Is Belgium's Dexia About To Be The First Greek Casualty?

Tyler Durden's picture

About a month ago Belgium's biggest bank, and as is now well known one of the most active borrowers at the Fed's discount window in the days following the Lehman crisis, issued €3.2 billion in FRNs with a two year maturity that had an odd feature: an ultra short term put feature (as the Bloomberg screen shows below, puttable June 26, 2011 at par) which can be exercised up to 33 days ahead of the put day (underwritten by Barclays, Citi and MS) or in other words, today. Well, as our source has told us, following recent downgrades of virtually all banks with Greek exposure (a topic further pursed by the below IFR article), the two largest investors in the bond: Blackrock, which owns the bulk or about €2.6 billion, and Barclays (among others) have exercised their put option. The speculation is that "either someone knows something or had a very rapid change of heart" and concludes that "this should make the whole funding thing relevant again" especially since banks continue to rely on the ECB exclusively for short-term liquidity needs. Also possible a jump in Fed Discount Window borrowings if the ECB is unable or unwilling to cross-collateralize even more Greek debt exposure. The advice: "start watching Libor/Euribor and the Forwards basis" for some near-term volatility. If this is confirmed, look for any/all other comparable short-term put deals to suddenly spring the investor option to pull their capital, and the domino avalanche to set off in earnest.

Issue DES page:

Dexia CDS:

And some more color (mostly red) from IFR:

Greece casts €100bn shadow over European banks

European banks remain saddled with almost €100bn of Greek government debt they can’t sell, hedge or ignore, after a number of recent deals to offload the exposure to reduce the impact of a possible default ended in failure, according to bankers involved.

The deals have been thwarted by a lack of willing buyers for the debt – even at record low prices – and that exposed lenders have been unable to buy protection because of the high costs, with top bankers advising their clients all they can now do is cross their fingers and hope for the best.

“The vast majority of these banks have just been unable to do anything,” said one European banker who has advised dozens of such banks. “Protection is too expensive, and markets for these bonds are illiquid, so many are riding out the problem. Right now, all they can do is shut their eyes and hope.”

Greek domestic banks are by far the biggest holders of the country’s bonds with some €50bn of exposure, according to a handful of estimates. But another €50bn is held at banks outside the country, with German banks alone exposed to around €19bn of the paper, while French banks hold another €15bn.

“For a lot of banks, their worst nightmare seems to be coming true,” said another investment banker who advises financial institutions on the continent. “We now know that the Greek smoke was indeed fire and a lot of people have now found themselves heavily exposed.”

“The big question is the exposure of some of our clients,” added the chief financial officer of one of Europe’s largest investment banks. “At some point something has to happen.”

As prices tumbled – the 10-year bond now trades at 51 cents on the euro – and fear grew that a default was inevitable, the window for selling was gone. “The state of liquidity in the Greek market would be too limited to support major asset reallocations involving Greek bonds at present,” said Philip Brown, head of public sector capital markets origination at Citigroup.

Perhaps remarkably, some banks even saw the drop in prices as a chance to increase their exposure to Greek bonds, so as to repo the instruments at full face value at the European Central Bank’s open market operations. “One chief financial officer told me I was a complete idiot not to be buying bonds and that was only back in April,” said one adviser, who asked not to be identified.

As for why CDS "protection" is now moot:

Even the credit default swap market doesn’t offer a way out. Indeed, net notional outstanding Greek hedges have decreased over recent months, falling to less than US$5.3bn now from more than US$9.4bn in late 2009, according to Depository Trust and Clearing Corporation data.

“CDS are beyond the level where you even bother to hedge,” said one analyst. “It’s easier in a way just to take the hit.” The cost of protecting €10m of five-year Greek bonds against default recently rose to €1.48m amid increased speculation that Athens would default.

The inability of banks to sell or hedge such exposure partly explains why the European Central Bank has been so keen to silence any talk of a restructuring or default. Central bankers will be keenly aware of the potential repercussions on the region’s banking system if such an event were to happen.

One potential tactic might be to delay any default or restructuring as long as possible. With every year that passes, exposure to such an event is decreased as bonds mature and are paid off in full. Of the estimated €270bn of Greek bonds currently in existence, about a third will mature by the end of 2013.

But while that might lessen the blow for the banks, politicians are likely to find such a solution less palatable than a full-blown restructuring. That’s because EU and IMF loans will have to fund those redemptions – essentially a government-sponsored bailing out of private bond holders. Insurance companies, pension funds and central banks hold a further €170bn of Greek paper.

Indeed, an added complication is the exposure of the ECB, which stepped into the market to buy Greek bonds last year. Under a default or restructuring situation, it would have to be recapitalised. Indeed, advisors say some clients see the ECB’s exposure as a reason such an event will be delayed.

“These banks know they are in good company – the ECB is in the same position and they too are unhedged,” said the first banker. “There is the presumption that it doesn’t really matter for the Landesbanken, they know they will get rescued. For them, this isn’t an immediately pressing issue.”

In other words, it just may be that the can kicking exercise is about to come to a very violent end.