Less than three months after Dexia SA got a clean bill of health in European Union stress tests, France and Belgium are considering a second bailout, moving the banking crisis from the continent’s periphery to its heartland.
“We’re seeing a practical example of contagion playing out,” said Jean-Pierre Lambert, an analyst at Keefe Bruyette & Woods in London, referring to Dexia’s “material exposure” to the debt of countries on the EU’s rim. “Investors aren’t quite sure what the sovereign debt losses will be, nor where the share price should be. They are concerned about the risks and reduce their funding.”
Dexia rose 6.7 percent to 1.08 euros by 12:15 p.m. in Brussels trading as European stocks advanced on speculation policy makers are examining measures to shield banks from the sovereign debt crisis. Dexia dropped 22 percent yesterday even after both the French and Belgian governments, which bailed out Dexia in 2008, pledged to support the bank.
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, Yves Leterme, Belgium’s prime minister, said yesterday.
Caisse des Depots
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.
The board of the Paris- and Brussels-based municipal lender met Oct. 3 to discuss a breakup of the bank after the sovereign debt crisis reduced its ability to obtain funding, said three people with knowledge of the talks.
Dexia 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.
French central bank governor Christian Noyer said that he has no concerns over the country’s AAA credit rating in the light of the decision to restructure Dexia. There’s no threat to any other of the French banks, which remain solid, he said in an interview on Europe1 radio station.
Investors are shunning European lenders, whose shares are down 36 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.
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 SA and Credit Agricole SA 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.
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 Credit Rating
Moody’s Investors Service put Dexia’s three main operating units on review for a downgrade on Oct. 3 on concern that the lender was struggling to fund itself. The rating company also expressed concern that the bank didn’t have sufficient collateral at its disposal, “potentially resulting in a further squeeze in its available liquidity reserves.” The bank’s shares are down 59 percent this year.
Moody’s also cut Italy’s credit rating yesterday on concern that the government will struggle to reduce the region’s second-largest debt.
Federal Reserve Loans
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 ($5.3 billion) 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 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.”
Chaulet said he wouldn’t be selling his holdings in other European banks in response.
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.
Allied Irish Banks Plc 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.”