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Edited Transcript of COFA.PA earnings conference call or presentation 29-Jul-20 4:00pm GMT

Q2 2020 Coface SA Earnings Call

BOIS-COLOMBES Jul 30, 2020 (Thomson StreetEvents) -- Edited Transcript of Coface SA earnings conference call or presentation Wednesday, July 29, 2020 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Carine Pichon

COFACE SA - Group Chief Financial & Risk Officer

* Xavier Pascal Durand

COFACE SA - CEO

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Conference Call Participants

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* Benoit Petrarque

Kepler Cheuvreux, Research Division - Head of Benelux Equity Research

* Benoit Valleaux

ODDO BHF Corporate & Markets, Research Division - Analyst

* David Barma

Exane BNP Paribas, Research Division - Research Analyst

* Edward Morris

JPMorgan Chase & Co, Research Division - Equity Analyst

* Hadley Cohen

Deutsche Bank AG, Research Division - Research Analyst

* Thomas Fossard

HSBC, Research Division - Co-Head of European Insurance and Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to the conference call for the presentation of Coface results for the period ending June 30, 2020. (Operator Instructions) As a reminder, this conference call is being recorded. And hosts for today's conference will be Mr. Xavier Durand, CEO; and Varine Pichon, CFO.

I would like to turn the call over to Mr. Xavier Durand. Sir, please begin.

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Xavier Pascal Durand, COFACE SA - CEO [2]

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Thank you, and good evening for those of you who are in Europe, and I guess good morning if you're in the U.S. We're happy to report today our results for the second quarter of 2020. And as you probably read in documents, we're reporting a profitable second quarter with a net profit of EUR 11.3 million, bringing the total profit for the first half of 2020 to EUR 24 million. We'll go into a lot more detail, but just to highlight on the first page, turnover is down 0.6% at constant FX and perimeter. It's declining a little more in the second quarter at minus 2.1%. That's, I would say, probably moderate despite the fact that a lot of our economies in Western Europe were actually in lockdown during that period.

On a number of items, the business have actually performed pretty well. I mean, new business is at a record. Retention is also at a record, and this drives positive net production of EUR 33 million for the first half. We're starting to see the first impact of the repricing that we've started, and we'll talk a little more about this. Services are growing 7%. Information services are up 13%. Of course, what we do not control is the activity of our clients, which continues to slow down. We do expect that to continue in the coming quarters as obviously the crisis is not over. And we are now entering a slow and differentiated recovery.

In terms of the losses. The first half net loss ratio is up 13.4% at 57.4%. That brings the net combined ratio in the first half to 88.6% and to 91.4% in the second quarter. So the gross loss ratio is up 18.1 points. It's been driven, in particular, by the provisions we've taken on the new vintage 2020 to cover what we anticipate is going to be a higher loss frequency as this vintage develops. When we take account of the government schemes that have been put in play, and I will again go into more detail, the net loss ratio is only up 13.4%. Our net cost ratio is down by 0.8% to 31.2%, and that reflects both the continuation of tight cost discipline all the projects that we've launched in the past and also the growth in our service revenues.

So as I said, EUR 24 million of net profit in the first half. Return on average tangible equity at 2.8%. Our solvency, that's an important point. You remember, we started from a very strong position in 2020. It remains very strong at 191%. That includes the support from the government. If we exclude the government support, it's still 183%, which is well above the target range of 155% to 175% that we had highlighted as being our comfort scale.

And then finally, as you probably recall, we had agreed to purchase a company in Norway called GIEK Kredittforsikring, which is the state-owned credit insurer. And we closed this transaction in the second quarter. This is the second purchase that Coface does in 1.5 years. It actually turns out that we will be expecting to book a badwill of about EUR 8 million at this stage, which will be booked in the third quarter given that the acquisition was closed in the month of July.

So Coface continues to execute in an environment which is challenging. And I show on Page 5. On the top, the latest forecast, which has changed a little bit from what we showed in -- at the end of the first quarter, I think since then, we've understood that the lockdowns have been longer and deeper and tougher, I guess. Then we anticipated the impact on the global GDP is actually going to be more. So we are, at this stage, thinking about minus 4.5% for 2020, followed by a recovery next year. But clearly, the impact of the pandemic will last well into 2021. This is a health crisis for which we have no vaccine at this stage, and obviously, no cure. We know that social distanciation works. And as the pandemic continues to flare in North America, in Latin America and to some extent it's coming back into places where we came out of lockdown. Social distanciation will be the key criteria or the key tool that we have to control the virus. As such, we expect a slow and differentiated recovery. We published a lot of literature on this. If you go to our website. And clearly, it will depend on the country. It will depend on the sector. And there will be a recovery. There is a recovery, but it will be slow and differentiated.

Our forecast in terms of insolvencies. You can see that on the bottom left-hand side, 33% increase from -- I would stress that point what was a low point in 2019. So that's a significant increase, and you see the main culprits here with the U.S. taking the lead, the U.K., Italy, France and to some extent Germany doing better than the rest. What's interesting in this crisis, which is very different from 2008 is that the reactions of the government, given that this is a health crisis, and there's no moral hazard, and I think the governments have learned from what happened in 2008. The governments have been very fast and very bold in taking action to protect the structure of the economy, implementing support mechanisms, which I think far surpass anything we've seen in the past.

So as a result of this, the claims activity that we've seen so far is well below what we experienced in 2008. We expect, obviously, monetary policies to remain highly accommodating going forward. In addition to supporting the economy through loans, guaranteed loans, through paying furloughed employees, et cetera, governments have been talking with the credit insurance industry in terms of putting in place schemes that would allow us to provide support to the economies and avoid what they feared, which would be a credit crunch or corporate credit crunch, if you will. And so we've signed contracts with 11 different governments. And I'll go again a little bit more into details, and there are another few ongoing at this stage. So in reaction of this crisis, which is completely unprecedented and you remember, we presented our Build to Lead plan literally 2 weeks before we went into lockdown. Coface has reacted extremely fast, and I would say extremely well on the things that we control.

