DBRS Assigns First-Time Ratings of AA (high) & R-1 (high) to Dexia Crédit Local

Dominion Bond Rating Service (DBRS) has today assigned first-time ratings to Dexia Crédit Local at AA (high) for its Senior Long-Term Debt & Deposits and R-1 (high) for its Short-Term Debt & Deposits, both with a Stable trend (see full list of assigned ratings below). These ratings reflect Dexia Crédit Local’s strong franchise as Europe’s largest territorial community lender, its low-risk and well-calibrated international diversification in public-sector lending, as well as healthy and stable financial fundamentals. The ratings are also based on the overall business and balance sheet strength of the entire Dexia Group. Finally, the ratings marginally incorporate DBRS’s expectation of some form of timely systemic support for Dexia Group in the extremely unlikely event of a stress scenario.

Dexia Crédit Local has, over the years, grown as Europe’s leading specialist in lending to local governments and in public finance. Being the premier public finance lender in France and Belgium, the institution has also successfully expanded its activities in Italy, Austria, Germany, Spain and other markets, including Central and Eastern Europe (CEE). These activities have expanded beyond Europe, especially after the acquisition in 2000 of financial guarantor Financial Security Assurance Inc. (FSA) in the United States. As such, Dexia Group enjoys a unique expertise worldwide, housed mainly within Dexia Crédit Local, its public financing arm. “Dexia Crédit Local is characterised by a very low-risk profile given the low-risk nature of its activities and its strict risk-management practices, together with strong and highly stable earnings capacity on a risk-adjusted basis,” says Jean-Luc Lepreux, Senior Vice President and lead analyst for the Dexia Group. Approximately two-thirds of counterparty exposures are public-sector-related and thus characterised by historically extremely low credit risk. Despite Dexia Group’s diversified business profile and involvement in retail and private banking, as well as in asset management and insurance, Dexia Crédit Local remains its main earnings contributor, generating more than 40% of group net income.

Dexia’s public-sector finance activities should continue to benefit from favourable tailwinds, reflecting long-term infrastructure needs in developed and emerging markets, as well as transfers of responsibilities from central to local governments. Going forward, Dexia Crédit Local’s strategy will focus on (1) expanding its international footprint, (2) leveraging its unique skills in public sector lending, structuring and credit enhancement and (3) developing synergies in project and infrastructure finance. This should continue to be done through organic and selected external growth opportunities, while maintaining Dexia’s overall prudent risk culture. Based on product innovation, the broadening of its client base and gradual geographic expansion, this strategy should help preserve Dexia Crédit Local’s dominant market position in France and further strengthen its international franchise.

Commenting on Dexia Group in general, DBRS adds that it is also very well positioned in Personal Financial Services (PFS), primarily as Belgium’s second largest retail bank and as Luxembourg’s third largest bank. In investment management, insurance and investor services (in joint venture with Royal Bank of Canada), Dexia’s brand name, franchise and contribution to group profits are more modest, but activities have developed well in recent years and add to the group’s business and earnings diversification. In the coming years, DBRS expects the Dexia Group to pursue a focused development of its main franchises. The group’s strategic priorities aim to (1) capitalize on its unique know-how in public finance, (2i) optimize and strengthen its PFS and (3) improve operating efficiency. The rating agency points out that the recent acquisition of DenizBank in Turkey has not materially diluted the group’s risk profile, given its modest relative size, healthy fundamentals and the transaction’s conservative financing. Generating the expected synergies and ensuring a smooth integration will nevertheless represent a new challenge for the group.

Dexia Group also displays sound profitability indicators, although not as strong as Dexia Crédit Local’s, as earnings at group level are somewhat diluted by PFS’s comparatively lower cost efficiency, reflecting Dexia Bank Belgium’s higher cost structure associated with its dense branch network. That said, Belgian retail banking activities have made progress in lowering their cost-income ratio, and contribute to the stability and predictability of Dexia Group’s consolidated earnings. Furthermore, the group’s other activities exhibit extremely solid asset quality, helping credit losses to remain substantially below other leading European or international institutions. This in part reflects the Dexia Group’s low-risk business profile, as well as its tight management and good infrastructure for measuring and mitigating credit risk, market risk, liquidity, funding and ALM. In particular, Dexia Group has very limited trading risk exposure, and the Treasury and Financial Markets division, while contributing handsomely to the group’s bottom line, focuses largely on providing structured transactions for the group’s customers, transacting on behalf of the core operating entities in their ALM management and managing Dexia’s liquidity and refinancing.

