Dexia May Be Left as Bad Bank as Governments Shun Injections

Dexia SA (DEXB) may be left with the lender’s worst assets under plans that would allow the French and Belgian governments to avoid injecting more capital into the bank, two people with knowledge of the talks said.

Under the option most favored by the French, the two governments would guarantee Dexia’s borrowings before splitting up the lender, said the people, who declined to be identified because the talks are private. Belgium may then assume Dexia’s assets in that country, while France’s state-owned La Banque Postale and Caisse des Depots et Consignations would buy Dexia’s French municipal-lending unit, leaving Dexia as the “bad bank,” the people said.

That would avoid an immediate recapitalization of the Belgian municipal lender, which would then sell its legacy assets over time, the people said. If the lender transferred its “bad” assets to a new company, the bank would need more capital because a sale would crystallize what are at the moment paper losses for Dexia, one of the people said. A final decision hasn’t been made and the talks are still fluid, the people said.

“Whether or not this structure would benefit shareholders depends on the prices at which France and Belgium would pay for their national assets,” said Alphavalue Bank analyst Christophe Nijdam. “One should bear in mind that the two states are ‘judge and jury’ as they are the majority direct and indirect shareholders of Dexia SA.”

Photographer: Jock Fistick/Bloomberg

Pedestrians walk past signs for Dexia SA near the banks headquarters in Brussels. Close

Pedestrians walk past signs for Dexia SA near the banks headquarters in Brussels.

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Photographer: Jock Fistick/Bloomberg

Pedestrians walk past signs for Dexia SA near the banks headquarters in Brussels.

2008 Bailout

Dexia’s breakup, three months after it got a clean bill of health in European Union regulators’ stress tests, transplants Europe’s banking crisis from the continent’s periphery to its heartland. The Brussels- and Paris-based bank, which received a bailout in 2008, is being rescued again after its short-term funding evaporated as Europe’s sovereign debt crisis worsened.

Dexia “is a good example of how a sovereign debt crisis can become a banking crisis,” Julian Jessop, chief global economist at Capital Economics Ltd. in London, said in an interview on “Bloomberg Surveillance” today.

The bank will pool its troubled assets into a “bad bank” with Belgian and French government guarantees to protect depositors and its municipal-lending unit, Yves Leterme, Belgium’s prime minister, said yesterday. The “legacy” division had about 113 billion euros ($150 billion) of assets on June 30.

Board to Meet

La Poste and Caisse des Depots will today discuss the takeover of Dexia’s French municipal-lending business, two people with knowledge of the matter said. The board of directors of La Poste, the French postal service, will also meet tonight to discuss the matter, said another person, who declined to be identified because the talks are private.

In France, the lender had 82.6 billion euros of outstanding municipal and project-finance loans supported by 3.8 billion euros of deposits at the end of the first half.

France will announce more details about Dexia’s rescue tomorrow, French Finance Minister Francois Baroin told RTL radio today. Belgian Finance Minister Didier Reynders said guarantees that will be provided will be “inferior” to the ones granted in 2008, when Belgium’s share exceeded 90 billion euros. He also said that Belgium has “no intention” of chalking up losses and will collect a fee in return for the guarantees. Dexia paid 489 million euros last year for them, according to company filings.

Dexia may also seek buyers for its Belgian bank, Denizbank AS in Turkey and its asset-management division, according to a person with knowledge of the talks.

Dexia Shares Rise

The French-Belgian bank won’t go bankrupt and France will guarantee deposits, French European Affairs Minister Jean Leonetti said in an interview on Canal Plus television today. “Coming to the rescue of a bank is not necessarily a bad deal,” he said.

Spokesmen for Dexia, La Poste and CDC declined to comment about the negotiations. The shares, which rose as much as 10 percent in Brussels trading today, closed up 1.3 percent at 1.021 euros for a market value of 1.99 billion euros.

Investors are shunning European lenders, whose shares are down 33 percent this year, on concern that the sovereign debt crisis has undermined their ability to fund themselves. U.S. money-market funds cut their holdings of commercial paper sold by foreign financial firms, mostly European, by 31 percent in the third quarter, according to data compiled by Bloomberg.

ECB Funding

The European Central Bank has been providing banks with as much short-term euro funding as they need at its benchmark rate against eligible collateral since October 2008, after the collapse of Lehman Brothers Holdings Inc. triggered a global recession. It has been forced by the debt crisis, spreading beyond Greece to Italy and Spain, to extend those measures and in August reintroduced longer-duration, six-month euro loans.

The ECB also joined with the U.S. Federal Reserve and other central banks on Sept. 15 to lend dollars to euro-area banks with three-month loans to ensure lenders have enough of the currency through the end of the year.

