Guest Post: The Dexia Effect

From Mark Grant, author of the financial commentary: "Out of the Box"

The Dexia Effect

As the banks in Europe report out earnings; or the lack thereof in most cases, it becomes clear that the LTRO is helping with liquidity but not with solvency past some very short term point. This is always the case of course but it is beginning to hit home. The balance sheets for many European banks have now swelled on the liability side with more and more debt piling up courtesy of the ECB while their assets decrease due to the Basel III mandates so that the financials of these banks begin to deteriorate. It is not just the losses from their Greek debt holdings that are coming into play but also their potential future losses from sovereign debt write downs markedly for Portugal soon I think but also perhaps for Spain and Italy in the near term as the recession in Europe brings new problems to the fore which will further reduce the value of sovereign and bank credits in Europe.

Nowhere is this more pronounced than for Dexia which reported out a loss of more than $15.5Bn for the quarter as they warned that they might be forced to “go out of business.” The governments of France, Belgium and Luxembourg had promised to provide capital of approximately $117Bn but to date the bank has received less than half of this amount. Dexia, is in fact, failing and rapidly and this is about to cause a significant problem for Belgium as I suggest either the avoidance of this country’s bonds or a more aggressive short here. Bloomberg reports this morning that there is a new accord that relaxes rules applied to Dexia and allows it to sell around $23 billion of state-backed debt without providing collateral in return. This, in my estimation, is an act of desperation as France and Belgium do not wish to take any further hits to their balance sheets but it is only a delaying tactic and one that just increases their contingent liabilities. I realize, of course, that Europe no longer counts contingent liabilities but I continue to use the old playbook when evaluating credits. As we all focus on the antics with Greece and wait and watch to see just what comes next as rhetoric finally gives away to facts, keep your eye on Belgium because they could be in for quite a rough ride as the liabilities of Dexia may overcome the country.

Too Much Ouzo

The Greek government said today that they expected at least an 85% participation from debt owners in their bond swap. These people have been living in La-La land for months but their proclamation only proves that they have left this place and have moved to the land of fairies and make believe. It must be that they sit in these meetings and continually tell lies to themselves and eventually believe what they have all given each other to swallow. There is way too much ouzo being served I suppose as I can personally count institutions that I know of with more than 15% of Greek bonds that are definitely not going along with the European plan. Once again in Europe it will be rhetoric bowing to reality in the end and the end now has a definitive date of March 20. Manufactured headlines only function until the data rolls in and then we will all see just who is in the bus and who has been thrown underneath it.

With Greece officially kicking off their debt swap moments ago it is important to examine the facts. The haircut is 53.5% of the principal value of the bonds. The average coupon is 2.63% for the first eight years and then 3.65% for the balance of the thirty year maturity. The ultimate net present value loss (NPV) will be almost 80% as close as I can determine it. I was particularly taken with the comment of the CEO of Commerzbank this morning when addressing the voluntary nature of the Geek swap as he said that it was about as voluntary as “a confession during the Spanish Inquisition.” There is an honest man in Europe afterall. Next we shall await the real percentage of people willing to go along with all of this, watch the law suits as they pour in and then glare intently to see if the CDS is triggered. Unanswered question are about to finally be answered and speculation will give way to hard data.

Also keep your eye on the role of the IMF in all of this. Currently the debt taken on by them is up against their legal limits for Greece and they have indicated that they will only put up around $17Bn for the new Greek loan. This will cause a 20% shortfall in funding which then must be assumed by the EU when the countries of Europe have not approved this amount of money. Before it was a promise of money but now it must be funded and I expect some major problems on this front. I also note that the Netherlands, in particular, has demanded additional funding for the stability funds in order to go along with the new Greek funding while Germany has refused to add new capital so that a show down of sorts is in the making. Here is another potential blow-up that may develop as promises of giving money run into the reality of squaring up with what was promised and then the costs to the sovereign balance sheets which could cause more downgrades as the new liabilities are assessed.