Annual report 2010 - Dexia.com

Notes to the consolidated financial statementsA.3. Credit quality of Dexia FinancialProducts' financial assetsA.3.1. History and nature of the portfolioOn 14 November 2008, Dexia entered into a sale andpurchase agreement with Assured Guaranty (Assured)relating to the sale of Financial Security Assurance HoldingsLtd (hereafter FSA Insurance), excluding its Financial Productsactivity (hereafter Dexia FP).The Dexia FP activity consisted, in substance, in (i) takingdeposits from third parties (in general from issuers – localauthorities or ABS issuers of instruments which whereenhanced by FSA Inc.) in favor of whom Dexia FP undertakesto remunerate such deposits at a determined level, pursuantto Guaranteed Investment Contracts, (“GICs”) and (ii)the reinvestment of these deposits, with the objective ofgenerating a net positive interest rate margin.Even though its initial rating was mostly AAA, Dexia FP’s assetportfolio includes a substantial proportion of instrumentsdirectly or indirectly linked to the American real-estate sectorwith a rating and/or a market value that have significantlydeteriorated because of the sub-prime crisis and the globalfinancial crisis.A.3.2. Consequences of the exclusion of the FPand States’ guaranteeThe FP activity was excluded from the sale to Assured.However, to the extent that FSA Inc. (the former subsidiaryof FSAH, renamed Assured Guaranty Municipal Holdings Inc.which provides, directly or through its subsidiaries, the creditenhancement activities of the Group) guarantees assets andliabilities of the FP activity, the exclusions of this activity fromthe scope of the sale necessarily means that the Dexia Groupmust guarantee the FP activities, so that guarantees given byFSA Inc. are not called upon. Given the financial situation ofthe Dexia Group, and to the maximum theoretical amountof the guarantee given by Dexia, it was considered vital bythe purchaser, that Dexia be itself guaranteed by the Belgianand French States. The share sale agreement entered intowith Assured therefore stipulated as a condition to the salethat either Dexia should post collateral (e.g. cash securities oreligible instruments), but in excessive proportions, at the timeof the signature of the agreement, or that a state guaranteeshould be given.The Belgian and French States consented to giving thisguarantee, and agreed with Dexia, under certain conditions,that their recourse against Dexia under this guarantee wouldbe converted into Dexia shares. That conversion right isorganized through the subscription rights.For a more detailed description of the guarantee, we referto the note 9.4.C. to the consolidated financial statements,Related parties transactions – Transactions with the Belgian,French and Luxembourg StatesThe main conditions of the Guarantee Agreement and theGuarantee Reimbursement Agreement are, in substance, thefollowing:• Dexia FP put. Dexia SA and Dexia Crédit Local SA (“DCL”)(Dexia and DCL are hereafter referred to as the “DexiaGuarantors”) entered into a put agreement whereby Dexia FPis entitled to sell to Dexia and/or DCL certain assets includedin the Dexia FP portfolio existing at the signature of theguarantee upon the occurrence of certain trigger events.• States’ guarantee. The Belgian and French States eachundertook to guarantee, severally and not jointly, theobligations of Dexia SA pursuant to the put agreement up toan amount equal to USD 16.98 billion and up to 62.3711%for the Belgian State and 37.6289% for the French State.• Guaranteed portfolio. The portfolio to which this putrelates is the Dexia FP portfolio after deduction of the“excluded assets” for a nominal amount of USD 4.5 billion,to the effect that the par value of the assets included in theportfolio to which the put relates is equal to USD 9.7 billionon 31 December 2010. The excluded assets are subject toa put contract between the Dexia Guarantors on the onehand and Dexia FP on the other, but the obligations of Dexiapursuant to this second put contract are not guaranteed bythe States.• Trigger events. Dexia FP has undertaken vis-à-vis Assuredto exercise the put in certain situations in order to assure theeffectiveness of the protection mechanism. These differentsituations are:(i) an asset default, i.e. a failure to pay the principal or theinterest due on the assets of the portfolio at the final maturity;in this case the put relates to those assets and the assets aresold to the Dexia Guarantors at their residual par value (i.e.face value) increased by the amount of interest due.(ii) a liquidity default, i.e. a failure by Dexia (at any date priorto 31 October 2011) to comply with its obligations pursuantto the liquidity agreement entered into or to be entered intoin favor of Dexia FP; in this case the put relates to a numberof assets whose residual par value is equal to the amountof the liquidity default, and the assets will be sold to theDexia Guarantors at their residual par value increased by theamount of interest due.(iii) a collateral default, i.e. a failure by Dexia to provide,between 29 September and 31 October 2011, collateral toDexia FP in an amount equal to the difference between theamount of the liabilities pursuant to the GICs and the marketvalue of the assets of Dexia FP after applying a haircut tothese assets; in this case, the put relates to a number ofassets whose residual par value is equal to the amount ofthe collateral default and the assets are sold to Dexia at theirresidual par value increased by the amount of interest due.(iv) an insolvency of Dexia (a defined in the GuaranteeAgreement) in which case the put relates to all the assetsManagement reportConsolidatedfinancial statementsAdditional information Annual financial statementsAnnual report 2010 Dexia211