You can see on the top left-hand side of Page 6 the number of prevention actions that Coface has taken over the last 4 years. And it's pretty clear, I guess, that since the beginning of this year, we have more than tripled the number of actions that we've taken from the last quarter last year and probably quadrupled from what it was in the first quarter. So the teams have responded well. We went into lockdown overnight. There's been no rupture of our service to clients or to brokers. Actually, we have committed not to do automated reduction plans, and we have not. This has all been manual, maintaining the dialogue with clients.

You can see on the bottom of that page that the total exposures for Coface are down 6.4% from where they were at the end of last year. I think this is the steepest decline and the strongest decline on record for 6 months that Coface has ever done. And you can see on the right-hand side how it breaks down by region. I thought it would be interesting for -- to provide you some color on where the risk has been altered most. Clearly, Latin America, and I don't think that will come as a surprise to anyone, down 27% from the end of last year. Central Europe, down almost 11%. North America, the numbers are a little skewed here because we did enter into a large contract in a better segment just before the crisis. But if you took that out, we would be down double digits. Asia Pacific at minus 5%. Northern Europe, on a pro forma basis, is down about 3% to 0.7%. Med and Africa at minus 7%, and Western Europe at minus 5%. So some very significant actions that have been taking in the spirit of what we committed to do when we started the Fit to Win, which is to maintain a strong level of dialogue with our clients.

In addition to managing the risk, obviously, being very selective in where we want to play, we have entered into contracts with governments, and you can see where we stand at the end of Q2 on the left-hand side of the chart. So we have finalized and signed contracts that have been approved by the different governments in countries -- in 11 countries, which represents about 50%, very close to 50% of our total exposures. There are ongoing discussions with other governments or for extensions of these programs, scope or geography, which are close to another 15%. So there's about 1/3 of our book -- a big 1/3 of our book, which, is at this point, we expect not to be covered when this is done.

This comes before -- in between us and the reinsurance programs that we have in place, which we remind you of on the right-hand side of the chart. You remember that we have 2 different quota shares for now 11.5% each. They are 2-year contracts, and they renew every 2 years on alternate years. We have an excessive loss policy, which leaves with Coface on 1 single event, something like 3% exposure to our total shareholder equity. And then we have stop-loss programs, which protect our downside when losses go over a certain level. Clearly, we maintain a broad pool of well-rated reinsurers with strong ratings. So we haven't altered our reinsurance policy, but the governments has come in between us and the reinsurance market. And I think that's something very new to this crisis.

On Page 8. I just wanted to highlight how we've thought about managing this crisis. And the left-hand side of the chart reminds you of what we said when we presented Build to Lead, and that was, again, beginning of March. So we said we want to be seen as a leader as a reference in this industry in terms of how we operate in terms of risk management being very proactive, very agile; in terms of service being quick, being very consistent and flexible to be able to adjust to whatever the environment holds for us; and in terms of the operating model being simple, integrated and digitized maintaining our focus on growing the business and creating value over the cycle, so investing in things that we see as profitable over the long term. Maintaining on average through a cycle a return that's above our cost of capital, and then putting in practice the culture that we've created that we spent over the last 4 years building for Coface and making sure that now it's a reality for the business.

And you can see on the right-hand side, how I think Coface has executed well on the things that we can control, whether it's new sales, new business, retention, prevention actions, total exposure management, how we manage the price, the sales of information, the cost management. I've touched on this, and I'll go into more details in the rest of the presentation. But I think on these elements that we actually can control most, Coface has done well in the first phase of this crisis over the last 6 months. And obviously, we're very careful about monitoring the things that we do not control as much like client activity, as I said, a lot of businesses have seen their turnover will be impacted significantly going forward and factoring volumes have been slow. And everybody can understand this in the second quarter, given that we're mainly in Germany and a lot of the country and a lot of surrounding countries were actually in lockdown mode. Fees volume, which is tied, to some extent, to the 2 items above. And then financial revenues in the portfolio, where clearly, the expansionary policies being put in place have an impact on rates and where we will see an impact on our own book. But again, we've been very conservative in the way we manage the book, and we're not looking to maintain the yield at the cost of risk that we wouldn't be comfortable with.

So -- and then in terms of the culture, I'd just say a word about this because we conduct an employee survey every 18 months, and we decided to go ahead with the survey, which we just got the results from literally 10 days ago. We had 94% spontaneous participation of all of our employee base worldwide into the survey in the course of 3 weeks, which is even higher than in 2018. And then the survey results were up 24 points from where we were last time at the level of the international benchmark. So I think Coface is actually -- the message I want to send here is we're on a ball. The business is operating well. And of course, we don't control the environment. And that's the thing that, that we'll have to go through. But anyways, the business is operating well on the things that we can control.

And I'll go into more details now on Page 10. You're used to seeing these slides. So we'll just peruse through them. As I said, turnover is down 0.6%, all other things equal. Trade credit is down 2.3%, and the decline is led by decline in client activity. The turnover is still benefiting from positive net production. And as I said, we don't expect that to necessarily continue over the next few quarters. But the good news is we've put a little more focus on service revenues and on information sales, which are up 7% and 13%, as I've already said. And as I mentioned earlier, factoring is down almost 14%. This is really a function of the draws that our clients are making on the capacities that are made available to them. And we've also started to obviously act on the pricing of that book. As we had highlighted, it was one of our strategies or key items in the context of Build to Lead. Then the fees-to-premium ratio is starting to creep up again, which I think is good.

