Wednesday, October 5, 2011

Dexia, Ireland and the Good Bank/Bad Bank fallacy

According to a Bloomberg article, Dexia will be split up into a Good bank and a Bad bank.

Readers may remember that Ireland tried to do the same thing with its banks.  In fact, Ireland tried without success on multiple occasions to remove all of the bad assets from its banks.

The fallacy of the Good bank/Bad bank concept is it requires market participants to "believe" that all the losses were put in the bad bank.  Without disclosure of the good bank's current asset and liability-level data, how are market participants suppose to verify how the bad assets were actually split up?

Without this verification, why should investors trust that the Good bank was cleaned-up and they should invest?
Dexia SA (DEXB), Belgium’s biggest bank, plans to pool its troubled assets into a “bad bank” with Belgian and French government guarantees to protect depositors and its municipal-lending business. 
The Belgian-French lender bailed out by the two governments in 2008 will put its “legacy” division, which held 113 billion euros ($150 billion) of assets at the end of June, into the bad bank, Belgian Prime Minister Yves Leterme told reporters in Brussels yesterday. Finance Minister Didier Reynders said...“What we’re looking for is not to spend taxpayers’ money on a dossier such as this one,” Reynders said. “Our wish is to consolidate, reinforce and safeguard the banking activity in Belgium, as our colleagues will do in France.” 
The creation of a separate entity with government guarantees may help shield Dexia’s banking units and avoid a repeat of the 2008 taxpayer-funded capital infusion. Belgium and France said yesterday they will take “all necessary measures” to protect clients and will guarantee Dexia’s loans. Both governments have stakes in the bank following its 2008 bailout...
For Dexia, “the fact that two countries are involved, both under pressure from rating agencies, makes it even more difficult,” said Benoit Petrarque, an Amsterdam-based analyst at Kepler Capital Markets with a “hold” rating on the shares. “We are not in 2008 anymore, when you could just inject multibillions of cash.” 
Prime Minister Leterme said yesterday that there’s “no reason justifying” Dexia Bank Belgium’s clients pulling deposits from the bank. Belgium guarantees that no client “will lose a single eurocent,” he said....
Dexia posted a 4 billion-euro loss for the second quarter, the biggest in its history, after writing down the value of its Greek debt. Once the world’s biggest lender to municipalities, it received a 6 billion-euro bailout from Belgium, France and its largest shareholders in September 2008 following the collapse of Lehman Brothers Holdings Inc.... 
Reynders said yesterday the guarantees that will be provided now will be “inferior” to the ones granted in 2008, when Belgium’s share exceeded 90 billion euros. 
He also said that Belgium has “no intention” of chalking up losses, adding that it will collect a fee in return for the guarantees. Dexia paid 489 million euros last year for use of guarantees, according to company filings. 
Dexia’s legacy division, which will be folded into the bad bank, has a pool of long-term assets that were put together so they could be financed with earlier debt guarantees. The division was created to meet European Union demands that earlier debt guarantees not be used to finance its commercial businesses and give investors greater clarity about its capacity to generate profits. 
At the end of June, the division included 95 billion euros of bonds with an average maturity of almost 13 years and $9.5 billion of mostly U.S. residential-mortgage backed securities, the majority of which were sold in July. 
It also had 11 billion euros of municipal loans in countries where Dexia has halted operations. 
Dexia may also transfer an additional 50 billion euros of assets from its municipal-lending units in Italy and Spain into the bad bank. Dexia agreed to dispose of its controlling stakes in Rome-based Dexia Crediop SpA and its joint venture with Barcelona-based Banco de Sabadell SA to win European Commission approval for its 2008 bailout. 

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