Dexia (Hold, TP=€5.20) - 12m target downgrade - Difficult to determine the future size of the group (3p)

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Dexia (Hold, TP=€5.20) - 12m target downgrade - Difficult to determine the future size of the group (3p)
Update
Dexia reported Q3 earnings at €274m, ahead of our€245m estimate, but below consensus. We note that our estimates were at the bottom of the consensus range owing to a high cost of risk. As expected, Public & Wholesale banking revenues dropped 27% over the quarter after a 17% fall in Q2 09 as the bank deliberately reduced its exposure to non-domestic markets. Conversely, costs for the group as a whole were under control, down 11% in Q3 after -7% in Q2. The group continued to reduce its bond portfolio, which is being phased out, at €139m vs €149bn end-Q2, thanks to the maturity of part of the portfolio but also due to new disposals (€11.3bn over nine months of which €4.7bn in Q3).
Impact
Dexia's main problem, i.e. the mismatch between its new production and the cost of financing, still has not been resolved. The company continues to see its cost of financing improve without the state guarantee at 43bp (38bp in October) on covered bonds, but this is 95bp on non-guaranteed senior debt. The group still has positive net margins on new production; however, in our view, these margins will erode owing to aggressive competition from other banks, notably in France. The deleveraging of the balance sheet had a negative impact on pre-tax profit in Q3 of €43m, and should continue to impact the group, as we do not expect strong performances from the treasury business over the few quarters. Thus, we have cut our earnings estimates by 12% for 2010e and 2011e.
Target price & rating
Hold maintained. Efforts have been made to reduce the portfolio in run-off, which has improved the risk profile but does not directly benefit minorities. Even including the improvement in the AFS reserve, our new 2010e tangible book value at €4.6 gives a valuation that may appear attractive (1.2x 2010e vs 1.7x for the sector) but is unwarranted given the group's weak appeal. Target price cut to €5.2 vs €5.6 (see next page) owing to the Corporate Centre.
Next events & catalysts
Full year earnings on 25 February, during which we hope to have more visibility on 1) Brussels validation of the bail-out, and 2) the disposals that Dexia may be forced to realise.