So on the next page, we look at the geographic split of volume as we usually do, and you can see Western Europe is down 4%. That's mainly lower client activity. Same story in Northern Europe, which is mainly Germany, where we see low clients in TCI -- low client activity, sorry. And as I mentioned, a decline in factoring volumes. Central Europe is kind of flattish on -- at constant scope, and growing a little bit on credit insurance, shrinking a little bit on factoring. Med and Africa continues to grow. They've been very strong in terms of the retention of their clients. They're good on driving fees and services. So we're seeing good performance there. North America is kind of flattish, again, with new business being pretty good, but lower activity from the clients. Asia Pacific, again, lower activity, and that's not a surprise. They were some of the first ones to enter into the crisis. Then Latin America, which is probably the one most difficult environments, net-net and correcting for FX because there's a lot of variations here, is slightly up. But that's, I've said this on prior calls, a result of the momentum we had there on the international contracts going back a couple of years, not something that's driven by aggressive business underwriting.

And to illustrate what I said earlier in terms of our ability to perform on things we can control, I go to Page 12 where you can see that new business for the first half is up at 86. It's the best year we've had since we started this whole turnaround effort. Retention is, again, the highest it's been at 93.4%. Pricing is probably the best in the last 10 years at -- so it's not massively positive, but it's a positive, and I don't think that's happened any time in the last 10 years, at 0.2%. And then volume is still positive, and that one I would expect, as I said, to continue to be challenging as the economy will recover, but will recover slowly over the period to come.

On the loss side, you see on Page 13, that for the first half, our loss ratio before reinsurance and including claims handling expenses is up at 59% from about 41% in the first half of last year. You can see the quarterly sequence with an increase, which started in Q1 and continues in Q2. The gross loss ratio for the first half of the year is really partly due to increased claims, but mainly further anticipation of an increase in corporate bankruptcies. As I said, there's been a bit of a disconnect between the macro impact and the micro impact and the companies are being supported by government. And so we haven't changed our reserving policies. We have used all of our ability to see through what's going on to increase the reserving on the new vintage, and you see that on the bottom right-hand side of the chart, with the new vintage 2020 being opened at a reserve rate of close to 88% from the 73% that we had last year. And at the same time, the recoveries on prior vintages continue to be pretty good at 31% for years -- underwriting years '19 and before. So that leads to the 56% risk performance for the first half.

Now the next Page 14 highlights how the different regions have performed. And I think I'd prefer to skip that one because you see the half year number. But just to continue the sequence, if you will, with you on Page 15, where, as usual, to keep it consistent from quarter-to-quarter, we show the large, more stable markets at the bottom and the more volatile and historically difficult markets on the top. So you can see that in Western Europe, after a spike in the first quarter 2020, which we explained was linked to an industry-wide claim but while things have come back down. So they're a little higher, obviously, than they were before, but that's mainly, as I mentioned before, the reserving process that we've gone through on 2020. Northern Europe is seeing the same thing, except that they also had some good recoveries on prior vintages. Central Europe is up at 57%, and Med and Africa, again, driven by the reserving methodologies up at 62%. On the top, you clearly see on the right-hand side, that Latin America is the toughest market. I mean we've reduced our exposures from where they were at the beginning of the year at 27%. That's after we had already reduced the exposures quite dramatically in 2019 and in 2018. So this market has seen some very, very large risk actions. I think we all understand, they were in a economic down cycle before the COVID crisis hits. The COVID crisis is raging and probably one of the less controlled in the world over there. And then there's additional social and political turmoil adding to the noise.

Asia is holding up pretty well, I would say, at 58%, pretty much like the 4 markets below them. And North America, traditionally, that's a market that reacts faster, both on the upswing and on the downswing, and this time is no different. You probably have seen the list of retailers that have gone into bankruptcy over the course of the last 6 months. It seems like the Mall of America has pretty much gone bankrupt. Household names, JCPenney and Neiman Marcus and Barneys and specialized retailers like J. Crew and G-Star RAW and Aldo for the shoes and Modell for the sports. And then we had Wendy's. And so I think the number of bankruptcies in the U.S. is pretty clearly on the upswing. There are no government programs in that part of the world. But the team, I think, is taking this into account, and we were adjusting, as I said, our exposure to these markets.

On Page 16, you can see our costs and how we've come in through the quarter at EUR 166 million, which compares to the EUR 177 million for the second quarter of '19. So we're down 5.1% on cost. That obviously is more of a cut than the drop in premiums, which means that the cost ratio is actually improving in the first half from 33.9% to 33.2%. So I think it's a good sign that the business is focused. The actions that we've started in the past are paying off. We're not letting go of our desire to simplify, digitize and make the business better. We are benefiting, of course, from savings that are linked to COVID. Nobody is traveling or hardly at this point. International business travel is something, and it's very difficult, et cetera, et cetera. We're benefiting from the cost benefits that came from the integration of our U.S. agents, which is now final. So these things are coming into play. But net-net, I think the business, let's say, what matters, I think, is where we're executing on the cost front and without abandoning our ambitions, when it comes to the Build to Lead plan.

So with that, I'm going to turn it over to Carine, who is going to take, as usual, the next pages in the presentation.

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Carine Pichon, COFACE SA - Group Chief Financial & Risk Officer [3]

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Thank you, Xavier, and good evening, everyone. So I will now comment on starting with reinsurance. The reinsurance clearly plays this role, which is to absorb the higher loss activity. When you look at the bottom part of the slide, you see that the cost of reinsurance, which was not far from EUR 50 million last year ended at end of June at a little less than around EUR 6 million of cost. It includes, for the first time, government scheme, which are import in several countries. The impact of these schemes represented a positive impact of EUR 8 million in Q2 '20. It also has, for consequences, to increase the premium cession rate. You see that we went from around 29% of premium cession rate in H1 '19 to a little at 40% in H1 '20 and also a higher cession rate of claims, which reflects also the schemes, but also higher opening loss ratio.

Continuing now, Page 18, the net combined ratio at 88.6% so -- for the first 6 months of the year, so an increase by a little less than 13 point of percentage clearly due to increase in claims ratio. Xavier has just commented it. And cost ratio is down by 0.8 points, which shows the good cost discipline we continued to execute. And on the quarterly basis when you may see out combined ratio is at 91.4%. The net cost ratio is at 33.5% versus 32.2% in Q2 '19, which is mainly due to the fact that commission rate, which is granted by government are lower than the usual one we have from external reinsurance. It has an effect on cost ratio. In terms of loss ratio, it's 57.9%. So it's quite stable if you compare with Q1 '20 because even if we have higher losses and expected increase in defaults, it has been absorbed by higher reinsurance and then particularly effect of government schemes.

