October 25, 2011 8:30 pm
Dexia brought to a halt
By Stanley Pignal in Brussels
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Pierre Mariani was desperate to raise cash. The eurozone crisis had made investors shy away from lending to just about any European bank in recent months, but Dexia, the Brussels-based financial group where he was entering his fourth year as chief executive, was finding it even more difficult.
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International lenders that provided Dexia’s day-to-day liquidity had become so spooked by its €21bn ($29bn) portfolio of Greek, Italian and other peripheral eurozone government bonds that they were increasingly reticent to supply further financing.
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But Mr Mariani, a bespectacled Corsican who once served as French president Nicolas Sarkozy’s top aide, had a lead that could give it at least a temporary respite: a group of Qatar-based investors appeared ready to make a quick purchase of the bank’s Luxembourg-based banking arm. The cash from the sale – perhaps €1bn of it – was not a permanent solution but would give Dexia breathing room.
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On the Friday before flying to the Qatari capital Doha, Mr Mariani and his top lieutenants received the news they were all dreading: Moody’s Investors Service, the credit rating agency, was considering a downgrade of Dexia’s bonds.
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The next day, Saturday October 1, Mr Mariani headed for Doha anyway for a 36-hour effort to clinch the deal. It was a long shot: the Qatari option had surfaced only two days before, pushed by Luxembourg authorities eager to see a bank on their territory transferred to a more stable parent.
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That is how Mr Mariani, a product of France’s elite civil service finishing school brought in to save the bank from near-collapse in 2008, found himself in a lounge at Doha’s antiseptic international airport waiting for a 2am Monday flight back when he received the call that told him his efforts would fail. Moody’s was to announce its review of Dexia debt before markets opened that morning.
.What happened to Dexia – its inability to raise liquidity because of its exposure to increasingly distressed eurozone sovereign bonds – is now gripping larger, more systemically important banks across Europe. The fear that Dexia is simply the canary in the coalmine – the sickest but not the only unhealthy bank trapped by a slow-moving credit squeeze – has been the biggest motivator pushing European Union leaders finally to attempt a system-wide rescue for their banks and bigger sovereign bond markets. That is the goal they hope to reach at today’s summit in Brussels.
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“The banking industry as a whole has come under clear pressure as a result of the eurozone crisis: fears around banks’ exposure to peripheral eurozone debt made investors weary of leaving their money [lent to] banks,” says Robert Law, an analyst at Nomura. “Dexia was a pretty extreme case because it relied heavily on wholesale funding, but the longer funding difficulties go on, the more banks are threatened.”
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Dexia’s own top cadre insists that the reforms started in 2008 could have turned it into a “normal” bank given another three years. “If the markets had stayed stable, we would have made it,” says one member of its executive committee. For European leaders, that may provide some hope. Perhaps Dexia was an anomaly and not the first of a series of toppling banks that governments are hoping to restore to soundness by a EU-wide recapitalisation scheme.
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Indeed, Dexia in some ways bears little resemblance to traditional lenders. Born of the merger of French and Belgian municipal lenders in 1996, it is majority owned by publicly controlled institutions in the two countries. Its governance reflected this: of nine French board directors, Mr Mariani is among seven graduates of the elite École Nationale d’Administration in Paris. The nine Belgians include Jean-Luc Dehaene, a former prime minister, as chairman. Only two of the 16 non-executives have private sector banking experience.
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But Dexia was also an anomaly in 2008. Still, in the weeks and months that followed, some of its supposedly “normal” larger rivals followed it into bail-outs and nationalisations. Whether the pattern repeats itself is the question that torments Europe.
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To be sure, Dexia’s problems were worse than most. It had gone through a period of wild expansion until 2008 and, despite a restructuring Mr Mariani imposed when he took over that October, by this year it still required €100bn of short-term financing to plug gaps in its balance sheet.
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Though the amount was down from €260bn three years earlier, filling the void was becoming harder as the debt crisis spread to larger eurozone members such as Spain and Italy.
Every weekday, a 6pm conference call of its most senior managers tracked the progress of the bank’s treasury team as it battled to secure a daily €10bn-€20bn in funding from the wholesale markets. A downgrade – or even the hint of one – would shut that avenue for months. Just as in 2008, Dexia would be starved of cash.
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Mr Mariani’s weekend dash to Doha was not without hope; he had fended off Moody’s in the past. On the Friday night before he left, he had told the rating agency he would do whatever it took to avoid being the first banking victim of the eurozone crisis, and the Qatar meetings were about exactly that. An appeal against a downgrade had worked just a few months before.
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But Moody’s was not to be placated this time. After the Monday announcement, Dexia’s 18 directors convened. In their 33rd-floor boardroom overlooking the modest Brussels skyline, they decided that even a rapid sale of healthy assets could not plug the liquidity gap. A day later, the governments of France and Belgium stepped in to guarantee up to €90bn of short-term funding; Belgium then nationalised the bank’s operations on its turf. Long-cherished plans for renewed independence were dashed.
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Dexia’s primary business was staid, offering long-term loans to businesses and municipalities. But in the three years before its first near-death experience, the bank had boosted its profitability by relying on cheaper short-term financing in the wholesale markets. It reinforced the effect by purchasing long-maturity bonds using short-term borrowings.
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By the time of its 2008 bail-out, 43 per cent of its balance sheet was financed by short-term loans, compared with single-digit percentages for a typical bank. Such an imbalance is known to be risky: Northern Rock, the British mortgage lender, failed in 2007 for much the same reason. The practice will be banned under incoming Basel III banking regulations as a threat to banks’ stability.
