Credit Logement : Recommendation lowered to Neutral on legacy Tier 1

Crédit Logement published its annual report on 28 April. We learnt in it that: 1/ "the part subject to the Tier 1 grandfathering clause is included in Tier 2 without limitations"; and 2/ "according to information received from the ACPR, the ACPR's supervisory board plans to revise the complementary capital requirement that Crédit Logement is currently subject to, while urging it to hold total capital equal at all times to at least 2% of guaranteed assets". - As such, Crédit Logement's belief that this debt will be treated by the regulator as Tier 2 after 2021 and the amendment of the ACPR's methodology (equivalent to a loosening for Crédit Logement) to calculate Pillar 2 requirements change the state of play and make our expectations obsolete. Our baseline scenario until now had been a disqualification of Tier 1 in 2021 and a capital need under Pillar 2 from 2018. - We can only acknowledge this new change in the calibration of capital requirements by the French regulator, and there is nothing to stop it from being repeated in the future. Crédit Logement has always been an investment with a strong ‘regulatory bias", as this release has demonstrated once again. - The current yield on legacy Tier 1 bond today is 1%. Based on a current price of 78.5%, a call in the best circumstances in 2021 would offer a yield of 6.8%, while a call in 2027 would give a yield of 3.3%. This YTC remains higher than the yields offered by the Tier 2 CASA 2027 (2.1%), Banque Postale 2028 (2.33%) and BFCM 2027 (2.26%), but it’s a purely hypothetical situation. We are lowering our recommendation from BUY to Neutral on Tier 1: as 1/ we no longer anticipate an "event" for 3-4 years that could drive an outperformance by the bond; but 2/ nor do we foresee any deterioration in the quality of this solid credit. - On the Tier 2 5.454% 2021, rated A1, we are maintaining our Buy recommendation. The yield is more modest at 0.39% but compares fairly favourably in view of rating differentials with other French banks. - >Support factors - - The group's uncontested market leadership, with a 30% share of non-assisted home loan guarantees in France. - An ownership base consisting of France's leading banks, which both refer business to the group and guarantee its solvency. The banks have made a commitment to the Banking Commission to guarantee jointly and severally the institution's solvency. - Expertise in risk control and loan selection and collection, ensuring excellent asset quality. - Pillar 1 capital ratios are adequate with a CET1 ratio of 15.51%, a Tier 1 ratio of 17.47% and a total capital ratio of 23.52%.- The ACPR's proposed amendment to Pillar 2 reduces Crédit Logement's capital requirements, delaying the need to shore them up. On our estimates, the capital ratios will need to be boosted by 2020 or 2021, whereas we had been expecting a transaction (AT1 and/or capital increase) from 2017-18.Points to watch - - The non-performing loan ratio is rising, but remains low. However, coverage of non-performing loans by the mutual guarantee fund (MGF) has deteriorated in recent years.- The Pillar 2 capital requirement stands at € 7.3bn for a total prudential capital requirement of € 7.6bn. As such, Pillar 2 capital ratios are fair, with a CET1 ratio of 5.51%, a Tier 1 ratio of 6.21% and a total capital ratio of 8.36%.