Having said that, looking now at Slide 19 and the financial portfolio. You know that we have -- our aim is to have a resilient investment income as much as possible. We have decided, you remember, to increase liquidity in the financial portfolio, and we want to keep and to secure our portfolio even as of today. So it has an impact on accounting yield, 0.6% compared to 0.9%, particularly in that low interest rate. Having said that, the net investment income is stable at around EUR 17 million because last year, we have had some negative one-off, which didn't recur this year.

Net income, Page 20, at EUR 24 million, EUR 11.3 million in Q2, we already commented on it. So the decline is coming from clearly current operating income and the increase in loss ratio. To me commented also in the tax rate. You see we have a tax rate at 46%. If you remember in Q1, it was even higher because we have one big claim in a country where we haven't booked any detailed tax assets. It didn't happen in Q2. So Q2 you see tax rate is around 39%. So it came back more to a level where we are more used to. But all in, on the first 6 months, it represents 46% of tax rate.

Page 21. So as usual, return on average tangible equity, you see on the bottom of the chart, 2.8%. I mean we already have commented that the decline is mainly coming from technical results, mainly from loss ratio deterioration and at a lower extent, with a small, lower financial result and a higher tax rate. Equity is very stable, and I will come back on it because here is the IFRS equity, but you will see also that (inaudible) is very high. You see that impact on the result of clearly of the first 6 months. But we also have a lower impact of revaluation reserves following a rebound on market. And also, we have a low treasury shares and currency translation despite the fact that you know that the currency have moved a lot during last quarter. So all in, equity is quite stable between end of '19 and end of June 2020.

So that's a good signal to go now page 3 -- part 3, on capital management. So still a very solid balance sheet, financial strength. Xavier mentioned it, but we have kept our rating AA- by Fitch and A2 by Moody's. Normal, we have been putting a negative watch continuing the current environment. And also, we have kept also AM Best with A (Excellent) with a stable outlook. This solvency and strong balance sheet also can be analyzed, Page 24. You see that we have a solvency ratio, which is estimated at the end of June, at 191%, which is clearly above the target range. You remember, which is between 155% to 175%. And even if it includes government scheme impact, this ratio would have been 183% without. So it would also have been above this target range.

Something to be looked in terms of evolution compared with end of '19. End of '19, we were at 203%, including the fact that we decided not to pay any dividend. And what you see is that the main reason of this decline in the own fund variation, meaning solvency shareholder because we have included in it not only clearly revaluation -- negative revaluation on financial portfolio but also we have reviewed anticipated losses, anticipated base estimates, and you directly have this effect in own fund variation.

A last comment on this slide, on the right part of this slide is as usual, sensitivity of this ratio to either market shocks or also loss ratio deterioration. On market shock, you see, and it's on purpose, you know that we want to be as much as possible not to be touched too much by change in financial portfolio. So that you may see because the gap you may have in solvency ratio can go by 7 maximum percent. So it's important, but not so huge, let's say, like that. Whereas when you look at the loss ratio evolution, if we had to replicate the crisis of 1/50, we will be at 175%. But even this ratio in that scenario is above or at the limit of the top range of the target trend. It shows that we have a very robust certainty over time.

Page 25, you have the split of this 191% between on the one hand, what you have in blue, which is the total required capital, EUR 1.1 billion. I shall say that this capital requirement is quite stable and resilient through that crisis, and it's thanks to a partial internal model because we have calibrated so that it can be seen through the cycle. And so we are very happy to have this model instead of the standard formula because there is no huge [practicality] in that calculation. However, and that's where we have the most impact. And I commented before on the eligible own funds, it's been at EUR 2.1 billion. We had a decline because we have reviewed the level of best estimate of provision, which is directly computed in (inaudible).

And now I let the floor to Xavier to talk about key takeaways and outlook.

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Xavier Pascal Durand, COFACE SA - CEO [4]

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So just to summarize what we've discussed here, we book our second quarter of profit in 2020 in an environment, quite frankly, which is quite extraordinary in terms of the disruption on one side, in terms of the government intervention on the other side. We maintained prudent reserving. But I think to me, what's important is that this quarter demonstrates, again, the resilience, the agility and the ability to kind of navigate the environment that we're all looking for in Coface. As you've seen, the solvency ratio, even excluding the benefit -- any benefit from governments, remains well above our target range. So we've got a strong balance sheet. I think we can say, we've successfully managed the first phase of this crisis. So we are focused on the crisis, but we don't lose sight of the strategy that we laid out in the Build to Lead.

There are some changes -- some tactical changes we have to make because the priorities are priorities. And -- but in the end, we're not changing our strategy. The risk prevention actions remain at an unprecedented level, I would say. We're still trying to grow selectively, very selectively. We're trying to -- we're remaining true to what we said in terms of creating value over the long term. Our risk exposures are down the most that they've been in the shortest period of time in the history of Coface. Our new business, client retention, pricing, service revenues, they're all going in the right direction, given the things that we can control. And solvency allows us to continue to be on the hunt if things ever come our way as we illustrated by the acquisition of GIEK. And I remind everybody, this is the second time we do an acquisition in the last couple of years.

And then finally, we continue to cooperate with governments to support the economy and participate in our industry. So clearly, the big unknown is the economic environment, the resurgence or not a resurgence of the virus. The sanitary situation really drives, in this case, the rest of the economy. So we're both continuing to focus on executing in this environment and trying to do the best with what's out there. And at the same time, we remain confident that Build to Lead is the right plan and that we're focused on doing that in the medium term.

So that's the story. And with this, I'm happy to turn it over to whoever wants to ask questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have our first question in from Thomas Fossard of HSBC. Once again, we have our first question in from Thomas Fossard of HSBC.

