and the online bank Boursorama. The multi-channel model allows the group to target different groups of clients. SG aims to reduce its branch network to 1,7 by 22, as it aims to fully digitise simple products and focus on advisory activity in the remaining branches. 2

3 RWA Split End-217 French retail 29% Corp. centre 3% IBFS 33% Total: EUR353bn IBFS Operating Profit 217 Fin serv corp Czech Republic Romania Other Europe 19% 26% 55% GBIS 35% Insurance Africa & others W Europe Russia 15% 15% 9% 8% 4% Right hand side: International retail. Fin serv corp: financial services to corporates Broad International Retail Network IBFS includes international retail banking, financial services to corporates and insurance. The division s contribution to group pre-tax profit increased to 49% in 217 from 37% in 216, largely as a result of lower LICs in international retail. In international retail, SG is active in several countries in Europe, mostly in CEE, the Mediterranean basin, sub-saharan Africa, French overseas territories and Russia. The group s largest international subsidiaries by assets are the 61%-owned Komercni Banka, the thirdlargest bank in the Czech Republic, the 99.95%-owned Rosbank in Russia, one of the country s leading privately owned banks; the 6%-owned BRD-Groupe Société Générale S.A., the third-largest Romanian bank by total assets, and the fully owned SGMB in Morocco, the country s fourth-largest bank. Apart from these subsidiaries, international retail operates in 33 countries through subsidiary banks. In CEE, SG has market shares of between 8% and 15%. These operations are jointly strategically important for the group. We consider retail operations in CEE and Russia as higher risk, given the large cyclical variations in profitability and LICs observed historically, notably in Russia and Romania. Nonetheless, SG has managed its exposures well and international retail banking generated a sound return on allocated capital of 16% in 217. Within IBFS, financial services to corporates cover equipment finance (through SG Equipment Finance) and fleet financing (through ALD Automotive). At end-217, ALD managed the largest vehicle fleet in Europe with 1.4 million vehicles and EUR16 billion rental fleet assets. Equipment finance accounted for an additional EUR17 billion loans. SG s insurance business mainly focuses on France and other European countries, offering life (about two-thirds of 216 insurance revenue) and non-life insurance products. At end-217, SG managed EUR114 billion client assets invested in life insurance policies. Targeted Investment Banking Strategy SG s GBIS division includes global markets and investor services, financing and advisory (F&A), and asset and wealth management. The group s franchise is stronger in Europe, which generated about 7% of GBIS revenue in 216, with smaller contributions from the Americas and Asia Pacific. Global markets (18% of 217 group revenue and 16% of group RWAs at end-217) includes SG s sales and trading operations in fixed income, currencies and commodities (FICC), and in equities. SG has the world s second-largest market share by revenue in equity derivatives, highlighting its sound franchise in the segment. This strength has allowed it to grow internationally, including in Asia Pacific. SG is also Europe s second-largest custodian (EUR3.9 trillion assets under custody at end-217). Its securities services business, which also includes clearing, trade finance and payment services, derives close to three-quarters of revenue from retail banking networks, highlighting the value of the integrated group. The integration of Newedge, a clearing, execution and prime brokerage specialist fully owned since 214, has expanded SG s business in the US and helped increase its institutional client base. F&A accounted for 9% of group revenue in 217. Half of F&A s revenue in 216 came from natural resources and asset financing. F&A also deals with corporate lending and advisory. While revenue is fairly stable, LICs can be lumpy, due to the size of certain underwriting commitments. SG s asset management operations are undertaken by Lyxor (EUR112 billion assets under management (AuM) at end-217), which specialises in alternative investments and has a good franchise in exchange-traded funds. SG s strong equity derivatives franchise supports Lyxor s activity. Private banking (EUR118 billion AuM at end-217) remains predominantly European, with part of the revenue generated through a joint-venture agreement with the French retail network. The bank is repositioning its client franchise in certain European markets, notably Switzerland and Belgium, which weighs on profitability. 3

