Watch for those FRBNY liquidity swaps to spring in action momentarily as Dexia was, is and will be the bank that sets off the dominoes in Europe's core.
Moody's Investors Service has downgraded to A3 from A1 the long-term senior debt and deposit ratings of Dexia Group's three main operating entities: Dexia Bank Belgium (DBB), Dexia Credit Local (DCL) and Dexia Banque Internationale a Luxembourg (DBIL). This was driven by the lowering of these entities' Bank Financial Strength Ratings (BFSRs) to D, which corresponds to Ba2 on Moody's long-term scale, from C-/ Baa2 previously. The outlook on the BFSRs is negative.
At the same time, the three entities' subordinated debt ratings were downgraded to Baa1 from A2. The short-term ratings of all three entities' were affirmed at Prime-1. The outlook on all ratings is stable. Moody's also downgraded Dexia's hybrid securities as detailed further below.
Today's rating actions conclude the review on the long-term ratings and BFSRs of Dexia's three main operating entities, initiated on 28 March 2011.
For a detailed list of ratings affected, please refer to the end of the press release.
Aa1 rated bonds of Dexia's issuing entities that benefit from a guarantee of the governments of France (Aaa/stable), Belgium (Aa1/stable) and Luxembourg (Aaa/stable) are unaffected by today's rating action.
DEXIA'S FINANCIAL IMBALANCES PUT PRESSURE ON THE GROUP'S INTRINSIC STRENGTH
Moody's says the downgrade of the ratings of Dexia's main operating entities' BFSRs and senior debt ratings reflects a combination of adverse pressures, in particular:
i) the rating agency's continued concerns about the group's still sizeable reliance on short-term funding (in excess of EUR 100 billion) and the consequent liquidity gaps that render it relatively vulnerable to adverse market conditions and a potential deterioration in the market perception of the credit;
ii) the substantial negative AFS reserves, representing potential losses that could be realized if Dexia needs to continue selling illiquid assets ahead of their contractual maturity. If credit spreads remain unchanged, the negative AFS reserves are still expected to represent around 50% of the group's Tier 1 capital at the end of 2011 when the sale acceleration program (announced on 27 May 2011) is completed;
iii) and, to a much lesser extent, the risk that the group's reduced production strategy in public finance (which is constrained by a high reliance on wholesale funding) could progressively affect Dexia's currently strong public-finance franchise.
Dexia continues to suffer from the consequences of the financial imbalances mentioned above, inherited from the pre-crisis period. The rating agency recognises the group has made material improvements since the peak of the crisis, despite unfavourable market conditions. However, in Moody's view, the path to a fully restored financial structure remains challenging.
"Although we recognise the acceleration of asset disposals announced by Dexia on 27 May 2011 is positive for the group's liquidity, risk profile and capitalisation, the magnitude of the contemplated sale is unlikely by itself to allow Dexia to reduce the liquidity gaps to such levels that could be considered as consistent with the previous rating level", says Yasuko Nakamura, a Moody's Vice President and Senior Analyst.
Moody's believes that the challenges Dexia is facing are more consistent with a BFSR of D, corresponding to a Ba2 on Moody's long-term rating scale. The negative outlook on the BFSRs reflects the risk that any deterioration of the Greek sovereign debt situation and subsequent possible contagion may, in addition to triggering direct losses on related securities holdings, have further negative consequences on Dexia's funding costs and market access.
Moody's continues to acknowledge the very high inter-company funding and credit support that currently prevails within the centrally managed Dexia Group. This is reflected in Moody's approach of assigning BFSRs at the same level for the three main group operating companies (DBB, DCL and DBIL).
LONG-TERM RATINGS AND SYSTEMIC SUPPORT ASSUMPTIONS
"Based on our perception that Dexia continues to benefit from very high systemic support, five notches of uplift from the Ba2 standalone rating are incorporated into the long-term senior debt and deposit ratings of A3,"adds Ms. Nakamura.
The high systemic support from France, Belgium and Luxembourg is evidenced by the capital increase in 2008, the funding guarantee program and the asset-guarantee scheme provided by these countries. This support, in turn, reflects the deep ties between Dexia and the public sectors of these countries, both in terms of its shareholder structure and from a business franchise perspective. For this reason, Moody's considers this involvement to be a more structural feature for Dexia compared with other commercial banks. This contributes to the stable outlook on Dexia's long-term ratings.
AFFIRMATION OF SHORT-TERM RATINGS
Moody's decision to affirm the Prime-1 short-term ratings reflects Moody's high expectations of systemic support for the group's financing needs.