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Xavier Pascal Durand, COFACE SA - CEO [2]

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Tom, are you on mute? Or is there a technical issue here?

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Operator [3]

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Thomas, if you can hear us, please go ahead. Right. Let's move on to our next question. Thomas, if you can hear us -- I think you are there. Is that Thomas Fossard of HSBC?

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Thomas Fossard, HSBC, Research Division - Co-Head of European Insurance and Analyst [4]

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Can you hear me?

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Xavier Pascal Durand, COFACE SA - CEO [5]

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Yes.

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Carine Pichon, COFACE SA - Group Chief Financial & Risk Officer [6]

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(foreign language)

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Thomas Fossard, HSBC, Research Division - Co-Head of European Insurance and Analyst [7]

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(foreign language) Three questions to start with. The first question was on the exposure drop, so minus 6.4% year-to-date. Just if you could provide a bit of kind of forward-looking view if you're there already or bearing in mind the current environment. Or if we should expect further cut in exposure towards the end of the year, so more work to be done in the second half of the year?

Second question would be on the cost. So it's quite impressive to see your internal cost dropping to EUR 126 million in Q2 stand-alone. It was interesting to better understand if there were specific one-off item or if EUR 126 million was now with the run rate for the coming -- for the upcoming quarters?

And yes, the third question for now will be on the duration of the schemes -- the governance schemes. Are they more or less all set in place with the time line of the end of the year currently? Or for part of them, they are already expected to be prolonged into 2021?

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Xavier Pascal Durand, COFACE SA - CEO [8]

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Okay. Well, talking about the governance schemes, yes, they more or less all try to target the bulk of the -- to focus on COVID. So basically, I think everybody understood that this thing started in March, and everybody is planning for these schemes to end at the end of the year. There might be one or maybe one, I can't remember, Carine, if there's one that goes into a bit longer, but...

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Carine Pichon, COFACE SA - Group Chief Financial & Risk Officer [9]

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Not yet, no. For the moment, (inaudible).

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Xavier Pascal Durand, COFACE SA - CEO [10]

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But I think it's all ending at the end of the year. And the question is what happens then. And I think this will really be a question of what's happening in the economy and in the sanitary side. So either we start to see things clearing out and the governments are focused on trying to wind down their programs or COVID is raging and they might decide to expand some of these. I think this is too early to say, and I don't want to speculate on this.

In terms of the cost, yes, you're right. We have a decline in cost. As I said, it's 2 things. It's probably more than 2 things. One is the structural changes that we've made to the business for the last 4 years, like the cleaning up over the rationalization of our agent network, et cetera, et cetera. So all these things continue to be true. The second thing is there are things that we've done that we probably wouldn't have done if there was no COVID crisis like we probably decided that given the current environment, we don't want to put new salespeople in places where the risk is higher. And then the third thing is, as I said, you just have the natural fact that people are not traveling anymore or things of that nature, which are typically COVID-related. So does that -- what does that mean for the future? Well, some of these things will be permanent and some of these things will actually come back, hopefully, because we'll get out of this crisis.

In terms of the exposures, what I would tell you is this is a never-ending job, right? So again, I think the key word I've insisted upon for the last 4 years, and I think it's starting to become reality is agility, right? So we are going to be doing the right thing where it needs to be done. And as you know, the second phase of the crisis is still to be spelled out. So we've done what we think we needed to do at this stage. And -- but we're not going to drop our eyes off the ball. We're not going to hide behind the government schemes that will be here for a while but then don't go away. So we're going to continue to manage exposures. Where that ends? I'm not going to give you a forward-looking statement on that one. Well, I'll tell you more on the Q3 and Q4 earnings call.

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Operator [11]

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We have a question now from Benoit Petrarque from Kepler.

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Benoit Petrarque, Kepler Cheuvreux, Research Division - Head of Benelux Equity Research [12]

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I hope the line is clear.

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Xavier Pascal Durand, COFACE SA - CEO [13]

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Yes.

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Carine Pichon, COFACE SA - Group Chief Financial & Risk Officer [14]

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Yes. Very good, Benoit.

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Benoit Petrarque, Kepler Cheuvreux, Research Division - Head of Benelux Equity Research [15]

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Okay. Good. Very good. Okay. So yes, the first question is on the Slide 5, where you show your GDP growth forecast. The ECB came with a minus 8%, I think, for the full year '20. You are minus 4%, and they have plus 5% in 2021. Why -- I mean, the minus 4% seems quite optimistic. So what is your view on that? And will a more negative GDP forecast, will that have an impact on your combined ratio provisioning potentially? So if we will see kind of Coface downgraded the 4.4%, will that lead to higher provisioning in the coming quarters? That's the first question.

The second one is on the kind of the claim activity and probably we are talking on a monthly basis here. Have you seen the peak of the claim activity already? Was that in June? Or is that still in front of us? So maybe could you maybe give a comment on this peak claim activity? And that will be very useful if you could provide data on monthly frequency, that would be extremely useful.

On the -- the third question is on the pricing. So you talk about small positive from pricing, still early sign, and we are not in the repricing season yet. But how much repricing do you expect? And also in considering the government schemes, can you also freely reprice?

Then the fourth one will be on the net earned premium. This is done, obviously, a transfer mechanism, but in the Q2 level a good run rate for the coming quarters because I think most of the schemes started during the quarter. So I was wondering if there's still be pressure on the net earned premium. And if you have time, it would be great to get a bit more comments on the Page 32, where you present the schemes. Maybe talk a bit more about kind of the different -- big differences between the schemes would be great.