4 Key Financial Targets (%) T Cost/income 75 a <63 Return on 4.9 a 1 b equity Basel III CET ratio Total capital 17.1 ~ ratio Basel III Tier leverage ratio LICs/average gross loans revenue growth (%) 2 c >3 LICs: Loan impairment charges a Excluding non-recurring items, notably EUR1.4bn litigation charges: 8.3% return on equity and 69% cost/income ratio b Corresponding to a 11.5% return on tangible equity c Shows cumulative average revenue growth rate Management and Strategy SG s strategy concentrates on selected growth opportunities and on improving the efficiency of its operations. We view the bank s 22 strategic plan as a natural evolution of prior objectives. SG has largely delivered on its plan, with the exception of return on equity and revenue growth targets, which were not met, partly because of the low-interest-rate environment. Between 215 and 217, SG delivered EUR1.2 billion in cost savings, higher than its EUR1.1 billion target, and at lower implementation costs than planned. Meeting the revenue growth objective of above 3% will be important for SG to meet its financial targets, as the group plans to contain the rise in operating expenses to 1.2% between 216 and 22. Sound or improving economic growth in many of the bank s key markets and the planned 3% growth in RWAs should help the bank generate revenue. Increasing revenue faster than operating expenses will be challenging in French retail, where strong competition erodes margins and changing client behaviour requires investment in digitisation. SG plans to close some back offices and reduce its branch network by 15% by 22 while increasing its digital offering. Sound economic growth in France should help the bank expand its franchise with corporates. The group s universal banking model offers crossselling opportunities, particularly in private banking and insurance. These initiatives should help grow revenue at a cumulative growth rate of above 1% between 216 and 22, but revenue fell 3% in 217 following high rates of housing loan renegotiations. SG s revenue growth target of above 5.5% for IBFS reflects its presence in fast-growing markets, including Russia and Africa, and in fleet leasing. We expect IBFS to continue driving profit growth for the group. The planned fall in GBIS s cost/income ratio (from 76% in 216 to about 68% for 22) partly relies on recurring savings of about EUR.35 billion financing investments in digitalisation, maintaining and expanding the equity derivatives and natural resources franchises and targeting selective growth, for instance in advisory and prime brokerage. SG s executive and senior management teams have been generally stable with the exception of some key departures, allowing a smooth implementation of the group s strategy. SG s board of directors has 14 members, of whom 1 are independent and two are elected by employees. The chairman and chief executive roles are split. SG applies the AFEP-MEDEF Corporate Governance Code, which provides best practice recommendations to listed French companies. Risk Appetite Strengthened Underwriting Standards We view SG s risk appetite as moderate. The group has a good record in managing and controlling credit and market risk, and exposure to higher-risk asset classes or products has remained limited. SG s main exposure is to credit risk (82% of end-217 RWAs). Underwriting standards in its French loan book are conservative. A large portion of retail banking assets relates to housing loans, where underwriting criteria largely rely on client affordability rather than on collateral value. SG favours originating housing loans that qualify to be guaranteed by Crédit Logement. The high proportion of new French retail loans that benefit from this guarantee underscores the bank s conservative underwriting. The bank also has material exposure to emerging markets in CEE, Russia and Africa. Origination in Russia has focused on larger corporates for a number of years, which has helped reduce credit risk. Better economic conditions and underwriting standards in Russia and Romania led the 55% fall in LICs for the bank s international retail business in

5 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 n.d. n.d. Banks We believe SG has a fairly conservative approach to credit risk in the corporate and investment bank compared with GTUB peers. The bank s appetite for riskier asset classes is generally below peers, but SG is willing to continue operating in businesses where it has a relatively limited presence and a sound record of risk management. SG s leveraged finance operations are predominantly European and focus on smaller transactions, which results in acceptably sized underwriting positions and a granular portfolio. Sound Risk Controls SG s risk reporting framework includes a comprehensive set of internal limits, with risk systems consistently applied throughout the group s international subsidiaries. The independent control function reports directly to a deputy chief executive. Internal and financial reporting is based on uniform definitions across the whole group, including on asset impairment, and riskmanagement divisions are segregated from business units. The group s centralised riskmanagement unit monitors key risk indicators and limits as defined by management, including credit, market, operational but also liquidity, business and insurance risks. Significant Legal Cases and Provisions Operational risk (14% of RWAs at end-217) is significant for SG as for peers, given its broad international presence and its large capital market operations. The bank remains exposed to conduct and litigation risk, and is facing several investigations that could result in material fines. SG s sound earnings and significant litigation provisions should provide a sufficient buffer to absorb further litigation costs. At end-217, litigation provision was EUR2.3 billion, of which about EUR1 billion was allocated to the Libyan Investment Authority (LIA) and interbank offered rates cases. Litigation Provisions Rise (EURm) 3, 2,5 2, 1,5 1, 5 Litigation provisions (LHS) Litigation charges (RHS) (EURm) Q16: Euribor fine refund. 