Annual report 2010 - Dexia.com

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Notes to the consolidated financial statementsManagement reportConsolidatedfinancial statementsAdditional information Annual financial statementsEvolution of the portfolio (in millions) 2009 – USD 2009 – EURO 2010 – USD 2010 – EUROAFS portfolio 2,467 1,713 2,742 2,046L&R portfolio 8,273 5,746 7,197 5,371Shape of the Conditional Default Rate (CDR) curve (weighted average) – Subprime 06 & 073025201510Gross amount 10,273 7,135 9,377 6,998Specific impairments (1,656) (1,150) (1,742) (1,300)Collective impairment (344) (239) (438) (327)Total 10,740 7,459 9,938 7,417Exchange rate USD/EUR: 31/12/10: 1.3399 and as at 31/12/09: 1.4399Dexia FP has also realised losses based on sale of assetsand on missing cash flows (shortfalls). The realised lossesrecognized from inception until 31 December 2010 amountsto USD 624 million.A.3.5. Assessment of expected economic lossesRisk management estimates quarterly expected losses onthe total remaining portfolio (AFS and L&R portfolio) based onmodels using discounted cash flows, including assumptionsthat are also used for the collective impairments on notimpaired bonds included in the L&R portfolio. Projectedeconomic losses are based on models and assumptions andalso include a reserve for model and parameters risksThe total future economic losses estimated by Dexiatherefore amount USD 1,796 million, being expected in thefuture, up to the maturity of the securities involved whichcan be far on time, over 20 years. They represent themanagement’s evaluation as at 31 December 2010 of the netpresent value (discounted at purchase spread) of the lossesthe portfolio could generate. Dexia confirms its estimates aredone with the best of Dexia’s knowledge and appreciation ofthe US market.TodayBase Case 2007 SubprimeThus, Dexia adjusted its 4Q 2010 scenario for US RMBSbased on the prior economic uncertainties but also takinginto account the recent events on the real estate market. Asat end December 2010, the amount of projected economiclosses have been estimated at USD 1.79 billion in addition toUSD 0.6 billion of realised losses.In a context characterised by a volatile economic environmentdespite recent positive indicators in the United States andlarge stocks of homes which will continue to weigh heavilyon the real estate market at least in 2011, Dexia adapted itsscenario taking into account the following considerations:• Over the past two years, servicers of mortgage loans havedramatically changed the way they treat seriously delinquentloans by modifying a significant part of borrowers by extendingthe scheduled maturity of the loans or reducing the interestrates (especially Subprime borrowers).These modifications aretranslating into new amortization schedules for borrowers bydecreasing the interest rate and thus reducing the monthlypayments. However, Dexia considers that a significantproportion of these modified borrowers should re-defaulton time. While default rates have improved in the last fewmonths due to these modifications, Dexia decided to extendits default curves to reflect this risk. Then, Dexia does notexpect default rates to come back to the level of thepre-crisis before 7 years.Base Case 2006 Subprime50jan-08apr-08jul-08oct-08jan-09apr-09jul-09oct-09jan-10apr-10jul-10oct-10Month 2Month 5Month 8Month 11Month 14Month 17Month 20Month 23Month 26Month 29Month 32Month 35Month 38Month 41Month 44Month 47Month 50Month 53Month 56Month 59Month 62Month 65Month 68Month 71Month 74Month 77Month 80Month 83Month 86Month 89Month 92Month 95Month 98Month 101Month 104Month 107Month 110214 Dexia Annual report 2010
Notes to the consolidated financial statements• In addition, the modifications have also been translated inthe model into interest rate reductions between 100 and 300bps (reducing the projected excess cash flow in our structures)and capitalization of the previously unpaid balances, bothbased on data observed over the previous 6 months.• At last, due to the weak visibility of home prices, the recentslight increase in observed severities, and trying to considerthe potential impact “foreclosure freeze” could have onloss severity, Dexia decided to take a more conservativeseverity assumption by applying a severity curve flatfor life (previously in 3Q 2010 it declined over timeafter two years).At last an active workout process has been recently launchedby Dexia to optimize recovery on the US RMBS portfolio:• In January 2011, Dexia filed lawsuit against certain partiesrelating to US RMBS purchased by Dexia during 2005, 2006and 2007;• Full-time RMBS recovery activity with a dedicated experiencedteam in New York will be implemented in 2011;• However, at this stage Dexia does not take intoaccount any potential positive impacts of initiatives inthe market but also within Dexia related to Put Backs orLitigation procedures (1) .A.3.6. Sensitivity analysisAs at 31 December 2010, based on the recent evolution ofthe portfolio, Dexia Base Case Scenario showing a USD 1,796million of projected economic losses assumes the followingkey changes in the model parameters: (i) the current defaultrates used for projections (end November 2010) would notimprove within the next 3 years and would need 4 additionalyears to go back to the levels which, in most cases, wouldstay above pre-crisis ones, (ii) current loss severity rates (lossexpected on a property that would have been sold followinga foreclosure process) would not show any improvement upuntil the end of the transactions.Dexia quarterly performs a sensitivity analysis on theestimation of economic losses. Key results of this analysis arethe following:• For instance, under a scenario based on deteriorated defaultrates vs. the base case (more limited recovery of defaultswithin 7 years) coupled with a higher loss severity (+5%compared to the current levels) that would imply a futherdeterioration in home prices with no improvement up untilthe end of the transactions, the expected economic losseswould increase to USD 2.3 billion;• As another example, under a scenario based on a flat CreditDefault Rates, severity loss rates and prepayments rates curves“for ever” starting from the current levels (thus assumingthat the current levels for these key parameters would neverimprove up until the end of the transactions), the expectedeconomic losses would increase to USD 2.8 billion;• A faster recovery in the US economy by 18 months comparedto the Base Case (improvement expected in 30 months insteadof 48 months in the Base Case), would decrease the expectedeconomic losses to USD 1.3 billion.B. Credit-risk exposure by class of financial instruments31/12/09 31/12/10Financial assets available for sale (excluding variable income securities) 101,441 81,976Financial assets designated at fair value (excluding variable income securities) 490 364Financial assets held for trading (excluding variable income securities) 6,056 4,919Loans and advances (at amortised cost) 359,846 349,310Investments held to maturity 1,611 1,460Derivatives 8,111 9,043Other financial instruments 1,801 2,401Loan commitments granted 68,624 57,397Guarantee commitments granted 38,152 40,748Total 586,131 547,617Management reportConsolidatedfinancial statementsAdditional information Annual financial statements(1) Recovery options to consider for every RMBS platform or CUSIP include (i) remedies based on the RMBS contracts, including the right to putback loansand (ii) non-contractual remedies, such as direct lawsuits against defendants such as the RMBS underwriters, originators, servicers and other parties based onfraud, securities law violations and other wrongdoing. Litigation can also result from pursuing contractual remedies, in the form of ‘breach of contract’ litigation(e.g., to force a party to honor its obligation to repurchase bad loans).Annual report 2010 Dexia215
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