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Xavier Pascal Durand, COFACE SA - CEO [16]

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Okay. A lot of stuff to cover. Let me start with the first question on the GDP. So I don't know (inaudible). What we have here is the global GDP outlook, right? So that includes a lower number for Europe and advanced economies and a better number for emerging markets, and some areas are still growing. So I would just caution that you're comparing apples and apples here. And then the second thing I would say, regardless of all of this is I just insist on the comment I made earlier, which is that, yes, this GDP drop is, quite frankly, unprecedented. I don't think we've seen anything like this since the Second World War. But at the same time, we haven't seen government reactions like we've seen since the Second World War either. So there is a bit of a disconnect between the headline number, if you will, and what's really going on, on the ground, which leads to your second question, I mean -- and I think I just answered it.

I mean the claims activity is not correlated to the GDP drop, like you would expect if there was no government support, right? So government measures are working. So it's hard to say when is the peak of claim activity going to happen. I don't think this crisis is over. As I explain, our losses today are, for a good chunk of them, linked to reserves that we've set up for the new year 2020. We're being reasonable the way we do this. We have kept the same metrics and methods. But clearly, there's a lag between the GDP and the way the market's reacting because I think, in particular, because of the government schemes that have been put in place in so many countries with so much money. I think we're talking about close to $10 trillion at this stage at the same time.

When it comes to pricing, as you point out, I mean, this is not pricing season for us. So I think the jury is out in terms of where this goes because it will -- a good chunk of the pricing will go towards the end of the year. As I said, I'm not going to make forward-looking statements, but we will apply the same principle that we've been advocating for the last 4 years. So no change in what to expect out of Coface. But where the economy stands, where competition stands, where government schemes stand at the end of the year, that's all to be determined when we get there.

In terms of the net premium, well, the same forces will be at play, right, as we go forward. So you'll have the new business. You'll have the price, which we've seen is better than before, but still not a big positive. And then you have what you call the activity of our clients, which I think is the big driver here, which we still expect will recognize the drop in GDP that we've been talking about. So I think we'll still have that.

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Carine Pichon, COFACE SA - Group Chief Financial & Risk Officer [17]

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Maybe -- because I think the question was also on net earned premium. So your question was maybe on cession, right? Is that correct, Benoit, which was your question?

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Benoit Petrarque, Kepler Cheuvreux, Research Division - Head of Benelux Equity Research [18]

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Yes. Yes.

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Carine Pichon, COFACE SA - Group Chief Financial & Risk Officer [19]

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Yes. So maybe I can take that, Xavier, if you want. Okay. So just -- sorry, it was Page 17. Be careful, it's H1 results. So presentation rate is for 6 months, knowing that the scheme have been implemented in Q2. So if you want to see something which is more in line with the [scheme entirely], you have to look in Q2. And then it will also depend on what will happen for the next schemes, which can be implemented if we come back on the slide, which is number, let me check 7. You see that here, you have the impact of around 50% of total exposure for 11 schemes signed. And we are still under discussion for 14% -- 15%, let's say, additional one, including large countries such as Italy and Poland. So it could have an effect that every time we have a finalization, we make a press release to lead to what will be the main financial features. So it's -- let's say, it will also depend on the speediness and (inaudible) nature of the schemes.

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Benoit Petrarque, Kepler Cheuvreux, Research Division - Head of Benelux Equity Research [20]

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Yes.

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Xavier Pascal Durand, COFACE SA - CEO [21]

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Okay. So I'll go to your question on Page 32. And if everybody flips to that page. How do you read this page? So you've got 2 kinds of schemes. One is what they call top-up, which is basically saying if we are ensuring a limit today and tomorrow we want to reduce that limit, the government is proposing to the client to step in to maintain some of that limit on their own account. So that's a line-by-line kind of thing, client-by-client kind of thing. A number of countries have chosen to go down that route, France to start with in the first scheme. But Israel, Portugal, Slovenia and Canada, that's the way they're going.

Clearly, it's a lot more cumbersome to manage. It's slow. Clients have to pay a premium so the impact of these programs tend to be less massive, if you will, on the economy. Then the other kind of program, which is actually the one that initially Germany put forward, which is basically taking a quota share of our business, where they take 65% of our premiums, and they take 90% of our claims for the things that are related to COVID, and that scheme has pretty much been copied or close or something similar by a number of other countries.

You see the list here, the Netherlands, the U.K. now, Belgium, Denmark and lately France, which has added this system to the existing quota share. So that's really how it works. They all have slightly different tweaks to them. So I'd just point out that for Coface, it's another sign of our ability to execute because it adds complexity to our business. I mean we have to manage all these different things and comply with all the rules that pertain to them. But the business has been quite actually good at putting all the stuff in place and managing it and publishing the numbers and doing everything that we need to do from a reporting standpoint. So again, to me, a good sign that the business is executing well.

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Operator [22]

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Our next question is from David Barma from Exane BNP Paribas.

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David Barma, Exane BNP Paribas, Research Division - Research Analyst [23]

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My first one was just a follow-up on one of the points discussed early on the extensions of the government schemes. And I just wanted to check the mechanism there because my understanding was that exposure cuts will take a couple of months to feed through your P&L. And so when we're thinking about 2021, does that mean that by sort of September or October, you will need to have a view aligned with the regulator in terms of what's happening on whether this thing extended or not.

My second question was on the solvency movement. Could you please remind us what the impact from the government scheme is on the solvency movements and what item is driving that?

And my last question is on recoveries. What's driving the level of recoveries in Q2, specifically? And should we expect that number to normalize as the share of the 2020 vintage with a higher share of bankruptcy feeds through?

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Xavier Pascal Durand, COFACE SA - CEO [24]

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Okay. When it comes to the government schemes, you're right to point out, it takes a couple of months or whatever the number is to adjust to a new reality for our business, right? It's an operational question, and it's a contract timing kind of question. So I think actually, the governments will probably want to provide the market and themselves with some kind of a view as to what's going to happen next towards the end of the year. To tell you where that's going to be September or November, I can't say. We're in politics here so.

So to me, situations can vary depending on, one, what's the real estate of the economy at that time, and then what are governments going to decide. But in any case, Coface is going to have to be ready either way, right? So we -- you have to count on yourself before you can count on others. And that's the way we're going to -- that's the way we're going to philosophically, if you will, while complying with everything that we told everybody we would do, that's the mindset, if you will, that we have to keep.

