Exane BNP Paribas Equity Research Focus Société Générale Banks - France Stock vs Sector Neutral Sector vs Market Underperform Price (18 January 2008) EUR85.3 Target price EUR130.0 (+52%) Earnings revisions 12/06 12/07e 12/08e 12/09e Net att. profit adjusted () Revised 5,221 5,304 5,399 5,903 Previous 5,239 5,450 5,939 EPS + Gdw (EUR) Revised 12.21 12.10 12.15 13.28 Previous 12.22 12.24 13.34 - % change ns (1) (9) Market cap./free float (EURbn) 37.9/29.0 12-month high/low (EUR) 158.4/85.3 Reuters/Bloomberg SOGN.PA/GLE FP DJ STOXX50 3,351.7 Risk rating B Per share data (EUR) 12/06 12/07e 12/08e 12/09e EPS adjusted 12.21 12.10 12.15 13.28 EPS reported 12.25 12.64 12.15 13.29 BVPS 65.58 69.91 76.43 83.94 DPS 5.20 5.36 5.47 5.98 Stockmarket ratios* 12/06 12/07e 12/08e 12/09e P/E (x) 9.8 10.5 7.0 6.4 P/E rel. DJ STOXX50 (%) 88.4 96.5 68.4 68.0 P/BVPS (x) 1.8 1.8 1.1 1.0 - High (x) 2.1 2.3 1.3 - - Low (x) 1.5 1.3 1.1 - ROE adjusted (%) 22.0 18.7 17.2 17.1 Net yield (%) 4.3 4.2 6.4 7.0 * Yearly average prices for FY to end-12/06, 12/07 P&L highlights () 12/06 12/07e 12/08e 12/09e Total revenue 22,417 24,107 24,937 26,751 Adjusted PBT 8,054 8,588 8,547 9,342 Net att. profit adjusted 5,221 5,304 5,399 5,903 Performance (%) 1-w 1-m 3-m 12-m Absolute (12) (14) (28) (33) Rel. DJ STOXX50 (7) (6) (17) (25) Rel. sector (5) (2) (8) (5) Price relative to DJ STOXX50 160 150 140 130 120 110 100 90 80 70 21/1/08 60 2005 2006 2007 2008 SocieteGenerale Relative to DJ STOXX50 S DATASTREAM Source: Datastream Waiting for clarification on ABS CDO exposure! Christian Noyer, governor of the Banque de France, said that French banks are still in the process of marking down assets. SG is exposed to US residential mortgage risk through EUR4.8bn of ABS CDOs. In Q3, the group decided to book EUR230m in writedowns i.e., a 5% discount rate on the exposure. This rate is unrealistically low compared to other banks. Based on the last reported figures, banks have already booked write downs of USD70bn in ABS CDO. This would mean that 35% of the ABS CDO has already been written down with 50% for Citi and 70% for ML. At this stage, SG has not disclosed any information on its indirect exposure to monolines. Due to a lack of proper corporate communication, it is clear that market sentiment rules. However, there is no reason that SG s exposure is significantly more than the other European banks. We believe that, at EUR85, the share prices a very worst case scenario i.e., 1) the potential impact of a recession in USA and low GDP growth in Europe and 2) the negative impact of additional write downs on the ABS CDO portfolio (70% in line with Merrill Lynch) and the potential reconsolidation of the conduits. This worst-case scenario could oblige SG to tap the market for EUR4.6bn. We estimate the downside potential of the stock is now very limited as the last share price values the worst for the bank. However, at this stage the market expects further information (writedowns on ABS CDO, exposure to monolines, potential capital increase). Last Friday, Christian Noyer, the governor of the Banque de France, said that he does not expect strong shocks (on the French banks). He is reasonably confident that French banks will weather this turmoil without any major problems even though they are clearly, like all banks in the world, still in the process of marking down assets. US financial guarantors descent into hell. These players insure USD40bn of RMBS and USD130bn of ABS CDO. A large part of these insured products are in the hands of the banking industry. If a financial guarantor goes bankrupt, protection bought by banks is worthless. In this current context, investors are focused on Société Générale s situation. Last Friday, the share price felt by 8.2% to EUR85, the lowest point since mid-2005. Only a 5% discount rate on its ABC CDO exposure At end-september 2007, the group was exposed to US residential mortgage risk through EUR4.8bn of ABS CDOs. The group decided to book EUR230m in write-downs i.e., a 5% discount rate on the exposure. Eric Hazart Paris: +33 1 44 95 35 68 eric.hazart@exanebnpparibas.com Important Notice: Please refer to our complete disclaimer/disclosure notice available on www.exanebnpparibas.com/compliance.
