France and Belgium give backing to Dexia

France and Belgium on Tuesday moved to contain the fallout of Dexia’s proposed break-up, extending guarantees to the municipal financing specialist and finding alternate ways for local authorities to fund themselves.

François Baroin, French finance minister, and Didier Reynders, his Belgian counterpart, said they would take “all necessary measures” to protect Dexia’s depositors and creditors in the transition, including guaranteeing the issuance of Dexia bonds to finance itself.

Dexia has long been among the most vulnerable of Europe’s banks, struggling to return to health after being one of the first lenders to require a bail-out in 2008.

The Franco-Belgian bank’s precarious position was prompted by a seizing up of the short-term financing markets it relies on to fund its activities.

The situation pushed Dexia’s board of directors to agree a plan which would put its healthy divisions – including its asset management arm and DenizBank, a Turkish retail lender – up for sale to finance its portfolio of souring sovereign and sub-sovereign debt.

Under the proposals, brokered during a six-hour board meeting on Monday night, a “bad bank” would be created to hold a portfolio of bonds worth up to €200bn ($130bn), which will receive state guarantees from Belgium and France, people close to the bank confirmed. The Belgian finance minister publicly endorsed the “bad bank” plan on Tuesday.

The plan to create a “bad bank” was approved by a Belgian cabinet meeting on Tuesday night, but it has not received the formal assent of the French authorities. Belgian unions on Tuesday claimed Dexia management had told them the “bad bank” will be based in France.

The government will ensure that no client of Dexia Bank Belgium “will lose a single euro cent”, said Yves Leterme, Belgian prime minister, on Tuesday.

Remaining activities, notably those financing French local authorities, are likely to be merged into wider structures such as the Caisse des Dépôts et Consignations, the French sovereign wealth fund.

Dexia shares fell by as much as 38 per cent on Monday, but recovered to close at €1.008, a 22.5 per cent drop.

The French government is working with the CDC and La Banque Postale, the retail banking arm of the postal service, on a plan to separate the French municipal lending arm into a separate structure which would distribute lending to the local authorities, according to a person close to the CDC. The plan would involve offloading €80bn of Dexia assets used for municipal funding from the bank’s balance sheet and transferring them to the new structure.

The Franco-Belgian bank’s fate will also have an impact in the US, where it is an important operator in the municipal bond market.

Dexia exited from many US activities after its 2008 bail-out, but it has continued to back a type of US municipal debt whose interest rates reset regularly. As its position has worsened, cities or other local borrowers who have Dexia-backed debt have seen their interest rates rise.

“Short term, [higher rates] are something they need to deal with,” said Tom Jacobs, an analyst at Moody’s.

US municipal issuers with Dexia-backed debt are paying on average about 2 to 2.6 per cent for debt that resets weekly, with some paying as much as 4 per cent, according to Thomson Reuters MMD, which tracks this market. That compares with a benchmark index for these debt deals that currently stands at 0.16 bps.

There could be ramification for Dexia, too. Under these deals, it is obliged buy back the local government debt if investors, spooked by the bank’s problems, are scarce at the auctions. Based on what Thomson Reuters MMD tracks, there are about $12bn of Dexia-backed deals.

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