Standard & Poor’s announced last week that it revised its outlook to negative from stable on the core entities of Dexia SA, citing the potential impact of “faster-than-expected deterioration of the U.S. housing market” on the Franco-Belgian bank’s bond insurer subsidiary Financial Security Assurance (FSA).


Standard & Poor’s noted an increased likelihood of “additional impairment charges and provisions” at FSA,  which could lead to “volatility in performance” and make internal capital generation more difficult for Dexia at the consolidated group level.


The 'AA'/'A-1-plus' long- and short-term ratings on the counterparty credit ratings of the core entities — Dexia Bank SA, Dexia Credit Local, and Dexia Banque Internationale a Luxembourg — were affirmed.


“The negative outlook reflects Standard & Poor’s view that, in the current challenging market environment, Dexia’s consolidated earnings may not be as resilient as previously anticipated, due to FSA’s exposure to U.S. mortgage-linked structured instruments,” the agency said. “We continue to expect Dexia to deliver satisfactory operating results before impairments and valuation losses and focus primarily on low-risk public finance business, while maintaining strong capitalization.”


Unlike many other insurers, FSA has minimal exposure to CDOs of ABS. But S&P noted FSA’s exposure to $7.5 billion in home equity lines of credit and $1.5 billion in second-lien Alternative-A mortgages as of March 31 as part of the reason for its concerns.


In May, FSA’s parent, Financial Security Assurance Holdings, reported in its first-quarter results that it had added $266.1 million in loss reserves on eight HELOC transactions and $86.9 million in loss reserves on four Alt-A closed-end second-lien mortgage transactions.


S&P also noted reduced valuations on assets held by FSA’s financial products group, which issues guaranteed investment contracts. The financial product group reported a $1.533 billion unrealized loss in a fair-value adjustment of assets in its portfolio in the first quarter.


“Some of these transactions have less credit protection than others and a deterioration in credit performance may give rise to impairment charges in the coming quarters,” S&P said.

As a whole, though, Dexia’s core entities “reflect in unmatched global franchise in public finance,” the agency said. It said it expects “large mark-to-market valuation losses on Dexia’s credit spread and public bond securities — which neither affect earnings nor regulatory capital — are likely to reverse over time.”


As one of three insurers carrying  triple-A ratings, FSA has grabbed a larger share of a shrinking bond insurance market. It had insured $31.6 billion in municipal issues through June, compared to $23.3 billion at this time last year, according to Thomson Reuters data.


Recently, though, it has come under increased scrutiny. Following FSA’s earnings announcement, Moody’s Investors Service said it would reevaluate the insurer’s mortgage-related exposure.


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