1H17 litigation charges largely refer to LIA settlement We believe the most material legal cases for the bank relate to investigations by US authorities into the setting of interbank offered rates and to the LIA case. On 19 March, SG said that it expected to have resolved these cases within the coming weeks. Civil litigation in the UK brought by the LIA in relation to the bank s investments entered into on behalf of the LIA was settled for EUR963 million in 1H17, but an investigation launched by the US Department of Justice and the Securities and Exchange Commission on the matter is continuing. A third relevant case relates to alleged violations of US embargoes and is still outstanding. The French tax authorities have recently confirmed they intend to question the tax deductibility of the EUR4.9 billion losses that resulted from Jérôme Kerviel s unauthorised trading in 28. A potential deferred tax asset (DTA) write-down would not affect the bank s regulatory capital, which already deducts DTAs. Major settled litigation cases related to Euribor rigging (EUR446 million fine in 213, of which EUR218 million refunded in 216) and the US mortgage market (EUR1 million settlement with the US Federal Housing Finance Agency in 214). Well-Controlled Growth We expect growth to be largely organic and within the bank s internal capital generation capacity, complemented by selected bolt-on acquisitions. SG s capital planning targets organic capital generation of about 25bp a year, with 3% RWA growth and a 5% dividend pay-out ratio. Small-scale acquisitions are typically made to strengthen strategic activities. The bank acquired the 5% stake in insurer Antarius that it did not already own in 2Q17. SG also purchased Parcours (vehicle leasing) and Kleinwort Benson (private banking). SG has some flexibility to partly finance these acquisitions by streamlining businesses. 5

6 In French retail, SG focuses on premium clients in a highly competitive market with low margins and has grown below the market in 217. SG expects to invest in growing its consumer finance operations, while growth in SME loans is sound and in line with peers. In GBIS, continuing to invest in asset finance and asset-backed products remains a priority for the bank. Material but Well-Controlled Market Risk SG s exposure to market risk arises principally through traded market risk, where the bank has a strong risk-management record, and through interest-rate risk in the banking book, where the bank has a sound limit system. The impact of a 1% parallel shift of the yield curve on the net present value of future residual fixed-rate positions is monitored and subject to an internal limit of EUR1 billion (about 1.6% of group equity). During 217, the sensitivity remained below.6% of the group s regulatory capital. The net interest margin sensitivity is also measured through various stress scenarios on interest-rate curves. Interest-rate risk in the banking book is managed using macro hedges and mainly arises from fixed-rate housing loans net of fixed-rate liabilities. The main challenge to hedge this risk is to maintain robust assumptions around housing loan prepayment rates and sight deposit stickiness to model the net asset duration. In 3Q17, SG took a manageable EUR88 million charge (1% of 217 French retail revenue) to adjust its swaps hedging housing loans. Higherthan-expected prepayments resulted in the amount of assets hedged becoming lower than the sum of the hedging swaps. As the proportion of housing loans being renegotiated has fallen significantly, we do not expect further hedging adjustments. However, prospects for sight deposits in a rising rate environment after a long period of low interest rates remain untested. We believe SG s traded market risk appetite is lower than most of its GTUB peers, but trading operations are significant relative to its size. The bank expects market activities to keep making up about a fifth of group revenue and RWAs. SG assesses its market risk using several risk indicators, including value-at-risk (VaR; 99% confidence interval, one-day holding period, oneyear horizon using the historical simulation method) and stress tests, and a wide range of limits are in place. About 9% of SG s market risk capital requirement is assessed through internal models. The bank s average trading VaR was a moderate EUR25 million in 