When it comes to -- so what was the second question?

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Carine Pichon, COFACE SA - Group Chief Financial & Risk Officer [25]

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I think the second question was what is the impact of the government scheme on solvency?

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Xavier Pascal Durand, COFACE SA - CEO [26]

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Yes. Yes. Solvency, Carine, you can answer that one.

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Carine Pichon, COFACE SA - Group Chief Financial & Risk Officer [27]

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Yes. It's a little less than 8 points. So when you see at end of June, we said it's 191%. So with 8.2% come back to 183%.

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David Barma, Exane BNP Paribas, Research Division - Research Analyst [28]

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And sorry, that 8 points, what's input in there?

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Carine Pichon, COFACE SA - Group Chief Financial & Risk Officer [29]

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Is the government scheme impact, the fact that we are protected by them? So you know it's a reinsurance treaty, in fact, that we have signed in most of the...

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Xavier Pascal Durand, COFACE SA - CEO [30]

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Governments take part of the risk and...

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Carine Pichon, COFACE SA - Group Chief Financial & Risk Officer [31]

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Take part of the risk.

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Xavier Pascal Durand, COFACE SA - CEO [32]

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And for the risk that the government takes, we don't have to allocate capital to that, right?

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Carine Pichon, COFACE SA - Group Chief Financial & Risk Officer [33]

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So we have capital relief.

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Xavier Pascal Durand, COFACE SA - CEO [34]

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And then the recoveries, I think there is a -- you're right to point out, there is a correlation in all the crisis that we've been through in the past. There is a correlation between the crisis and the level of recoveries you get on past vintages. So I do not make forward-looking statements here, but it will depend also on a little bit on the outlook.

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Operator [35]

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We have one final question from Edward Morris of JPMorgan.

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Edward Morris, JPMorgan Chase & Co, Research Division - Equity Analyst [36]

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Few questions, please. The first one, just on the government schemes, can you just clarify, is there any conditions attached for Coface in participating in these programs? Are there any sort of requirements that they place on you either when it comes to capital management or anything else that we need to think about now that you participate in them?

And then secondly, I noted on the -- one of the first slides, you gave your solvency ratio 191% or 183%, excluding the government schemes. So I'm just wondering why do you quote this ex government schemes figure. Is it because you could choose to opt out, and that will give you more freedom in some way? Or just wondering sort of how and why should we think about this 183%?

Next question is on the 50% of business that is not -- of exposure that is not covered by government schemes. Can you -- I mean presumably, your actions in managing exposure have been much more drastic for the half of the business that isn't covered. But just if you could talk a little bit about how you're managing the risk on that half of the business, that would be great.

And then lastly, your loss ratio ticked in the quarter, obviously, they have increased. And you said that, that's really due to reserving prudence rather than actually seeing any claims at this point. So I'm just interested whether you think the loss picks that you've done for Q2 are a good proxy for the rest of the year? Are these loss picks that are sort of intended to reflect what your current view of the claims environment will look like as we go forward? Or should we expect that lower loss picks continue to deteriorate before they start getting better?

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Xavier Pascal Durand, COFACE SA - CEO [37]

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Okay. Interesting. So government schemes. Well, let me ask...

(technical difficulty)

would it be if you didn't have the government scheme. So are you doing okay? Because basically, you're being (inaudible) by the government? Or are you guys doing standing on your own feet, right? So I think you've got the answer here. And I think we just wanted to clarify that, yes, government schemes do help in this case. But...

(technical difficulty)

that can be safe going forward. The second thing is, the goal of these government schemes is for the governments to avoid a liquidity crunch. So governments are obviously, very keen on making sure that insurers to not just massively withdraw limits, and their support is there to kind of help us not have to do this, given the circumstances. So the requirements that we've entered into and they are -- I think they're probably public because all these government schemes are public, you guys can go and read through them, is that we would not go into massive -- into massive reduction plans, computer-driven blind, if you will.

So we have to have that a logic for where we need to adjust exposures. I think there's a recognition broadly and every scheme is different. So I'm not going to go into every one of the details, but there's a recognition broadly that if risk is bad, nobody wants to take it, right? I mean, neither us nor the clients, which usually retain a part of the risk themselves, nor does the taxpayer really want to just give money to things that are -- so it's all a matter of nuances from there in terms of what the requirements are here.

Are we being more drastic in the 50% not covered? We've been quite homogeneous in the way we've thought about the business, quite frankly. What happens is that the fact that there's a government scheme might tweak a little bit the competitive dynamics in the market, it might make some interest more bold when it comes to trying to win new business or things like this. So we have to be, again, tactical, smart, agile, and we're watching very, very carefully all -- everything. But essentially, we're adjusting the risk where we think the risk needs to be adjusted because we know that these schemes are not there to last forever.

The last question was -- I can't remember...

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Edward Morris, JPMorgan Chase & Co, Research Division - Equity Analyst [38]

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On loss picks?

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Xavier Pascal Durand, COFACE SA - CEO [39]

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The loss picks. Well, I mean, it's our -- it's the central scenario on a range of scenarios. Of what we believe needs to be booked based on our current reserving methodologies, which we haven't changed and which reflect a fair estimate of where we think in that central scenario of things should be. So -- but again, this is an exercise that we keep -- we'll have to keep doing every quarter as things develop.

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Operator [40]

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We have more questions. Our next question comes in from Hadley Cohen of Deutsche Bank.

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Hadley Cohen, Deutsche Bank AG, Research Division - Research Analyst [41]

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Sorry, my head just actually asked one of my questions. But just a very quick follow-up question on the solvency side, please, Carine. The -- can you just explain to me -- sorry, if I missed this, what are the moving parts in the own funds are versus last year? You mentioned -- I heard the obvious mark-to-market effects. But I just -- I wasn't sure what you were building in, in terms of your assumptions around claims experience. Is that just what you've seen so far this year and what you've booked already? Or is there -- are you building in more than that within solvency?

