Date of Release: 2008-11-17

Dexia Group

DBRS Downgrades Dexia Entities to AA (low) Following Q3 2008 Results; Trend Revised to Negative

DBRS has today downgraded all the long-term ratings for the entities of the Dexia Group (Dexia or the Group), including the Senior Long-Term Debt & Deposits ratings for the Group’s three main operating banks, Dexia Bank Belgium, Dexia Crédit Local and Dexia Banque Internationale à Luxembourg, to AA (low) from AA. The trend on all long-term ratings has been revised to Negative. The short-term ratings for these entities have been downgraded to R-1 (middle) from R-1 (high). The trend on the short-term ratings is now Stable. DBRS’s rating action follows Dexia’s announcement of its Transformation Plan and its Q3 2008 results.

The rating downgrade reflects the challenges that the Group faces in adjusting to a different funding environment versus the low credit spread and abundant wholesale funding markets of recent years. While the Group has strong customer franchises and a leading position in public finance that underpin the current ratings, the Group’s earnings are constrained by its reliance on wholesale funding that has become more expensive and more difficult to obtain, and a securities portfolio that is under stress at a time when credit costs are rising. As one element of its Transformation Plan, the Group is refocusing its businesses on its core client franchises to drive funding and revenues. Going forward, the Group intends to ensure that there is a closer alignment between its lending activities and the ability of its franchises to generate deposits or other franchise-based funding. Also factored into this rating action is the positive benefit of the sale of FSA and the continued strong support of the governments of Belgium, France and Luxembourg. In the near term, government support helps ensure access to funding and preserves capitalization. The Negative trend on the long-term ratings takes into account the stress on the Group’s earnings from rising credit costs, legacy exposure to FSA’s financial products businesses, its securities portfolio and the challenges posed in executing its plan in the current difficult environment.

For Q3 2008, the Group reported a large net loss of EUR 1.5 billion, a steep decline from positive earnings of EUR 532 million in Q2 2008 and EUR 439 million in Q3 2007. The financial crisis had a major negative impact of EUR 2.2 billion in Q3 2008, of which EUR 460 million was from FSA. The remaining EUR 1.7 billion impact on net income was due to other financial market effects, including exposure to Lehman Brothers, Icelandic banks, Washington Mutual and Hypo Real Estate totalling almost EUR 750 million. Revenues of EUR 315 million for Q3 2008 declined 84% versus Q2 2008 and were down 78% versus Q3 2007. Expenses increased to EUR 1.1 billion for the quarter, up 10% versus the prior year and driving down operating income to a negative EUR 740 in Q3 2008, as compared to a positive EUR 485 million in Q3 2007.

In additional to announcing Q3 results, Dexia disclosed a Transformation Plan consisting of five main elements: (1) the sale of the Financial Guaranty Business of FSA; (2) the refocusing of the Group’s business on their core franchises; (3) the reduction of risk; (4) expense reduction; and (5) executive management changes. Dexia announced the sale of most of FSA to Assured Guaranty Ltd (Assured) for a total consideration of approximately USD 722 million, comprised of a 50% cash payment and 50% in newly issued Assured shares. This will result in Dexia owning close to 25% of Assured. The Financial Products Business of FSA, a USD 16.5 billion portfolio, will be retained by Dexia and managed by FSA Asset Management (FSAM). Dexia will cover the first USD 4.5 billion of losses generated by this business, of which USD 1.4 billion has already been reserved. If this business generates losses greater than USD 4.5 billion, the Belgian and French governments have agreed to guarantee the assets managed by FSAM. In addition, Dexia will continue to provide FSAM with an unsecured liquidity line of USD 5 billion.

DBRS views positively the Group’s refocusing on its core client franchises of Public Banking and Retail and Commercial Banking, building out the businesses of these franchises in their core markets and selective geographic areas. Dexia has reinforced this focus by shedding the non-core business of FSA. DBRS also sees the planned reduction in the Group’s bond portfolio, the ceasing of proprietary trading activities and decreasing market risk limits as bringing the benefit of both reduced risk and lower leverage of the core franchise. Additionally, the mismatch of assets and liabilities on the balance sheet will be minimized as Dexia takes advantage of the government guarantee to rebuild short- and medium-term liquidity, maximize deposits, and adjust lending to correspond with funding capabilities. Operating profits are likely to benefit from success with the targeted 15% expense reduction; EUR 300 million in cost savings has already been identified, with significant results expected in 2009. Finally, Dexia has a new executive management team which supports this new organization and should facilitate the implementation of the plan.

On 30 September 2008, Dexia announced that Belgian, French and Luxembourg government entities and existing shareholders had agreed to inject a combined EUR 6.376 billion of capital into the Group. EUR 6 billion of capital was provided in the form of equity, while EUR 376 million was provided in the form of convertible bonds. With this capital injection, Dexia’s solvency ratio improved to 14.5% as of Q3 2008, up from 11.4% in Q2 2008 and 9.1% in Q4 2007. The capital provided by the government entities and existing shareholders confirms DBRS’s expectation that systemic support is available to Dexia. Dexia’s strong franchise as a leading lender to public-sector institutions with deep relationships to municipalities, states and other government entities also supports DBRS’s view that Dexia is likely to receive support as needed, especially in the current environment.

If Dexia makes solid progress with its Transformation Plan and returns to sustainable positive earnings, DBRS would see potential to return the trend to Stable. However, a sustained period of negative earnings and further franchise deterioration could lead to further negative ratings pressure.


Note:
All figures are in euros unless otherwise noted.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.