217. Overall, traded market risk has declined in recent years, reflecting both a lookback period with lower market volatility and structurally lower inventory, partly due to stricter regulatory capital requirements. Higher market volatility seen in 1Q18 could lead to higher market-risk RWAs, but we believe that this could also help the bank generate more revenue in client flow-based activities. Asset Split End-217 Due from banks 5% Cash and central banks 9% AFS assets 11% Fixed assets 2% Other 7% Other assets mainly include guarantee deposits paid on financial instruments Fair valued assets 33% Customer loans 33% SG hedges a large part of its balance sheet so that there is limited volatility in its CET1 ratio as a result of foreign-exchange fluctuations. Equities in the banking book amounted to EUR6.1 billion at end-217 for those in the prudential scope (excluding insurance activities), which included minority stakes in corporates and financial institutions and private equity investments. Financial Profile Asset Quality SG s asset quality is weaker than domestic and GTUB peers, despite material improvements since end-213. SG s impaired loan ratio was still a relatively high 5.% at end-217 (end- 216: 5.7%), despite a 13% yoy decline in the stock of impaired loans. At end-217, 51% of impaired loans were in France, 17% related to eastern Europe, 12% to western Europe, with a combined 14% to Africa and the Middle East. SG s French loan book includes Credit du Nord s SME-focused portfolio, with higher impaired loan ratios compared with SG s average, and consumer finance activities. We estimate loans in Russia, which account for 2% of the group s loan book, account for just under 1% of group impaired loans. 6

7 SG s comparatively high gross impaired loan ratio partly reflects slower write-off practices in the French banking sector, as well as international operations in higher-risk markets. In line with French peers, the bank typically aims to fully resolve problem loans instead of writing them off at an early stage. Despite the group s sound record in impaired loan recoveries, slow writeoffs can result in LICs accruing through time. The relatively high volume of unreserved impaired loans, which amounted to 19% of Fitch Core Capital (FCC) at end-217, leaves the group s capital more exposed to unexpected shocks, in our view. Non-Performing Exposures (% gross exposures, end-1h17) (%) SME Corps ex SME Households Total BNPP SG GBPCE Credit Mutuel Credit DB BARC HSBC Agricole BNPP: BNP Paribas S.A.; SG: GBPCE: Groupe BPCE; Credit Mutuel: Groupe Credit Mutuel; Credit Agricole: Groupe Credit Agricole; DB: Deutsche Bank AG; BARC: Barclays plc; HSBC: HSBC Holdings plc. HSBC SME exposure: (EBA disclosure) Source: EBA Transparency Exercise Falling Loan Impairment Charges (bp) Impaired loans/gross loans (RHS) French retail (LHS) IBFS (LHS) GBIS (LHS) Group (LHS) (%) SG s exposure at default (EaD) including off-balance-sheet commitments was EUR872 billion at end-217. About 8% of the bank s credit risk is calculated using the internal ratings-based method. Corporate clients are an important component of the bank s European franchise and accounted for 37% of the group s EaD (at end-217). Commitments to corporates were well diversified by industry, generally well collateralised and largely to investment-grade corporates, with a small percentage of poorly rated counterparties. LICs have continued to benefit from improving macroeconomic conditions in key markets, which resulted in loan-loss provision reversals in Romania and the Czech Republic in 217. The supportive economic environment in France also contributed to reduce loan and other impairment charges to 19bp of gross loans for 217, down from 37bp in 216 according to the bank. We expect LICs to increase slightly and SG expects LICs to account for between 35bp and 4bp of gross loans by 22 (between 25bp and 3bp for 218). Balanced Mix in French Retail SG s French retail accounts for about 4% of total loans at end-217 and is evenly balanced between lower-risk housing loans and loans to business clients, which includes higher-risk loans to SMEs and self-employed professionals, including through Credit du Nord s network. SG s underwriting standards in French housing loans have proven conservative, in line with other French banks that focus on debt repayment capacity rather than collateral values. We believe this leads to limited credit risk. Housing loan performance is mainly sensitive to employment and household debt capacity. Consumer finance activities globally included at end-217 a small loan book (EUR11 billion) as part of French retail, and EUR18 billion consumer loans in the rest of western Europe, notably including Germany and Italy. Impairment charges in consumer finance can be high, but are compensated by healthy margins. Fleet leasing (including ALD) and factoring loans were a further EUR33 billion at end-217. These loans generally perform well, but require management of residual value risk. International Retail Remains a Vulnerability IBFS s loan book (about 3% of total loans) is in our view SG s main asset-quality challenge. Exposure to emerging markets in eastern Europe, Russia and Africa can suffer from sharp changes in economic conditions and therefore lead to more volatile LICs. Strong GDP growth 7

