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Dexia looks could be the first casualty of the eurozone crisis.The French and Belgian governments are deciding how best to protect the Brussels-based bank from collapse. They appear to be considering two different ideas:
– A new bailout with massive capital injections from both governments. Some French experts worry this could put France’s AAA rating at risk
– Splitting up the bank. French state-owned La Banque Postale and Caisse des Depots et Consignations would buy Dexia’s municipal lending unit, and Belgium would assume its assets. Dexia would thus become a “bad bank.”
How did Dexia get this far underwater?
Dexia's creditors feared the financial institution's exposures to U.S. Financial Security Assurance Holdings Ltd. and German bank Depfa.
It applied to Belgium, France, and Luxembourg for a bailout and got an $8.5 billion capital injection. Then in November 2008, it got $200 billion in state guarantees.
The Federal Reserve also lent huge amounts of money to the bank in order to stave off muni bond disaster during the last financial crisis.
But it then proceeded to report a profit in the first quarter. It then ruled out the possibility of breaking itself up, and later tossed aside any merger intentions.
Luxembourg, French, and Belgian governments renewed guarantees, but lowered the amount they would provide to around $130 billion.
Shooting for a balance sheet reduction of 35% by 2014, the bank attempted to sell off operations in Slovakia, Spain, and Italy.
The bank also embarked upon plans to increase exposure to the retail banking sector.
Dexia's share price fell 39% of the course of 2010.
In 2011, Dexia sold lots of toxic assets and agreed to participate in the Greek bond swap. It has been forced to write off huge portions of its assets, and reported losses of $5.7 billion after Q2.
It used to provide cheap financing to municipal and national governments. It has been forced to increase the interest rate it charges debtors to 12% recently and accelerate the terms of their loan maturity.
Moody's downgraded long-term and senior debt ratings of three of Dexia's main businesses in July. Its board held an emergency meeting Monday after Moody's threatened a full downgrade of the bank from its Aa3 rating.
Dexia has also been virtually cut off from interbank markets.
France and particularly Belgium would be hard hit in the event of a Dexia collapse, and say they won't let this happen.
However, there are doubts that they can actually make good on this promise, as Dexia's total assets are more than 150% of Belgian GDP.
Former French PM Laurent Fabius said France was was 'caught by the throat,' since bailing out the bank could jeopardize its AAA rating.
French officials quickly denied that such an action would damage France's credit rating. 'The Belgian and French states will put much less money into this operation than the British put into the Royal Bank of Scotland or Barclays,' concurred France's central banker Christian Noyer.
France reportedly favours a plan to split up the bank.
Under this plan, Belgium would assume its assets and France would buy its municipal lending unit. Dexia would then be left as a 'bad bank.' Its 'bad' assets -- guaranteed by French and Belgian governments -- would then be transferred to a new company.
French state-run investment fund Caisse de Depots and postal bank Banque Postale will announce a decision on how to secure the bank tomorrow, according to French Finance Minister Francois Baroin.
Everyone's worrying this banking stress might lead to contagion among France's other fragile banks, and then spread throughout the European banking sector.