HYBRIDS AND JUNIOR SUBORDINATED DEBT RATINGS
The agreement reached between Dexia and the European Commission (EC) in 2010 included a ban on common dividend payments, other than in the form of new shares issued by Dexia SA and its three main operating entities, until the end of 2011. These common dividend restrictions have a direct impact on Dexia's hybrid securities with optional payment features because hybrid coupons can only be suspended when common dividends have not been paid for a period of time. Since the related hybrid documents contain a pusher, common dividend payments "push" hybrid coupon payments. With the restrictions on common dividend payments, hybrid coupons were suspended on the non-cumulative Tier 1 instruments issued by DCL and Dexia Funding Luxembourg (DFL) and the cumulative Upper Tier 2 instrument issued by DBB. Since some or all of the coupons payable on these securities have been suspended over the past two years, we continue to apply an expected loss approach to position their ratings.
Due to the downgrade of Dexia's BFSR as well as revisions made to the likely time period for coupon suspension, Moody's has taken the following rating actions:
• DCL: DCL's 4.3% EUR700 million preferred stock rating was downgraded to Caa1 (hyb) from B3 (hyb). The outlook is negative. No coupon has been paid on this security over the last two years and we expect coupon suspension to continue for another year. DCL has the weakest solvency within the group and holds a large part of the legacy assets, which is likely to exert further pressure on the bank's equity. Moody's view is that DCL may need some capital at some point in time, which could be provided through a reallocation of capital within the group. As such, the risk of continuing non-payment of common dividends in the near future is high, even after the EC ban on the payment of common dividends is lifted, which in turn increases the probability of suspension of the preferred stock coupon.
• DFL: the B3(hyb) rating on the 4.892% EUR500 million non-cumulative preferred stock issued by Dexia SA's issuing vehicle, DFL, was confirmed.
The outlook is negative. DFL did not pay a coupon on this security in 2009, but paid one in 2010 due to the capital increase by incorporation of reserves at Dexia SA in the same year. Moody's assumption is that no coupon payment will occur in 2011 because of the EC's continuing ban on payment of the common dividend. However, coupon payments may resume as soon as 2012 as a consequence of some pressure from the Belgian and French shareholders to receive common dividends from Dexia SA. Once common dividend payments are made, they will "push" the preferred stock's coupon payments under the terms of the pusher.
• DBB: the rating on the 6.25% junior subordinated debt issued by DBB was downgraded to B2 (hyb) from Ba2 (hyb). The outlook is negative. No coupon has been paid on this security over the last two years. Moody's assumes that no coupon payment will occur in 2011 because of the EC's continuing ban on the payment of common dividends. However, coupon payments may resume as soon as 2012 because the group may then need to upstream common dividends from DBB as a way to reallocate capital within the group and to be able to pay a dividend to Dexia SA's shareholders. Once common dividend payments are made, they will "push" the junior subordinated debt's coupon payments under the terms of the pusher.
Additionally, Moody's downgraded DBIL's preferred stock (6.821% EUR225 million) rating to B3 (hyb) from B1 (hyb). The outlook is negative. Since we expect coupon payments on this hybrid to continue, the rating is now positioned based on normal notching rather than through an expected loss analysis. Due to its net loss trigger feature, which results in the suspension of coupons on a non-cumulative basis upon a trigger breach, the rating is positioned four notches below the Adjusted Baseline Credit Assessment (Adjusted BCA). Moody's arrives at the Adjusted BCA by adding parental and cooperative support, if applicable, to the BCA, which excludes systemic and regional support.
Simultaneously, Moody's downgraded the ratings of the other cumulative junior subordinated issues of DBIL and issuing vehicle Dexia Overseas Limited (guaranteed by DBB) to Ba1 (hyb) from Baa1 (hyb), in line with the downgrades of Dexia's main operating entities' intrinsic financial strength ratings. Moody's anchored the ratings from the Adjusted BCA and added one notch because the trigger for mandatory coupon suspension is effectively insolvency, which means that these hybrids will not likely absorb losses until the bank is close to liquidation rather than as a "going" concern. These securities have paid all their coupons to date.
The negative outlook for all the above rated hybrid securities directly results from the negative outlook of the group's main operating entities' intrinsic financial strength ratings.
TRIGGERS FOR POTENTIAL DOWNWARD/UPWARD RATING PRESSURE
Downward pressure may be exerted on the BFSRs from any material delay or a change in Dexia's strategy or external factors that could hamper the group's ability to continue to implement its financial restructuring program and improve its fundamentals.