8 in Romania and a stabilising economic environment in Russia contributed to LICs halving in international retail in 217. Overall, IBFS s LICs accounted for 29bp of gross loans in 217, which we consider as being at a cyclical low and flattered by provision reversals. SG s loan portfolio in the Czech Republic (EUR24 billion at end-217) is the largest of its international retail operations and we do not expect it to be a major driver of LICs as the economy approaches full employment. Economic stabilisation and the focus on larger corporates in Russia resulted in more sustainable LICs, which fell 7% yoy. Exposure at default net of provisions in Russia was about EUR16 billion (37% of FCC) at end-217, of which 35% related to retail clients and 25% to large corporates. Foreign-currency mortgage loans have reduced significantly in Russia, and portfolios in Poland and the Czech Republic are small. Low but Volatile Credit Provisions in GBIS SG s sizeable corporate finance activities are reflected in GBIS s loan book of EUR136 billion at end-217. Exposures are typically well-managed. LICs are a smaller proportion of average loans compared with other divisions, but large corporate exposures can lead to lumpy LICs and reversals: the division released 1bp of average gross loans in loan loss reserves in 217. This partly reflects recoveries on counterparties sensitive to oil prices, which have recovered since 216 and accounted for a limited 6% of EaD at end-217. Higher provisioning in metals and mining (4% of EaD) have reduced risks, in our view. SG s overall exposure to higher-risk sectors remains moderate. Leveraged finance is not an area of strong focus and mainly relates to the European market, which is less exposed to rising interest rates in the US. Underwriting exposures are comparatively small and well diversified. Fair Valued Assets (EURbn) 217 (% equity) Trading portfolio Bonds Shares Derivatives Reverse repo Fair value option Bonds Shares Loans, others Total fair value assets Exposure to securitisations is moderate compared with that at most GTUB peers and is declining as SG is running down its now small legacy asset portfolio. SG mainly acts as a sponsor for asset-backed securities transactions and to a much lesser extent as an originator to manage its own credit risk and create securities eligible for repo transactions. At end-217, SG s exposure to consolidated ABCP conduits, for which the group provides liquidity lines, was EUR18 billion. Significant Equity and Reverse Repo Books Fair valued assets accounted for a material 33% of assets at end-217. SG s sizeable trading portfolio mainly reflects large derivative replacement values and reverse repurchase agreements, but also sizeable equity and bond holdings. Of the EUR42 billion fair-valued financial assets, EUR51 billion related to the insurance business. Derivative counterparty risk is mitigated by master netting agreements and cash collateral, which bring the net trading derivative exposure to a still significant EUR41 billion at end-217, from EUR134 billion positive replacement values. Two-thirds of these were interest rate instruments. Reverse repos are broadly match-funded by repo borrowings (EUR4 billion net borrowing position, less than 1% of total funding excluding derivatives). Assets measured using the fair value option include structured bonds and loans fair-valued to reduce accounting asymmetries with the hedging instruments. Level 3 financial assets, whose valuation is based on financial models with unobservable inputs, were EUR6.6 billion at end- 217 (a manageable 16% of CET1 capital) and included less liquid derivatives and long-term equity investments. Most of SG s exposure to sovereigns and financials is to well-rated counterparties. Close to 8% of banking client exposure at default was rated A and above at end-217, with less than 1% being sub-investment grade. 8

9 ('a' earnings implied factor score) Banks Earnings and Profitability SG s sound earnings capacity benefits from its universal banking model. Client, product and geographical diversification mitigate shocks in single regions or businesses, while also benefitting from growing businesses, particularly in international retail and fleet management. More volatile capital market activities account for a lower share than GTUB peers, but higher than most European universal banks. Profitability in retail banking is helped by SG s presence in recovering or fast-growing emerging markets, and well-integrated insurance and consumer finance operations. Simplified Pre-Tax Profit Split 217 pre-tax profit French retail and commercial banking Corporate & investment bankingª Financial services and international retailᵇ BNPP SG CM11 CA GBPCE % 5% 1% CA: Credit Agricole; CM11: Groupe Credit Mutuel-CM11. a Includes