Annual report 2010 - Dexia.com

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