Total exposure to ABS CDOs Super Senior AAA tranches Nominal after discount 1,333 1,721 1,771 Attachment point 31% 15% 32% Underlying Mezzanine High grade Mezzanine Year of issuance 2005/06 2006/07 2005 Source: Company SG takes a top-down approach to valuing the write-downs. The bank expects a forward looking scenario of USD200bn of cumulative losses for the entire industry in the US residential mortgage sector. Until now, SG assumes a 30% probability of default compared with the current delinquency rate (< 15%) and a 49% loss given default i.e., a cumulative loss of 14.6% for 2006 and 2007 issuances. During our last contact with the company last December, Frederic Oudéa, SG s CFO, said that assumptions have not yet been finalised for the closing accounts in order to leave potential room for manoeuvre. This rate is unrealistically low The cumulated gross direct exposure to RMBS and ABS CDO markets disclosed by banks is respectively USD80bn and USD200bn. Based on the last figures reported by the banks, they have already booked write downs of USD80bn, of which USD70bn in ABS CDO. This would mean that 35% of the ABS CDO has already been written down, which is consistent with our initial expectations. But this is probably not enough. Last week, Citigroup decided to writedown 50% of its high grade ABS CDO and 59% of its mezzanine ABS CDO. Citi s management said that assumed housing price adjustments have been lowered since 4 November estimates. The overall level of housing price adjustments used in Citi s valuation methodology is approximately 6.5% to 7% downward for each of the next two years. Merrill Lynch has depreciated 69% of its high grade ABS CDO and 72% of its mezzanine ABS CDO. The group highlights that 2006 and 2007 are more toxic than initially expected. Nevertheless, it is important to highlight that the kitchen sink lead by the two US banks correspond to the appointment of new CEO. Simultaneously, Citi and ML booked writedowns of respectively USD950m and USD2.6bn on their exposure to US financial guarantors (mainly on ACA). If a financial guarantor goes bankrupt, protection bought by banks is worthless. Last week, Moody s placed the AAA insurance financial strength rating of MBIA under review for a possible downgrade. There are two possible read across for Société Générale: First point, the 5% discount on the gross exposure looks unrealistically low even if the comparison is not very easy to do as each ABS CDO is different (attachment point, waterfall, etc). If we apply ML s extreme depreciation rate, SG could have to book additional write downs of EUR3bn before tax. According to our expectations, this could have a negative impact of 80bp on the Tier I ratio. Additional depreciation - Impact on the Tier I ratio Potential impact % of exposure before writedowns 35% 50% 70% Scenario Average market Citigroup Merrill Lynch Additional writedowns before tax 1,689 2,413 3,378 Additional writedowns after tax 1,182 1,689 2,364 Impact on the Tier I ratio -0.4% -0.6% -0.8% Tier I after additional writedowns 7.5% 7.3% 7.1% 2
Second point, SG s exposure is a netting of the hedges i.e., purchases of CDS protection from various third parties, including monoline financial guarantors, insurers and other market participants. At this stage, SG has not disclosed any information on their monoline exposure. Due to the lack of proper corporate communication, it is clear that market sentiment rules. However, we believe there is no reason that SG s exposure is significantly higher than the other European banks. Other negative impacts on Tier I ratio Last November, SG announced it reconsolidated its PACE SIV due to the tough market conditions and will refinance it. PACE had a total asset size of USD4.3bn at 30 November. At this time, the group remains confident in the underlying quality of assets acquired. The impact on the Tier I ratio is limited to 0.05%. Last December, SG decided to exercise its call option to