financing, global markets, investor and securities services, trade finance b Includes insurance, asset management, specialised financial services and international retail Operating Profit/RWAs SG vs. peers (%) Green line: SG. Red dot: GTUB peer median. Blue dots: GTUB peer range Source: Fitch Unusually large litigation expenses (including allocations to provisions and the LIA settlement), totalling EUR1.4 billion, weighed on SG s results in 217. Excluding litigation, SG s operating return on RWAs would have improved 4bp to 1.9% for 217. SG s reported 4.9% return on equity (RoE) in 217 was also dented by a EUR39 million restructuring charge in French retail banking, the tax impact of French tax reform and other exceptional items, without which SG would have generated a 8.3% RoE, 4bp higher than in 216. We expect SG s operating profitability to remain sound. SG targets a cumulative average growth rate in revenue of above 3% by 22, enabled by RWA growth of about 3%, with higher growth targeted in international retail and specialised financial services. At the same time, SG plans to generate about EUR1.1 billion in recurring savings from 22, funded by about EUR1.5 billion in investments, EUR.5 billion of which were expensed in 217. Delivering cost savings will be important to improve operating leverage and meet the group s expected 1.2% operating expense growth between 216 and 22. Retail Banking Drives Group Pre-Tax Profit Pre-tax profit by business (EURm) Reported pre-tax profit French retail restructuring costs -33% +38% 2,5 2, -21% 1,5 +6% +18% 1, +14% 5 +54% International retail French retail Global markets & investor services French Retail Revenue to Stabilise in 218 Financial services to corporates Financial advisory Insurance Wealth & asset management 27% 22% 18% 13% 11% 9% 1% Excluding 'other' in IBFS and the corporate centre. Bold: yoy % change. Percentages below the x-axis show the business' contribution to group pre-tax profit (excluding corporate centre) and may not add up due to rounding. We expect SG s French retail division to generate adequate returns in 218, despite pressure on costs from investments in digitisation. Revenue pressure should ease into 218, as the rate of housing loan renegotiations fell to a low 3% in 4Q17 and SG expects revenue to be broadly unchanged in 218. The favourable interest-rate environment for borrowers in France had resulted in a high proportion of housing loans being renegotiated at lower interest rates, which has put pressure on banks net interest income. Early repayments resulted in early redemption fees, which temporarily boosted revenue, mostly in 215 and 216. About 21% of SG s loan book was renegotiated in 216, with a further 11% in 217. Net interest income, which accounted for 56% of revenue in 217, fell 6% yoy and led to a 3% revenue decline. Pre-tax income in the division fell 12% yoy to EUR1.9 billion in 217, excluding restructuring charges and a small fine. SG has positioned itself conservatively in the French market, aiming to favour client profitability over client acquisition, even at the expense of market share losses. Competition has eroded net interest margins, and SG s approach is to minimise balance-sheet risks from low-margin products. Fee generation will therefore be key to grow revenue, and SG s integrated insurance 9

10 FICC F&A Equity AWM SS Prime Banks and consumer finance offering should help. Investments in digitalisation will result in a growing cost base, making revenue growth even more important. Significant Contribution from International Retail International retail banking s contribution to pre-tax profit increased to 27% in 217 from 19% in 216, excluding the corporate centre. The 25% pre-tax profit increase in IBFS was mainly attributable to international retail, which benefitted from very low LICs and favourable economic conditions in most regions. Economic growth is cyclically strong in Romania and is accompanied by rapid loan growth in Africa. The Czech Republic s is the second-largest contributor to international retail s net income, and the country benefits from low unemployment. Recovery in Russia led to loan growth and significantly lower LICs. This demonstrates the benefits of SG s presence in faster growing economies, but at the same time highlights the variability of income in more volatile regions. GBIS' Revenue Variability Average revenue (LHS) 217 revenue (LHS) (EURbn) Volatility (RHS) (%) Equity: Equity sales and trading. SS: Securities services. Average revenue: Average yearly revenue Volatility: Quarterly standard deviation/average revenue, Source: Fitch 5 We expect consumer finance operations to continue to perform well. In western Europe, loan growth was a strong 15% at constant scope and exchange rates, buoyed by car loans. Financial services to corporates accounted for a meaningful 13% of pre-tax profit excluding the corporate centre and saw a 6% pre-tax profit rise, reflecting new equipment finance business and ALD s growing vehicle fleet, despite its lower contribution following the initial