DBRS Comments on Dexia Group Q2 2009 Results; Ratings Unaffected – Senior at A (high)

DBRS has today commented on the Q2 2009 results for Dexia Group (Dexia or the Group). Following these results, the ratings remain unchanged for Dexia Bank Belgium, Dexia Credit Local and Dexia Banque Internationale a Luxembourg at A (high) for Senior Long-Term Debt & Deposits and R-1 (middle) for Short-Term Debt & Deposits. The trend on all ratings remains Negative.

For Q2 2009, Dexia reported net income of EUR 283 million. The Group was profitable for the second consecutive quarter in H1 2009, following two quarters of significant losses in H2 2008. In this quarter, all business lines were profitable. Increased revenues and stable expenses contributed to generating sufficient gross operating income to absorb elevated credit costs with a precautionary addition to reserves. Dexia continues to benefit from the support of the Belgian, French, and Luxembourg states (collectively, the States), which is bolstering the markets’ confidence in Dexia’s liquidity. Indicative of this confidence is Dexia’s ability to tap the wholesale markets. DBRS views positively Dexia’s continued progress with its Transformation Plan, announced concurrently with Q2 2009 results, which resulted in reduced risk, improved liquidity and increased focus on its core client franchises. While DBRS remains mindful of the Group’s elevated credit costs, exposure to run-off securities portfolios and challenges in executing its Transformation Plan successfully, DBRS views these concerns as having been appropriately factored into the current rating level.

Dexia reported gross operating income, which is net of expenses and before provisions, of EUR 765 million in Q2 2009 compared to EUR 807 million in the prior quarter and negative EUR 1.4 billion in Q4 2008. Excluding FSA, revenue growth was sustained by new loan production at wider spreads in core markets and continued strong results in the Group’s Turkish entity, DenizBank, offset by the impact of the States guarantee fees and reduced fees on mutual funds and insurance products. The Group recorded extraordinary gains in the quarter due to the sale of FSA and capital gains on bond sales at DenizBank. Expenses were down by EUR 302 million, or 26%, versus Q4 2008, providing an added boost to gross operating income.

The cost of risk remained elevated in the quarter at EUR 361 million, mainly due to EUR 175 million of collective provisions in anticipation of economic deterioration going forward. Impaired loans were EUR 3.6 billion at 30 June 2009, largely flat to the level of the prior two quarters. Even at this elevated level, the ratio of impaired loans to total loans stood at just 1.04%. Dexia has maintained its coverage level of reserves for impaired loans by increasing provisions, bringing its coverage ratio to 64.1% from 58.9% at year-end 2008. Though credit costs remain elevated, Dexia generated sufficient gross operating income to absorb provisions.

Management reported progress on Dexia’s Transformation Plan, which is focused on four main priorities: (1) the sale of FSA; (2) reducing risk; (3) decreasing expenses; and (4) its core client franchises. In the quarter, the Group completed the sale of FSA Insurance to Assured. It now has a 13.9% stake in Assured. The Group has remaining exposure to the Financial Products (FP) portfolio of USD 16.3 billion that is in run-off, but this risk is provided for. It also retains USD 11.8 billion in Guaranteed Investment Contract (GIC) liabilities supported by liquidity guarantees from the States. Dexia also has its bond portfolio of EUR 149 billion in run-off, which is down 5.7% versus year-end 2008. Overall, the Group has reduced its risk profile by deleveraging the balance sheet, with a 9% reduction in assets and a 3% drop in risk-weighted assets versus year-end 2008. Its liquidity position is improving through long-term debt issuance and deposit growth. Additionally, Dexia continues to reduce risk by centralizing capital markets activities, reducing VaR, and running-off non-core activities, such a proprietary trading. Expenses were down in the first half of 2009 with a target of EUR 200 million in additional expense savings in the second half of the year and EUR 600 million by 2011. With its businesses reporting positive results, the Group is also showing results from its focus on its core client franchises in Belgium, Luxembourg and Turkey for its retail banking business and France, Belgium, Italy and Spain for its public finance business.

DBRS views capitalization as sufficient given the support of the States. The Group is currently in discussions to extend its debt guarantee by a year, meaning no new issuance of government-guaranteed debt after 31 October 2010. Dexia’s core Tier 1 capital ratio stood at 10.4% at 30 June 2009 compared to 9.6% at year-end 2008. The Group maintains a core equity base of EUR 17.0 billion on a regulatory basis. After factoring in negative accumulated other comprehensive income (OCI), Dexia’s equity capital base stood at EUR 9.1 billion, considerably improved from EUR 5.6 billion at 31 December 2008. The Group’s available for sale reserve declined due to spread tightening on its run-off bond portfolio. While capital injections from the States have helped Dexia bolster its capitalization and improve its risk profile, DBRS sees recurring revenue generation as critical for Dexia to absorb portfolio losses, cope with the elevated cost of risk and maintain its capitalization in the coming quarters.

Dexia’s funding and liquidity situation has improved with the re-opening of the covered bond market. The Group issued EUR 37.7 billion in long-term debt year-to-date, of which 59% has been guaranteed by the States. The Group has also grown its deposits by 3% to EUR 79 billion in its retail banking business, funding 13% of its balance sheet. As the Group is predominantly wholesale funded, it is critical for Dexia to regain its broad access to the markets. A key step in re-establishing the markets’ confidence in Dexia is demonstrating that the Group’s financial health is being restored. DBRS views the positive results of the quarter and success thus far in implementing its Transformation Plan as signs of progress that are viewed positively from a ratings perspective.

Note:
All figures are in euros unless otherwise noted.

The applicable methodologies are Analytical Background and Methodology for European Bank Ratings, Second Edition, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.