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In a May interview with the Financial Times, Mr Mariani said that when he took over Dexia, the bank was like a “hedge fund of rates”: it played on the spread between long-term and short-term interest rates to generate returns. His task, he said, was to de-risk Dexia on behalf of its state shareholders, which directly and indirectly controlled three-quarters of its shares.
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Despite Dexia’s peculiarities, however, it was brought down by the same forces currently shaking the entire sector. Nearly every big bank has been having problems in raising financing to run its normal operations. So-called “term markets”, which banks tap for loans extending from two to five years, all but closed from June to September. Only this month have the most solid lenders, such as HSBC and Deutsche Bank, again been able to raise funds that way. “These markets work best when everyone is happy with the world,” says Jeremy Sigee, a Barclays analyst.
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Shorter-term markets, while still open, have become gummed up as lenders such as big US money market funds, which control the deepest pools of cash, grew wary of lending to European banks. Stress tests imposed by regulators – which identified Dexia as one of the continent’s safest banks as recently as July – did little to alleviate concerns, since those did not test for large writedowns on sovereign debt.
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An increasing number of private sector lenders, including Dexia, turned to the European Central Bank for liquidity, accepting the higher costs entailed in borrowing from Frankfurt. Dexia’s use of ECB facilities swelled from €17bn in April to €40bn in early July, a figure constrained only by the amount of collateral it was able to offer in return for the loans. Overall liquidity provided to European banks by the ECB topped €500bn in August. The authorities were keeping large sections of the banking system afloat.
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One way banks can find cash for operations is through normal profits made on their business. But there, Dexia was also suffering. On August 4 it posted second-quarter losses of more than €4bn, weighed down by the restructuring plan. The afternoon of that announcement, Dexia’s French-dominated management prepared for their normal summer holiday. “We were drained, exhausted,” says one senior executive. “The idea is that August is the best period to take time off because nothing happens.”
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But August would prove the cruelest month. The next day brought shock waves when Standard & Poor’s stripped the US of its triple A credit rating. In addition, a second €109bn bail-out for Greece, agreed in July by European leaders, began to unravel as markets came to understood how rosy the assumptions were that underpinned it. The Greek rescue “helped us for maybe two weeks”, says one Dexia executive. “Then it was back to crisis-as-usual.”
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The very volatility of the markets began eating away at Dexia’s limited cash reserves. Investors started piling their money into safe havens such as German bonds, driving down interest rates even though markets had been expecting an inflation-driven rise.
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For a “hedge fund of rates”, as Dexia still was to some extent, the implications were profound. The interest rate swing did not make an impact on its profits, as a result of equal-but-opposite hedges taken out to that effect. But the complex hedge itself became a problem: it required ever-growing amounts of cash to keep it going. The bank had to put up an extra €130m in collateral for every basis point that long-term interest rates dropped. By early October, an extra €16bn was needed. It was money it neither had nor could borrow.
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Dexia is now going through what amounts to an insolvency process: whatever healthy assets it owns, including the Luxembourg unit, are being auctioned to finance a “bad bank”. Its market capitalisation is down to around €1bn, from €29bn in its heyday. “It is not the outcome I would have wished for,” Mr Mariani told a Belgian newspaper last week.
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An adviser to one of the parties involved in Dexia’s collapse says it is now clear souring markets and the need for capital pushed Dexia past the point where a bail-out was inevitable weeks before the Moody’s warning.
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“This idea that they could sell enough assets to provide the money needed to muddle through – it was pure fantasy,” the adviser adds. “It should have been obvious by early September that a large intervention was needed. The moment traditional funding routes closed up, Dexia’s life was measured in weeks.”
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Business turns to bond markets
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There are mounting signs that France’s banking turmoil could be creating a lending squeeze, causing companies to rush to bond markets, write Robin Wigglesworth and Tracy Alloway.
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For their part, some French executives say they are not worried about domestic lenders, and have turned to debt markets only as part of a general move towards relying less on bank financing. “This trend isn’t specific to France,” says Gilles Bogaert, managing director of finance at drinksmaker Pernod Ricard, which issued a $1.5bn bond last week. “Companies across Europe want to rely less on bank debt.”
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However, the extent of French bond issuance – particularly in September, when French companies sold almost $13bn, accounting for a large majority of eurozone issuance – has raised the eyebrows of investors and bankers. “It’s pretty spectacular,” says Marco Baldini of Barclays Capital. “If it wasn’t for the French corporates, we would have very limited issuance in Europe.”
Some analysts maintain that heavy French bond sales are linked to concerns that domestic funding conditions will become tighter, given pressure on the country’s banks to prune their balance sheets. BNP Paribas, Société Générale and Crédit Agricole, the biggest listed lenders, will need to shed €600bn-€ 800bn worth of assets, according to UBS – far more than BNP Paribas and Société Générale have signalled they may offload as they grapple with higher funding costs and potential recapitalisation. “It will come cheap to neither the domestic economy nor banks,” argues Omar Fall of UBS, noting that the lenders may even have to shed “strong franchises” such as corporate financing.
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According to the Banque de France’s latest survey, standards for lending to businesses tightened significantly in the third quarter. Further tightening is expected in the final quarter, Deutsche Bank said in a recent research note.
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While French lenders are overwhelmingly likely to continue to back blue-chip domestic companies, who provide them with many income streams, there are concerns that smaller entities could feel a squeeze.
“Groups like us, that have a global footprint and a leadership position, are attractive clients for banks, but they will possibly be more careful with smaller companies,” Mr Bogaert concedes.
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Copyright The Financial Times Limited 2011
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