DBRS Comments on Dexia Group’s Q3 2009 Results; Ratings Unaffected – Senior at A (high)

DBRS has today commented on the Q3 2009 results for Dexia Group (Dexia or the Group). Following these results, the ratings remain unchanged for Dexia Bank Belgium, Dexia Crédit Local and Dexia Banque Internationale à Luxembourg at A (high) for Senior Unsecured Long-Term Debt & Deposits and R-1 (middle) for Short-Term Debt & Deposits. The trend on all ratings remains Negative.

Dexia reported net income of EUR 274 million in another positive quarter, down only modestly versus Q2 2009. With three positive quarters in 2009, totaling EUR 808 million, Dexia continued to show progress with its Transformation Plan. This plan was implemented after Dexia reported a significant net loss of EUR 4.1 billion in H2 2008 due to the impact of the crisis. The Group’s focus on generating earnings in its core businesses is important in this improvement. For a second consecutive quarter, all three business lines were profitable, a significant turnaround from Q3 2008, when all three segments had losses. Dexia’s prospects have also improved as it significantly enhanced its funding and liquidity position through increased access to the repo markets, issuance of unsecured, unguaranteed funds, and a significant reduction in short-term guaranteed funding. While Dexia continues to benefit from the support of the Belgian, French, and Luxembourg states (collectively, the States), the Group has begun to emerge from this support by issuing new unguaranteed debt in 2009. Dexia issued EUR 12.4 billion of covered bonds and EUR 9.1 billion of senior debt for 9M’09 on an unguaranteed basis, meaning that 49% of new medium- and long-term issuance was non-guaranteed.

In Public & Wholesale Banking, revenues were down versus Q2 2009 mainly reflecting lower draws on U.S. liquidity lines and related income reduction, plus higher liquidity costs and the absence of the Q2 revenue boost from CVAs on swaps in Italy and the U.S. With Dexia focused on its core markets, loan production was in the same range as the second quarter. Importantly, Dexia’s focus on its core clients was evident in the evolution of long-term commitments, which remained largely flat quarter-over-quarter and year-over-year in core markets, though other markets declined more significantly, illustrating the Group’s success with its strategy. Additionally, Dexia’s margins earned on new loans in core markets match the increase in the Group’s cost of funding. Dexia is also being selective about new commitments in the very competitive environment in the domestic market for loans. Even with successful cost control and a lower cost of risk, net income declined to EUR 95 million. Retail and Commercial Banking fared better with revenue growth helped by increasing deposits in Belgium and a strong performance in Turkey. Flat expenses and a decline in the cost of risk also contributed, as net income increased to EUR 125 million. The major turnaround was in Asset Management and Services (AMS), where net income rose from EUR 9 million in Q2 2009 to EUR 96 million in Q3 2009, driving the overall improvement for the three business lines. The principal driver was Insurance with strong revenue growth. Asset Management was also up on increased revenues, while Investor Services was largely flat. Dexia’s success with controlling costs in AMS was also evident in largely flat expenses.

Dexia reported gross operating income, which is net of expenses and before provisions, of EUR 453 million in Q3 2009 compared to EUR 765 million in the prior quarter, which benefited from the completion of the sale of FSA to Assured. Excluding FSA, the modest revenue decline was mainly due to balance sheet deleveraging and market normalization. DBRS views this positively, as the Group is focused on strengthening its balance sheet and core franchise rather than on revenue growth. At EUR 84 million, the cost of risk was down 70% on a linked quarter basis and down 90% from Q3 2008, excluding FSA. This reduction was helped by a EUR 59 million reversal of impairments on the Icelandic banks and Lehman collateral and the moderate cost of risk charges in the core businesses. Dexia’s gross operating income was over 5 times this level of the cost of risk as compared to just over 2 times in Q2 2009. This illustrates Dexia’s ability to generate sufficient income to absorb provisions and provides it with a larger cushion to absorb credit costs going forward.

As part of its balance sheet deleveraging process, Dexia has reduced its bond portfolio in run-off by 12% since year-end 2008 to EUR 139 billion, of which 97% is investment grade. While Dexia’s smaller bond portfolio in run-off, the Financial Products portfolio of USD 15.8 billion, is only 36.1% investment grade, its quality appears relatively stable with only 1% of the portfolio entering into the non-investment grade category in the quarter. Impaired loans were EUR 3.7 billion at 30 September 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 1.09%. Dexia has maintained its coverage level of reserves for impaired loans by increasing provisions, bringing its coverage ratio to 63.6% from 58.9% at year-end 2008.

Dexia’s funding and liquidity position is improving with its successful long-term debt issuance and deposit growth. As the Group is largely wholesale funded, DBRS views Dexia’s regaining broader access to the markets at manageable cost as significant progress. The Group has extended the States’ debt guarantee by a year, meaning no new issuance of government-guaranteed debt after 31 October 2010. Currently, Dexia’s guaranteed debt outstanding is EUR 62 billion, down substantially from its peak of EUR 95 billion in May. In addition to issuing non-guaranteed debt, Dexia has also grown its deposits by 9.6% year-to-date to EUR 80 billion in its retail banking business, driven by Belgium and Turkey.

DBRS views capitalization as considerably bolstered by the support of the States and Dexia’s progress in reducing its risk profile. Besides the run-off in its bond portfolios, risk is being lowered through centralizing capital markets activities, reducing VaR, and running-off non-core activities, such as proprietary trading. The core Tier 1 capital ratio was 10.8% at Q3 2009 versus 9.6% at year-end 2008, with a core equity base of EUR 18.3 billion on a regulatory basis. After factoring in negative accumulated other comprehensive income (OCI), Dexia’s equity capital base stood at EUR 11.7 billion, considerably improved from EUR 5.6 billion at 31 December 2008. The Group’s available-for-sale reserve improved by EUR 4.7 billion over the same time period due to spread tightening on its run-off bond portfolios.

DBRS sees recurring revenue generation as critical for Dexia going forward. Continued success with its franchise and solid financial results are important in demonstrating the Group’s financial health and strengthening the markets’ confidence in Dexia. DBRS sees the positive results of the three quarters in 2009 and success thus far in implementing the 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.

This is a Corporate (Financial Institutions) rating.