public offering of a 2% stake in 2Q17. Insurance premium growth helped pre-tax profit, with an increase in the share of more remunerative unit-linked policies to 26% at end-217. Some Volatility from Market Activities Muted client activity and market volatility in 217 resulted in a 5% yoy revenue fall for GBIS. Revenue was 7% lower in fixed-income sales and trading, 6% lower in equity sales and trading and 6% lower in financing and advisory, resulting in GBIS s 9% yoy pre-tax profit fall. Financing and sales and trading revenue are largely determined by changing client activity and therefore introduce some earnings volatility. This is mitigated by the bank s relatively wellbalanced mix between fixed-income and equity activities, and fairly resilient revenue historically for market activities. The contribution from sales and trading (18% of group revenue in 217) and financing activities (9%) was manageable and towards the lower end of GTUB peers. Higher market volatility should increase clients hedging and portfolio rebalancing, boosting GBIS s revenue. Capitalisation and Leverage SG s capitalisation is adequate, but sensitive to a structural weakening in the group s earnings generation. The bank s diversified business model results in strong internal capital generation, while capital ratios are at the lower end of GTUB peers. SG targets a 12% Basel III fully loaded CET1 ratio by end-22, and expects to operate with a CET1 ratio of about 11.5% by end The group s 11.4% CET1 ratio at end-217 fell 1bp yoy, reflecting the commitment to a minimum 5% dividend pay-out ratio amid significant litigation charges, restructuring costs and negative tax effects in 217. Excluding these items and an operational risk RWA add-on (14bp negative impact), SG would have generated 41bp of RWAs in capital organically in 217, net of dividend provision (5bp negative impact), which we view as strong. We expect organic growth and bolt-on acquisitions to be funded by internal capital generation or business sales. In 217, the sale of a 2% stake in ALD more than offset the negative capital impact of the acquisition of the remaining 5% stake in Antarius and the disposal of SG s Croatian subsidiary. SG s capital remains sensitive to unexpected litigation costs in excess of the bank s strong earnings and provisions for litigation, which increased to what we view as a material EUR2.4 billion at end-217. More challenging than expected collateral realisation or impaired loan recoveries could also weigh on capital, as unreserved impaired loans accounted for a comparatively high 19% of FCC at end

11 We expect SG will execute on its plan to sell up to 5% of RWAs in non-core businesses by 22, which will help it reduce its CET1 capital generation needs. This is because SG would have to increase its CET1 capital by about EUR7 billion by end-22 to meet its 12% CET1 target and its 3% RWA growth target for its businesses, excluding the corporate centre and non-core business reductions. Between end-214 and end-217, SG s CET1 capital increased by EUR4.5 billion. SG's Total Capital (% RWAs) CET1 AT1 T2 AT1/T2 Total capital a Jan 17 Jan 18 Jan 19 Graph does not show additional Tier 1 and total capital Actual Target requirements (= CET % AT1 + 2% Tier 2). Basel III fully-loaded Including countercyclical buffer (.1% in 219) Source: Fitch, SG a Illustrative figure based on SG s 22 target capital structure of 12% CET1, about 1.5% - 2% AT1, about 3% Tier 2, about 7% senior non-preferred and maximum 2.5% senior preferred debt. SG s 22 CET1 ratio target of at least 12.% is well above its % CET1 requirement (excluding.1% in respect of the counter-cyclical buffer) pursuant to the ECB s Supervisory Review and Evaluation Process (SREP), assuming no changes to the 1% G-SIB buffer and 2.5% capital conservation buffer the bank will be subject to in 219. We expect the bank to keep solid buffers above regulatory minima. At end-217, SG had a buffer of about EUR1 billion over its 8.7% SREP CET1 requirement applicable in 218, which is the relevant threshold under which discretionary payments (dividends, coupons, bonuses) can be restricted. Focus on Senior Non-Preferred Debt 12. SG s 22 implied total capital ratio target of about 17% is lower than its previous 18% target, as the bank optimises its cost of complying with total loss-absorbing capacity (TLAC) requirements, favouring senior non-preferred (SNP) debt rather than Tier 2 subordinated debt. At end-217, SG had issued around EUR7 billion of SNP debt (1.9% of RWAs). Together with 17.1% in total capital, the bank s TLAC-eligible instruments amounted to 19% of RWAs, close to the 19.5% TLAC requirement by 219. We believe the bank can reach the 219 target with further SNP issuance, which could potentially rise up to 4.5% of RWAs in 222 if the bank chooses not to use senior preferred debt to meet its 21.5% TLAC requirement from 222. This is feasible, given the bank s plans to issue around EUR6 billion-eur7 billion SNP debt annually between 218 and 22. The TLAC term sheet allows the inclusion of up to 2.5% of RWAs in senior preferred debt, giving SG further flexibility. SG s Basel III fully loaded Tier 1 leverage ratio of 4.3% at end-217 was within its targeted range of between 4.