The European Debt Crisis and the Euro - Page 48

By Matthew Dalton

Of DOW JONES NEWSWIRES

LUXEMBOURG (Dow Jones)--Belgian government ministers are meeting Tuesday evening to discuss the fate of Dexia S.A. (DEXB.BT), as the bank's executives scramble to put together a restructuring plan in the face of a market onslaught that has effectively turned the once high-flying global lender into a penny stock.

Discussions between Dexia, the French and Belgian governments and local Belgian entities with a major stake in Dexia are honing in on a break-up of the bank, said a person close to the discussions.

The plan would likely see Dexia sell off its asset management business and DenizBank, its fast-growing retail bank in Turkey, the person said. Its Paris-based public finance arm, Dexia Municipal Agency, would be sold to the French savings banks Caisse des Depots & Consignations, or CDC, and La Banque Postale, people familiar with the matter said.

And EUR95 billion in "legacy" assets--including about EUR20 billion of bonds from troubled euro-zone countries--would be placed in a "bad bank" backed by guarantees from the Belgian and French governments.

The Belgian retail banking business would be left as a stand-alone business.

"It will be drastic," the person said. "Any other solution won't be accepted by financial markets."

The most difficult issue will likely be how to divide the burden of guaranteeing the assets and debt of the bond portfolio between the Belgian and French governments.

Belgian Prime Minister Yves Leterme, Finance Minister Didier Reynders and other ministers are to meet at 1800 GMT, a spokesman for Leterme said. Representatives of Dexia will not be present, the spokesman said.

Dexia has spent the last three years trying to undo a decade of over-zealous lending to governments across the world, using volatile wholesale funding. The seize-up of financial markets in the aftermath of the Lehman Brothers' collapse exposed deep flaws in Dexia's business model; the bank has since tried to remake itself as a retail bank focused in Belgium and Turkey, home to its fast-growing DenizBank subsidiary.

But the lingering effects of the 2008 crisis and the emergence of major problems in the euro-zone periphery caught up with Dexia. The bank accumulated large holdings of euro-zone sovereign debt during its decade-long lending spree: about EUR21 billion in debt from the troubled periphery, including EUR3.8 billion of Greek bonds and EUR13.4 billion of Italian bonds. Dexia's total holdings of Greek, Italian, Portuguese, Spanish and Irish debt is nearly three times the book value of its equity, one of the biggest exposures to the euro-zone periphery of any bank in the world.

Nor has Dexia solved its funding problems since 2008. The bank has sharply reduced its need for short-term funding from EUR260 billion in October 2008 to EUR96 billion at the end of June. The bank has been methodically paring its bloated balance sheet: EUR518 billion at the end of June, down from about EUR650 billion three years ago.

But customer deposits, the most stable source of funding, are still only 25% of total liabilities. That means Dexia must depend heavily on issuing covered bonds--which link borrowing to specific high-quality assets--and regular long-term bonds. The current market turmoil makes either option extremely difficult, particularly for a bank like Dexia with large exposure to the euro-zone periphery.