Europe’s banks are paying close to the highest premium to borrow in dollars in the swaps market since December 2008, with the three-month, cross-currency basis swap falling to 106.5 basis points below the euro interbank offered rate.

French banks including Paris-based Societe Generale (GLE) SA and Credit Agricole SA (ACA) are particularly vulnerable to deterioration in market confidence as they have large balance sheets, significant wholesale liquidity needs across different currencies and reduced prospects to rebuild capital, Jean- Francois Neuez, a Goldman Sachs Group Inc. analyst in London, wrote in a note to clients yesterday.

‘By No Means Alone’

The cost of insuring the debt of France’s three biggest banks rose yesterday, with Societe Generale up 32 basis points to 384, Credit Agricole 24 basis points higher at 287 and BNP Paribas SA up 23 basis points to 286, according to CMA prices. An increase signals deteriorating perceptions of credit quality.

“Dexia is by no means alone in terms of being at risk here,” said Simon Maughan, head of sales and distribution at MF Global Ltd. in London. “There are plenty of other banks out there that have grown their assets way in excess of their deposit base like Dexia. That makes them massively exposed. It feels like the capitulation has started, and people are saying we’ve had enough of this state of affairs and something concrete needs to be done.”

Dexia’s Roots

Dexia emerged from the 1996 merger of Credit Local de France and Credit Communal de Belgique SA, the biggest municipal lenders in their respective countries. Unlike Credit Local de France, which relied exclusively on wholesale funding for its lending, the Belgian firm also operated a retail bank in Belgium and a private bank in Luxembourg.

Over the past decade, the Franco-Belgian bank sought to combine with another retail bank in France and elsewhere in Europe to reduce its reliance on wholesale funding. It failed to merge with Italian lender Sanpaolo IMI SpA in 2004.

That dependence on wholesale funding hobbled Dexia as money markets seized up after Lehman collapsed, and the lender turned to emergency funding from central banks. It was one of the largest euro-area users of emergency loans from the Fed, borrowing $58.5 billion as of Dec. 31, 2008, according to data compiled by Bloomberg.

Dexia posted a 4 billion-euro loss for the second quarter, the biggest in its history, after writing down the value of its Greek debt. Once the world’s largest lender to municipalities, it received a 6 billion-euro bailout from Belgium, France and its major shareholders in September 2008.

‘A Bit Late’

“Dexia’s model is vulnerable because it is dependent on short-term funding,” said Benoit Petrarque, an Amsterdam-based analyst at Kepler Capital Markets. “But the bank could have sold its legacy sovereign bonds portfolio over time and earlier. It didn’t want to take the losses. Now it’s a bit late.”

The bank, which marked down some of its Greek debt by 21 percent, may have to take additional losses if it writes down those loans to market prices.

“Dexia is a very specific case,” said Francois Chaulet, who helps manage about 250 million euros at Montsegur Finance in Paris, including shares in BNP Paribas (BNP) and Societe Generale. “You can’t compare it to BNP Paribas or Societe Generale. It faces huge exposures after selling toxic products to local regions, and it’s very highly leveraged.”

Dexia passed the EU stress tests in July with regulators saying it had sufficient capital to withstand a recession and losses on its sovereign debt. The lender’s core Tier 1 capital ratio, a measure of financial strength, was 10.4 percent in the test’s adverse scenario, surpassing the 5 percent minimum required by the European Banking Authority.

‘Dexia Didn’t Work’

“The decision to maintain Dexia as it is after the 2008 bailout was not a viable option,” said Alphavalue’s Nijdam, who wrote in 2010 a report on Dexia titled “Unpalatable recipe of kebab-wrapped froglegs marinated in Belgian beer.” “From day one, the creation of Dexia didn’t work.”

Allied Irish Banks Plc (ALBK) and Bank of Ireland Plc passed the EU’s examinations in 2010, while Anglo Irish Bank Corp. wasn’t tested. Later that year, a liquidity shortfall caused when depositors withdrew funds from Irish lenders helped prompt EU governments and the International Monetary Fund to agree on an 85 billion-euro bailout for the country.

“The European stress tests lacked a critical element, which is full harmonization of capital,” KBW’s Lambert said. “In the case of Dexia, because it’s a Belgian bank, it was able to exclude the paper losses on its sovereign bonds to calculate its capital ratios. Basel III is going to help harmonize the accounting method.”

To contact the reporters on this story: Anne-Sylvaine Chassany in Paris at achassany@bloomberg.net; Jacqueline Simmons in Paris at jackiem@bloomberg.net; Gavin Finch in London at gfinch@bloomberg.net

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net.

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