The long and short-term ratings could experience downward rating pressure in the event of a multi-notch downgrade of the BFSR. Downward pressure on the long and short-term ratings could stem from Moody's considering that a lower probability of systemic support would be extended to Dexia.
A material acceleration in the improvement of the group's financial structure, following an easing of tension in the markets, could exert upward pressure on Dexia's BFSR.
However, we see limited upward pressure on the group's long-term debt ratings from its current A3 because improvements in the bank's fundamentals are likely to be offset to a certain degree by a decrease in systemic uplift.
IMPACT ON SUBSIDIARIES
The ratings on a number of subsidiaries and issuing vehicles are affected as follows:
- DCL's BFSR downgraded to D with negative outlook from C-, deposit and senior unsecured debt ratings downgraded to A3 from A1, subordinated debt rating downgraded to Baa1 from A2, and preferred stock rating downgraded to Caa1 (hyb) from B3 (hyb); all long-term ratings have a stable outlook, except the preferred stock rating which has a negative outlook. The
Prime-1 short-term rating is affirmed;
- DBB's BFSR downgraded to D with negative outlook from C-, deposit and senior unsecured debt ratings downgraded to A3 from A1, subordinated debt ratings downgraded to Baa1 from A2, junior subordinated debt rating downgraded to B2 (hyb) from Ba2 (hyb); all long-term ratings have a stable outlook, except the junior subordinated debt rating which has a negative outlook. The Prime-1 short-term rating is affirmed;
- DBIL's BFSR downgraded to D with negative outlook from C-, deposit and senior unsecured debt ratings downgraded to A3 from A1, subordinated debt ratings and junior subordinated debt ratings downgraded to Baa1 and Ba1 (hyb), respectively, from A2 and Baa1 (hyb), and preferred stock rating downgraded to B3 (hyb) from B1 (hyb); all long-term ratings have a stable outlook, except the junior subordinated debt and preferred stock ratings which have a negative outlook. The Prime-1 short-term rating is affirmed;
- Dexia Funding Luxembourg's backed preferred stock confirmed at B3 (hyb) with negative outlook;
- Dexia Kommunalkredit Bank's long-term senior unsecured rating downgraded to Ba2 with negative outlook from Baa2;
- Dexia CLF Finance's backed senior unsecured rating downgraded to (P)A3 with stable outlook from (P)A1;
- Dexia Public Finance Norden's backed long-term bank deposit rating downgraded to A3 with stable outlook from A1. The Prime-1 short-term rating is affirmed;
- Dexia Credit Local New York Branch's long-term bank deposit rating downgraded to A3 with stable outlook from A1. The Prime-1 short-term rating is affirmed;
- Dexia Credit Local Tokyo Branch's long-term bank deposit rating downgraded to A3 with stable outlook from A1. The Prime-1 short-term rating is affirmed;
- Dexia Funding Netherlands' backed long-term senior unsecured rating downgraded to A3 with stable outlook from A1 and backed subordinated debt rating downgraded to Baa1 with stable outlook from A2. The (P)Prime-1 short-term rating is affirmed;
- Dexia Overseas Limited's A1 backed long-term backed senior unsecured rating downgraded to A3 with stable outlook from A1, backed subordinated debt rating downgraded to Baa1 with stable outlook from A2, and backed junior subordinated debt rating downgraded to Ba1 (hyb) with negative outlook from Baa1 (hyb).
The following ratings remain unchanged:
- Dexia Financial Products' backed short-term rating of Prime-1;
- Dexia Delaware LLC's backed short-term rating of Prime-1;
- DenizBank A.S.'s C- BFSR, Baa2 long-term domestic currency deposit ratings, Ba3 long-term foreign currency deposit ratings, P(Ba1) foreign currency senior unsecured, Prime-2 short-term domestic currency deposit ratings and Not-Prime short-term foreign currency deposit ratings are unchanged. The outlook on the BFSR and domestic currency deposit ratings remains stable and the outlook on the foreign currency deposit and senior unsecured ratings remains positive.
- Dexia Credit Local, Stockholm Branch's short-term deposit rating of Prime-1;
- RBC Dexia Investor Services limited's issuer rating of Aa3.
Moody's says that any potential impact of this rating action on the group's covered bonds and Dexia Sabadell and Dexia Crediop will be considered separately.
The principal methodologies used in this rating were Bank Financial Strength Ratings: Global Methodology published in February 2007, Incorporation of Joint-Default Analysis into Moody's Bank Ratings: A Refined Methodology published in March 2007, and Moody's Guidelines for Rating Bank Hybrid Securities and Subordinated Debt published in November 2009.