Although Dexia Crédit Local is primarily market-funded, DBRS believes that it faces very limited liquidity risks. The institution holds a portfolio of high-quality liquid assets that fully covers short-term funds. According to DBRS’s assessment, Dexia Crédit Local could operate one full year without accessing capital markets for funding. Liquidity is also closely monitored and actively managed, and supported by the group’s solid deposit base in Belgium and Luxembourg. In addition, DBRS views as a key competitive advantage Dexia Crédit Local’s low cost of funding in the capital markets secured by the issuance of covered bonds, notably through its subsidiary Dexia Municipal Agency. “We have been very comfortable over the years with Dexia Group’s risk and liquidity management,” notes Sam Theodore, Managing Director for European bank ratings. All these elements underpin Dexia Crédit Local’s AA Intrinsic Assessment (IA) equivalent.

Furthermore, DBRS is of the opinion that, as the premier lender to the territorial community sector, Dexia is a critically important financial institution for the French and Belgian economies. In France, local governments are key economic factors, accounting for approximately 50% of expenditures within the public sector, while their operating revenues represent approximately 10% of French GDP. This assessment is also valid in Belgium, where Dexia enjoys a strong position in public finance, in addition to being the second largest retail bank. Based on an SA2 Support Assessment, Dexia Crédit Local’s senior long-term debt rating of AA (high) is one notch above its IA equivalent, reflecting the expectation of some timely form of systemic external support. That said, DBRS views the scenario of a financially healthy group like Dexia needing any form of outside support as extremely unlikely for the foreseeable future.

Commenting on rating change drivers, under the current strategy and business model of the Dexia group and Dexia Crédit Local, DBRS sees little potential for uplift in Dexia Crédit Local’s ratings for the foreseeable future, given that the already high level of these ratings positions it among the most creditworthy credit institutions in Europe.

On the other hand, a material merger with, or acquisition of, a weaker entity, whether at the Dexia Group or at the Dexia Crédit Local level, could exert negative pressure on the ratings, if such a transaction is carried out on less-than-optimal economic terms or if acquisition-related execution risks are poorly managed. DBRS also notes that negative rating connotations could emerge from a material shift of Dexia Group’s business mix away from public sector financing and into a heavier reliance on more sensitive wealth investment activities. While asset management, private banking, insurance and securities services may not necessarily display higher risks, DBRS nonetheless believes that enhancing critical mass or substantially expanding these activities should remain challenging as the group faces strong international competitors. Finally, any easing of the group’s very tight liquidity management or significant decapitalization could also penalize Dexia Group’s credit profile.

Intrinsic Assessments and Support Assessments (the latter on a scale from SA1 to SA4) are the two building blocks of DBRS’s bank ratings, as per the new bank rating methodology announced in 2006 (to view that report, “Analytical Background and Methodology for European Bank Ratings,” published in January 2006, visit www.dbrs.com).

The following ratings were assigned with a Stable trend:

Dexia Crédit Local − Issuer, Long-Term Debt & Deposits and Senior Long-Term Debt & Deposits at AA (high); Subordinated Debt and Junior Subordinated Debt at AA; Preferred Shares at AA (low); and Short-Term Debt & Deposits and other short-term instruments at R-1 (high).

Dexia Crédit Local is headquartered in Paris and had total assets of €276 billion at the end of June 2006. The Dexia Group is headquartered in Paris and Brussels and had total assets of €547 billion at the end of September 2006.

Note:
Issuer ratings apply to all general senior unsecured obligations of the issuer in question.

The full report providing additional analytical detail is available by clicking on the link under Related Research at the right of the screen or by contacting us at info@dbrs.com.

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