take the majority stake in the Russian Rosbank. This has a negative impact of 35bp on the Tier I ratio. The potential reconsolidation of the conduits could erode SG s Tier I ratio by 40bp. As of September, the group managed six conduits for a total amount of EUR20bn. Note that at this stage, SG does not have a conduit facing a liquidity problem. Commercial conduits Total amount SG Liquidity line given Car Loans Trade Receivables Commercial mortgagees Consumer loans Equipment loans Residential mortgage Antalis 5,535 6,528 17% 66% 4% 0% 0% 10% 3% Barton 10,311 16,694 39% 4% 0% 3% 0% 8% 46% Asset One 481 782 0% 12% 51% 1% 15% 0% 21% ACE Canada 707 790 90% 0% 0% 0% 10% 0% 0% ACE Australia 2,091 3,281 0% 0% 0% 0% 5% 87% 8% Homes 930 2,003 0% 0% 0% 0% 0% 100% 0% Total 20,054 30,078 28% 20% 2% 2% 1% 21% 26% Source: Company Capital increase or not? Other Based on our current expectations, we estimate that SG s Tier I ratio will be around 7.7% at end-december 2007. This is slightly higher that management s target (7.0% to 7.5%). But it is important to make two specific comments regarding SG s financial structure: Its financial structure has very low leverage. According to our estimates, hybrid capital accounts only for 14% of Tier I capital (vs 25% maximum). If necessary, SG can issue hybrid debt in order to respect its Tier I target. However, in the current conditions, this kind of resources is expensive. Basel II will have a positive impact on SG s Tier I ratio with a positive impact in domestic retail banking and neutral in CIB. But at this stage, Société Générale does not quantify the potential impact. We already know that the full control of Rosbank and the reconsolidation of the SIV erode SG s Tier I ratio by 40bp. In the table below, we calculate the potential capital increase SG could issue to maintain its Tier at the low end of management s target range. In the worst-case scenario i.e., writedowns of 70% of ABS CDO portfolio and full reconsolidation of conduits, SG has to tap the market for EUR3bn. It is clear that the dividend could be cut under this extreme scenario. 3
Potential capital increase - key assumption a Tier I target of 7% Tier I as of September (7.7%) Rosbank SIV Add. Writedowns Conduits Tier I after Target Gap Capital increase Impact already known (0.35%) (0.05%) 0% 0% 7.3% 7% 0.3% 965 + Write downs - Average market (0.35%) (0.05%) (0.4%) 0% 6.9% 7% (0.1%) (322) + Write downs (Citi's) (0.35%) (0.05%) (0.6%) 0% 6.7% 7% (0.3%) (965) + Write downs - (ML) (0.35%) (0.05%) (0.8%) 0% 6.5% 7% (0.5%) (1,608) Worst case (Write downs ML + Conduits (0.35%) (0.05%) (0.8%) (0.4%) 6.1% 7% (0.9%) (2,894) In a more challenging context, rating agencies could oblige SG to maintain a Tier I ratio of around 7.5%. Under this scenario, SG could have to tap the market for EUR4.6bn. Capital increase to maintain a Tier I ratio at 7.5% Tier I as of Sept.(7.7%) Tier I after Target Gap Capital increase Impact already known 7.30% 7.5% (0.2%) (643) + Write downs - Average market 6.90% 7.5% (0.6%) (1,929) + Write downs (Citi's) 6.70% 7.5% (0.8%) (2,572) + Write downs - (ML) 6.50% 7.5% (1.0%) (3,215) Worst case (Write downs ML + Conduits 6.10% 7.5% (1.4%) (4,501) The market prices the very worst scenario Currently, we have a target price of EUR130 per share for SG based on a sum of parts method. Sum of parts - Société Générale Equity Net Profit ROE Sus. ROE COE Valuation method Valuation PV per Implicit Implicit Allocated 2008e 2008e retained () share (EUR) P/E 08 P/BV 08 Retail banking 13,003 2,823 22% 31,980 72 11.3 2.5 - Domestic retail banking 6,722 1,435 21% 18% 8.6% P/BV=ROE-g/COE-g 16,067 36 11.2 2.4 - International retail banking 2,169 716 33% 30% 10.1% P/BV=ROE-g/COE-g 8,389 19 11.7 3.9 - Financial Services 4,112 672 16% 15% 9.3% P/BV=ROE-g/COE-g 7,524 17 11.2 1.8 Corporate & Investment banking 5,857 1,913 33% 29% 11.4% P/BV=ROE-g/COE-g 16,197 37 8.5 2.8 GIMS 1,259 693 55% 8,054 18 11.6 6.4 - Asset Management 