France, Belgium to aid ailing Dexia

France and Belgium promised to support stricken bank Dexia via guarantees for a "bad bank" holding its worst assets in a bid to prevent its troubles from deepening the euro zone debt crisis.

Laid low in recent weeks by its heavy exposure to Greece and problems accessing wholesale funds, Dexia saw its shares drop as much as 38 per cent to an all-time low today as confidence in the group collapsed.

"We have to put all the dangerous parts outside of the bank. It is here where the state guarantee will come into play, it's what's called a 'bad bank'," Belgian finance minister Didier Reynders said after a joint Franco-Belgian government statement pledging support.

Dexia shareholder France was working to break off Dexia's French local lending arm and combine it with French state bank Caisse des Depots and Banque Postale, a senator from French president Nicolas Sarkozy's centre-right party said.

Yves Leterme, the caretaker prime minister of fellow Dexia shareholder Belgium, summoned core cabinet members to an emergency evening meeting to discuss the bank's problems.

Luxembourg, not a shareholder but home to one of Dexia's three main arms, said it would take an active role in the bank's restructuring. Finance minister Luc Frieden said he did not expect final decisions on the bank's future today, adding it was "not a panic situation".

Investors appeared to take a different view and despite the assurances Dexia shares were still down 18 per cent at €1.0650 by 13.45 GMT, having slumped to an all-time low of €0.81 earlier in the day.

That valued its equity at about €2.15 billion according to Reuters data - in contrast with a holding of €3.8 billion of Greek sovereign bonds and the bank's total credit risk exposure to the country of €4.8 billion, one of the largest among non-Greek lenders.

Dexia has already taken a €338 million loss to cover a 21 per cent Greek debt discount agreed by private investors.

However, it stands to lose more if European finance ministers decide to make banks take bigger losses on Greek debt than they have already agreed to accept, as was being discussed by ministers.

Apart from Greece, Dexia is also suffering from a mismatch between short-term borrowing to finance long-term lending to public authorities, which prompted a €6 billion bailout in 2008. Bank-to-bank lending was once again under pressure today with rates at their highest in more than a month.

Dexia's overall credit risk exposure is €512 billion, of which €60 billion is in North America. So its exposure to the multi-trillion dollar U.S. municipal debt market has the potential to reverberate across the Atlantic too.

The rescue plan looks likely to involve a break-up of the bank, with the sale of healthier operations, such as its Belgian and Turkish banking businesses, as well as the creation of the state-supported bad bank.

A French government source confirmed that asset sales were at the centre of the rescue proposal but said a capital injection was not currently under consideration.

Neither France nor Belgium are keen to pump in more money, given budgetary constraints.

The spread between Belgian 10-year bonds and equivalent German bunds, a sign of the perceived risk of Belgium debt, pushed above 2 per cent today to a three-week high.

Data from Markit showed the cost of buying protection against a French sovereign default nudged historic highs, rising by 5.1 per cent to 199 basis points, against an all-time-record of 200.5 bps set on September 22nd. Belgium's sovereign credit default swaps were trading 20.75 bps wider at 292.5 bps, just 6 bps off their own record.

ING chief euro zone economist Peter Vanden Houte said if state intervention was indeed limited to guarantees, then French and Belgian finances should not be hit too hard.

Dexia is not the only European bank facing a need for capital as regulations become tougher, profits sag and lenders face losses on sovereign bonds if the euro zone crisis is not resolved.

Banks face a €148 billion capital shortfall under a base case and a €227 billion shortfall under a stressed scenario, according to analysts at JPMorgan, who say Unicredit, Deutsche Bank, Lloyds Banking Group, Societe Generale and Barclays each face a deficit of over €7 billion under its stress assessment.

If banks are unable to raise the capital privately, government ownership of the sector could jump to 22 per cent from 7 per cent now, JPMorgan analyst Kian Abouhossein said in a note.

European bank stocks were down 4.4 per cent, with Dexia the weakest in the sector.

Reuters