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Carine Pichon, COFACE SA - Group Chief Financial & Risk Officer [42]

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Okay. I can take the question, Xavier. In fact, the 2 main -- that's what you mentioned, 2 main reasons of the change. The first one is the revaluation of the financial portfolio because, as you know, we have market value in solvency on funds so because of the decline and even after the [reval], we are still a decline compared with the beginning of the year. It has a effect and solvency. The second one also, it's the fact that you know that in solvency equity, we put a best estimate of the provision, best estimate of the loss ratio. So the one as of today. So we have reviewed this one, that also leads to the fact that the reserve level has increased. And so that's what you may see in that solvency. So it's a review of claims and mainly anticipated one.

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Operator [43]

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Our next question comes from Benoit Valleaux of ODDO BHF.

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Benoit Valleaux, ODDO BHF Corporate & Markets, Research Division - Analyst [44]

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So few questions from my side. First of all, regarding new production, we've seen a strong increase in H1. I just wanted to know where you are gaining some clients. And more specifically, do you enjoy some strong growth in North America or not in current environment?

Second question my side is still regarding cost. Do you see some further potential cost efficiencies due to, for example, on working or maybe after the cleaning of your portfolio, you may have, in some case, a more regional approach and close maybe some local offices?

And third question, to come back on solvency, you gave a sensitivity to (inaudible), say, every 50 years at the end of June with negative impact of minus 16 percentage points. It was at minus 21 percentage point at year-end '19. It seems that it is based on your 191% solvency margin taken into account the government schemes. So I just wonder what will be the sensitivity if we exclude government scheme in the long term, if we look at the 183% you gave as a solvency at end of June.

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Xavier Pascal Durand, COFACE SA - CEO [45]

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So Carine, I'll let you answer the last one, which I -- you're probably better placed than me to...

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Carine Pichon, COFACE SA - Group Chief Financial & Risk Officer [46]

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What was the question, Benoit?

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Xavier Pascal Durand, COFACE SA - CEO [47]

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In terms of the -- sorry, in terms of the other 2 new production, we came into 2020 without anticipating COVID. So we had a plan that we just came out of, which is Fit to Win. We were going into Build to Lead. We're executing on that strategy. We've got momentum, all the actions that we've taken are continuing. And so I think you see some of that in the numbers, right? But of course, we adjust our underwriting to the reality of what's out there, and we're not going crazy and writing business that makes no sense. So what you're seeing here is the result of the strategy. In terms of cost efficiency, it's an interesting point. Because I think what we learned in this crisis is that we could operate all from home. We would never have tried something like this under any circumstance in the prior world. But with COVID, we didn't have a choice. And we realize it is possible.

So what we're going through now is trying to think through what of that can be permanent and what of that will have to go back to face-to-face and offices and all that good stuff. And I don't think we have the answer. It's way too early. While we know we can work in a crisis mode from home for period of 3, 4 months, that's been proven. What does it mean for the long term? What activities can be done remotely and what is better done face-to-face, I think we still have to learn a lot on that.

And then the other thing I would say is, yes, maybe there are some office efficiencies, but I guess a lot of people are going to be looking for renters at this stage. And then second thing is, when you work from a distance, you also need to invest in technology. So does that translate into a net-net cost down, maybe, I don't know. It's way too early to say. I wouldn't expect a radical change in the business because anyways, even if we wanted to do something radical, we are tied into leases and things like this that are multiyear. So it's an interesting topic, debate. I don't expect a revolution in the short term.

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Carine Pichon, COFACE SA - Group Chief Financial & Risk Officer [48]

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So maybe I can take the question, Benoit. I think your question was to explain the gap between the 190% or 183%, let's say, without government scheme, and the sensitivity, we have provided you, Page 24 of 175. So it clears that the gap, the difference between both ratio is less than it could have been in the previous years because we already have started to have some increase in claims. So we are already in a crisis to say like that. And so the gap of the sensitivity is lower because we are in between, let's say, a very good situation last year and one of the over 50 years credit equivalent. I hope it's your question. Just want to make sure I answered it correctly.

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Benoit Valleaux, ODDO BHF Corporate & Markets, Research Division - Analyst [49]

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That's clear. But the 175%, what is the impact of the government scheme within the figures if there are average impact? You have 8% of...

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Carine Pichon, COFACE SA - Group Chief Financial & Risk Officer [50]

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Okay. So I take your point. I wouldn't expect it to sustain, but I have to check. I will suspect quota share. I will suspect because it's quota share. So I would suspect, yes. But in any case, I will make a follow-up with Thomas to check.

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Operator [51]

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Our next question comes from Thomas Fossard of HSBC.

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Thomas Fossard, HSBC, Research Division - Co-Head of European Insurance and Analyst [52]

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Yes. Just a final one. I know you don't like to comment too much on specific names, but this one is particular. Just wondering if you were exposed to some losses regarding (inaudible)? And if it's the case, will you be able to transfer the losses to 90% of them to the German government? Or is there an issue with the underwriting year and the government scheme will not apply?

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Xavier Pascal Durand, COFACE SA - CEO [53]

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Yes. As you say, we don't like to comment, but I don't think that's a topic for Coface.

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Operator [54]

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And with that, ladies and gentlemen, we conclude the Q&A. As we have no more questions, I would like to return the floor to the presenters for their final words.

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Xavier Pascal Durand, COFACE SA - CEO [55]

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Well, look, no, thank you all for joining and being with us today. We -- obviously, we're progressing through this crisis, and we're all learning as things go forward. As I said, feeling good about the execution, lots of uncertainty out there, lots of things, lots of moving parts. So we will update you on the next chapter of the story. I think it's on the 29th of October for the third quarter income call. So thanks for joining, and I think with this, we can end the call now.

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Operator [56]

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Ladies and gentlemen, this concludes today's conference call. Thank you all for your participation. You may now disconnect.