% and 4.5% by 22 and was broadly in line with European GTUB peers. TLAC-eligible instruments accounted for 6.6% of leverage exposure at end-217, well above the 6% 219 requirement and just shy of the 6.75% 222 requirement. Limited Impact of Regulatory Revisions SG's SREP CET1 Capital Requirements (% RWAs) G-SIB buffer Capital conservation buffer Pillar 2R Pillar Following the finalisation of the Basel III framework in December 217, we believe the impact on SG s capital ratios will be manageable. The bank estimates that the proposed revisions to credit and operational risk measurement would increase end-216 RWAs by 1% based on the end-216 balance sheet. We expect SG will adjust its business model to mitigate the actual impact, which will only be visible once the revisions to the capital framework become binding, likely from 222. The fundamental review of the trading book could significantly increase

12 > 227 Banks market risk RWAs, but these accounted for a limited 4% of total RWAs at end-217. SG indicated that the implementation of IFRS9 should have a limited impact on the CET1 ratio of around 15bp upon adoption of the accounting standard in January 218. Long-Term Funding End-217 Interbank & TLTRO 14% Secured 14% Subsidiaries 9% Subordinated debt Senior nonpreferred 4% Structured notes 31% Senior preferred 15% 14% Total: EUR168bn. Totals may not add up due to rounding Long-Term Funding Maturities (EURbn) As of end-217 Funding and Liquidity SG s long-term funding profile is well diversified by source, with customer deposits accounting for 46% of total funding excluding derivatives. Client deposits covered about 65% of funding excluding derivatives, repos and trading liabilities, which are broadly matched on the asset side. Wholesale funding of about EUR25 billion remains material and accounted for the remainder. It includes deposits from banks (around half of which are matched by interbank assets), senior unsecured and subordinated debt, and short-term borrowings. The group is a regular issuer in the market and has a granular and well-diversified investor base. Long-term funding maturities are fairly well distributed over the next four years. Structured senior notes account for a material 31% of total long-term funding at end-217 (which also includes certificates of deposit and commercial paper with remaining maturity greater than a year). These structured notes are beneficial to the group in terms of cost of funding and are distributed to institutional investors, private banks and retail networks, domestically and internationally, which provides for a sufficiently diversified funding base for these instruments, which are, however, not TLAC eligible. Subsidiaries accounted for 9% of total long-term funding, consistent with SG s strategy to increasingly self-fund foreign subsidiaries. The group has made notable progress in this respect, as retail banking subsidiaries outside France raise funds from customer deposits and local issuances. Funding provided by the group to international retail banking subsidiaries (excluding consumer finance) was EUR1.8 billion at end-217, higher yoy but on a longer downward trend (EUR3.9 billion at end-214). Short-term wholesale funding of EUR6 billion at end-217 contributed only 8% of the funded balance sheet, which compares well with European peers, and has declined materially since 213 (15%). The bank has implemented a nominal internal limit on short-term wholesale funding since end-214. The group s liquid asset buffer, around half of which typically relates to deposits with central banks, more than covers short-term wholesale funding (around three times at end-217 and end-216). US dollar-denominated assets typically account for between 2% and 25% of group assets, with US dollar funding in excess of assets. SG has reduced the funding from US money market funds, which fell to USD5.9 billion at end-217, compared with USD6.4 billion at end-216 and USD15.1 billion at end-215. Access to short-term US dollar funding for SG is largely provided by deposits from central banks, corporate deposits and asset managers. Sound Liquidity Management SG s liquidity management is prudent and its liquidity buffer is ample and of good quality. The group s liquidity coverage ratio (LCR) was comfortably above regulatory minima, at 124% on average in 4Q17. SG disclosed that its net stable funding ratio was above regulatory requirements (more than 1%). The bank actively manages the size and composition of its liquid asset buffer ahead of idiosyncratic events. The vast majority of high-quality liquid assets (HQLA) included in the bank s liquid asset buffer qualified as level 1 HQLA. The bulk of the liquidity buffer is held by the parent company. We believe liquidity is largely fungible across the group, given that deductions from the LCR s numerator due to fungibility restrictions are small. 12