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Dexia to Set Up ‘Bad Bank’ With France, Belgium Guarantees

Dexia, BNP Resist Greek Losses Three Times Worse Than Booked
Dexia, which in August posted its biggest quarterly loss ever, has written down the 1.6 billion euros of Greek bonds it holds that expire before 2020 by about 340 million euros, according to Citigroup. Photographer: Jock Fistick/Bloomberg News

Dexia SA, Belgium’s biggest bank, plans to pool its troubled assets into a “bad bank” with Belgian and French government guarantees to protect depositors and its municipal-lending business.

The Belgian-French lender bailed out by the two governments in 2008 will put its “legacy” division, which held 113 billion euros ($150 billion) of assets at the end of June, into the bad bank, Belgian Prime Minister Yves Leterme told reporters in Brussels yesterday. Finance Minister Didier Reynders said details of the plan will be released after talks with partners.

“What we’re looking for is not to spend taxpayers’ money on a dossier such as this one,” Reynders said. “Our wish is to consolidate, reinforce and safeguard the banking activity in Belgium, as our colleagues will do in France.”

The creation of a separate entity with government guarantees may help shield Dexia’s banking units and avoid a repeat of the 2008 taxpayer-funded capital infusion. Belgium and France said yesterday that they will take “all necessary measures” to protect clients and will guarantee Dexia’s loans. Both governments have stakes in the bank following its 2008 bailout.

Dexia’s board met on Oct. 3 to discuss a possible breakup of the lender after Europe’s debt crisis reduced its ability to obtain funding, said three people with knowledge of the talks, who declined to be identified because the negotiations are private. A breakup would mark the clearest evidence yet that the banking crisis spurred by the sovereign-debt woes is spreading to the core of the euro region.

Dexia's Shares

Dexia’s shares, which yesterday dropped the most in three years, rebounded in early trading today. The stock gained 9.1 percent to 1.10 euros at 9:04 a.m. in Brussels, after plunging 22 percent yesterday.

Belgian bonds sank and the cost of insuring Belgian government debt with credit-default swaps surged to a record on concern Dexia’s possible breakup will increase the country’s debt load, the third-highest in the euro region.

The extra yield investors demand to hold Belgian 10-year bonds instead of German bunds of similar maturity widened 29 basis points to 210, the most since Sept. 14. Credit-default swap contracts on Belgium climbed to a record 309 basis points, according to CMA prices.

Belgium’s credit rating, now the second-highest investment grade, has a negative outlook at Standard & Poor’s and Fitch Ratings, while debt-insurance costs indicate France’s AAA rating is the weakest of the six top-rated euro-area nations.

‘Negative Pressure’

Moody’s Investors Service warned yesterday that euro-area nations with ratings below the top AAA level may face downgrades, saying “all but the strongest euro-area sovereigns are likely to face sustained negative pressure on their ratings.” Moody’s yesterday lowered its rating on Italy for the first time in almost two decades on concern the government will struggle to reduce its debt.

For Dexia, “the fact that two countries are involved, both under pressure from rating agencies, makes it even more difficult,” said Benoit Petrarque, an Amsterdam-based analyst at Kepler Capital Markets with a “hold” rating on the shares. “We are not in 2008 anymore, when you could just inject multibillions of cash.”

Prime Minister Leterme said yesterday that there’s “no reason justifying” Dexia Bank Belgium’s clients pulling deposits from the bank. Belgium guarantees that no client “will lose a single eurocent,” he said.

Asset-Management Division

The lender may hive off its French municipal loan book into a venture funded by state-owned La Banque Postale and Caisse des Depots et Consignations, and seek buyers for its Belgian bank, Denizbank AS in Turkey and its asset-management division, one of the people with knowledge of the talks said.

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 biggest lender to municipalities, it received a 6 billion-euro bailout from Belgium, France and its largest shareholders in September 2008 following the collapse of Lehman Brothers Holdings Inc.

Moody’s put Dexia’s three main operating units on review for a downgrade on Oct. 3 on concern the lender was struggling to fund itself.

“Dexia has experienced further tightening in its access to market funding,” Moody’s said in a statement.

Wholesale Funding

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.

That reliance on wholesale funding hobbled the bank as money markets seized up after Lehman collapsed, and Dexia turned to emergency funding from central banks. It was the biggest euro-area user of emergency loans from the U.S. Federal Reserve, borrowing a $58.5 billion as of Dec. 31, 2008, according to a Bloomberg News compilation of data obtained through Freedom of Information Act requests, months of litigation and an act of Congress.

In September 2008, France and Belgium led the first rescue of Dexia, buying a combined 3 billion euros of stock. The bank’s existing shareholders, which include Caisse des Depots et Consignations and Belgium’s Holding Communal SA, provided an additional 3 billion euros.

First Bailout

Less than a month later, Dexia also obtained as much as 150 billion euros of debt guarantees from France, Belgium and Luxembourg, of which it tapped a maximum of about 96 billion euros in May 2009. The bank stopped issuing government-backed debt in June 2010. It still had 29 billion euros outstanding at the end of last month.

Reynders said yesterday the guarantees that will be provided now 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, adding that it will collect a fee in return for the guarantees. Dexia paid 489 million euros last year for use of guarantees, according to company filings.

Dexia’s legacy division, which will be folded into the bad bank, has a pool of long-term assets that were put together so they could be financed with earlier debt guarantees. The division was created to meet European Union demands that earlier debt guarantees not be used to finance its commercial businesses and give investors greater clarity about its capacity to generate profits.

Municipal Loans

At the end of June, the division included 95 billion euros of bonds with an average maturity of almost 13 years and $9.5 billion of mostly U.S. residential-mortgage backed securities, the majority of which were sold in July.

It also had 11 billion euros of municipal loans in countries where Dexia has halted operations.

Dexia may also transfer an additional 50 billion euros of assets from its municipal-lending units in Italy and Spain into the bad bank. Dexia agreed to dispose of its controlling stakes in Rome-based Dexia Crediop SpA and its joint venture with Barcelona-based Banco de Sabadell SA to win European Commission approval for its 2008 bailout. Moody’s lowered Italy’s debt rating by three levels to A2 late yesterday.

“In the current environment, the size of the non-strategic asset portfolio impacts the group structurally,” Dexia said in a statement yesterday. “This is why the board of directors asked the CEO, in consultation with the relevant governments and the supervisory authorities, to prepare the necessary measures to resolve the structural problems.”

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