328 292 PE 08 of 11.5 3,212 7 11.0 9.8 - Private Banking 437 221 PE 08 of 11.5 2,650 6 12.0 6.1 - Boursorama 27 12 fw market value 513 1 19.0 - Securities Serv & Fimat 494 153 PE 08 of 10 1,680 4 11.0 3.4 Equity not allocated 1,698 45 3% 1 times BV 1,698 4 37.5 1.0 Core Tier 1 capital available 22,142 Other - CC and adjustments 325-74 Gr average PE -817-2 Rosbank buy option 490 1 Total 5,399 57,603 130 10.7 We have also valued the group based on a bearish ROE scenario which corresponds to a recession of the US economy environment (see our last report on French banks published in October 2007). We applied the last low ROE point of the cycle in CIB, which was reached in 2002, a year of corporate turmoil. At that time, ROE was 14% compared to 48% in 2006. In domestic retail banking, our ROE assumptions under our worst-case scenario imply the loan growth will decelerate more rapidly than expected and the pressure on margins will continue to be severe. We applied a ROE of 18% vs 23% in 2006. In asset management, we have reduced the P/E multiples by one point reflecting the deterioration of the gross margin (less profitable assets, lower performance fees than in 2006). Based on these assumptions, and adjusted for the recent increase in the market risk premium, SG s fair value could be EUR100 i.e., 16% upside to the last price. 4
We have valued SG based on a scenario which includes the impact of a depreciation rate of 70% on the existing ABS CDO and of the reconsolidation of the conduits. According to our calculations, the group could have to issue EUR4.6bn of fresh capital to keep its Tier I ratio at 7.5%. Based on all of these assumptions, SG s fair value could be EUR107 compared to our current EUR130 target price. If we did the same calculations based on the bearish economic scenario, the FV could be EUR82 per share, in line with the last share price. FV under different scenarios EUR Last price 86 Upside / downside potential Current target price 130 51% FV based on a bearish economic scenario 100 16% FV after taking into additional writedowns on ABS CDO and reconsolidation of conduits Share price (after EUR4.6bn capital increase) 107 24% Worst case (after EUR4.6bn capital increase) 82 (5%) Conclusion Last Friday, the share price dropped by 8.2% to EUR85. This is close to the fair value we calculate based on a very worst-case scenario i.e., a less attractive economic scenario and the impact of the different negative elements on the Tier I capital. As we already mention, this FV includes the impact of the reconsolidation of the six conduits. This assumption is very severe as these are not facing liquidity problems. We estimate the downside potential is now very limited as the last share price values the worst for the bank. Nevertheless, in short term we do not expect a massive rebound of the stock as long as the group does not disclosure further information about additional writedowns and its exposure to financial guarantors. 21 January 2008 Forthcoming events Date Event 21 Feb. 2008 FY 2007 Results 13 May 2008 Q1 2008 Results 5 Aug. 2008 H1 2008 Results 6 Nov. 2008 Q3 2008 Results Commitment of transparency (see www.exane.com/disclosureequitiesuk for details. Complete disclosures available on www.exane.com/compliance) Exane is independent of BNP Paribas (BNPP) and the agreement between the two companies is structured to guarantee the independence of Exane's research, published under the brandname «Exane BNP Paribas». Nevertheless, to respect a principle of transparency, we separately identify potential conflicts of interest with BNPP regarding the company/(ies) covered by this research document. Exane Analyst s Investment Equity stake Amended after Additional Liquidity Corporate Distributor personal Disclosure to material banking provider links interest US Law French Law company conflicts NO NO NO NO NO NO NO NO NO Source: Exane BNP Paribas Potential conflicts of interest: None. Source: BNP Paribas 5