Dexia Pushed Over The Edge by Betting Against German Bunds

You couldn't make this up. According to the Belgian press, Dexia was sunk mainly by a single trade, which we hereby would like to nominate as the 'most stupid trade of the decade'.

Apparently the bank was short German bunds in the middle of the euro area crisis, via otc interest rate swaps. Originally, these swaps were meant to hedge the bank against interest rate risk on its other assets, mainly loans to cities and municipalities.  However, somehow the bank's managers 'forgot' to hedge the hedge, and ended up with an €46 billion margin call. That's what is usually politely referred to as a 'slight lapse in risk management'.

As the Belgian paper De Standaard reports (our translation in between paragraphs):

„Dat Dexia liquiditeitsproblemen had, was al langer bekend. Maar waarom moest de bank net nu een tweede maal gered worden door de overheden? Volgens ingewijden kwam de doodsteek van risicovolle speculatie met renteswaps – ruilcontracten op lange termijn in allerlei munten – die in hoofdzaak werden afgesloten in de periode 2004-2008. Ze moesten de moederbank Dexia wereldwijd indekken tegen het renterisico op haar langlopende kredieten aan steden en gemeenten.“


„That Dexia had liquidity problems was known for a while already. But why had the bank to be rescued a second time by the authorities? According to insiders the coup de grace was delivered by risky speculations in interest rate swaps – long term contracts in all sort of currencies – most of which were entered into in 2004-2008. They were supposed to hedge the parent bank Dexia worldwide against interest rate risk on its long term loans to towns and municipalities.“

„Maar een blunder kwam de bank duur te staan. Aan de renteswaps kleefde namelijk een belangrijk risico. Kortweg gezegd: als de Duitse langetermijnrente zakte, verloren de renteswaps aan waarde en moest Dexia cash bijstorten als onderpand. Een risico waartegen de speculatieve bankiers van Dexia zich blijkbaar 'vergaten' in te dekken met verzekeringscontracten in de markt.“


„However, one blunder became costly to the bank. Namely that there was considerable risk attached to these interest rate swaps. Simply put: when German long term interest rates fell, the swaps declined in value and Dexia had to extend cash as collateral. A risk the speculating bankers at Dexia plain 'forgot' to insure themselves against with hedge contracts in the market.“

„Een dure gok, bleek deze zomer. Toen de schuldencrisis deze zomer opflakkerde, kochten de beleggers massaal veilig Duits schuldpapier, waardoor de Duitse langetermijnrente een historische duik nam. Intern gingen alle alarmbellen rinkelen, want Dexia moest plots miljarden euro aan cash geld bijstorten.“


An expensive bet as it turned out this summer. As the debt crisis flared up this summer, investors bought massively into safe German bonds, which caused German long term interest rates to take a historic dive. Internally all the alarm bells started to ring, as Dexia suddenly had to extend billions of euros as (margin) collateral.“

„Het gevolg? Binnen Dexia raakte steeds meer geld geblokkeerd. Was dat eind mei nog 30 miljard euro, dan was dat eind september al opgelopen tot 46 miljard euro. Van elke euro die Dexia toen op de markten ophaalde om zich te financieren, moest de bank de helft reserveren als onderpand voor de ongedekte renteswaps.“

„The result?  More and more cash became blocked within Dexia. At the end of May it was € 30 billion, at the end of September it had increased to 46 billion euro. Of every euro Dexia borrowed in the markets to finance itself, the bank had to reserve half to post it as margin collateral for its uncovered interest rate swaps.“


Good grief! If this is true, then it puts all the post failure obituries reporting on  the CEO's innocent, well-meaning but ultimately futile attempts to 'put out the fire' at the bank into a fresh perspective.

The CEO somehow didn't notice that they were losing their shirt when Bund yields fell? What was he doing there? According to Reuters, he managed to put in place a '€ 600 million savings plan'. Apparently that's what he did while the bank got a €46 billion margin call – a 'paper loss' that would be immediately realized if the bank were to close its positions out now – and of course there is always the  possibility for the loss to grow if German yields should fall further.

Jean-Luc Dehaene, the chairman of Dexia and manager of its Belgian subsidiary,  by the way was once Belgium's prime minister. We suppose the country can consider itself lucky for not having a government at present.



Dexia CEO Pierre Mariani: 'The firefighter who couldn't put the fires out' according to comments in the press. That's one way of putting it (he had three years to get his fire hose into position; perhaps its a case best explained by what made Milton Jones' last summer 'not very good'. He set up a colonic irrigation clinic, which was reportedly 'hit particularly hard by the hosepipe ban' – see the details at 3:04 in this video.)

(Photo source: Reuters)




Dexia chairman, former Belgian prime minister Jean-Luc Dehaene. He looks a bit like the 'Kingpin' from Marvel's Daredevil comics.

(Photo source: Reuters)



The last three years were no fun for Dexia's shareholders. In fact, the past 5 years were no fun. In 2007, this stock traded at 25 euros, which is to say it is down by a less-than-cool 97% – click for higher resolution.



Large Losses Revealed By Austria's Erstebank

Among the more interesting developments yesterday was the big loss reported by Austria's Erstebank. In particular, the main reason for the loss was the revaluation of the Swiss Franc mortgage loans the bank has outstanding in Hungary. CHF loans were very popular in many CEE nations, and Hungary's government has simply enacted a law that makes it possible for debtors to pass on the losses stemming from the strong rise in the Swiss Franc to the banks. Hungarian debtors can now pay back these loans in Forint.

It seems possible to us that an even bigger headache is going to be created by these CHF loans (we have frequently mentioned this problem before and now it is finally breaking into the open). Other nations may decide to emulate the Hungarian example, and even if they don't, the strong CHF has made the situation of many borrowers untenable – so a wave of defaults is practically assured.

As Reuters reports:

Erste Group Bank, emerging Europe's second-biggest lender, said it would lose up to 800 million euros ($1 billion) this year and not pay a dividend after taking hits on foreign-currency loans in Hungary and euro zone sovereign debt.

The Austrian bank's shares were down 13 percent at 18.01 euros by 1215 GMT on Monday, compared with a 0.1 percent higher European banking sector .

"This is clearly disappointing news. In our view, today's announcement is likely to trigger a cycle of ratings downgrades and renew concerns over capital in the light of worsening operation environment in eastern Europe," GFI Research said. Chief Executive Andreas Treichl said Erste's core tier one capital ratio, a key measure of banks' financial strength, would end the year at 9.2 percent of risk-weighted assets, steady versus the end of 2010.

He said Erste had not been approached by regulators about joining a European push to recapitalise banks, nor did he believe Erste would have to take part in such an exercise.

Erste scaled back and marked down to market values nearly all its exposure to the sovereign debt of struggling euro zone countries, changed the way it handles credit default swaps, and took big writedowns in Hungary and Romania.

The kitchen-sink approach and volatility on financial markets means Erste will delay for at least a year repaying 1.2 billion euros in non-voting capital which it got from Austria during the 2008 global banking crisis and skip a 2011 dividend. The market had expected 2011 net profit of 967 million euros and a dividend of 70 cents per share, according to Thomson Reuters data.

Erste cut its sovereign exposure to Greece, Portugal, Spain, Ireland and Italy to 648 million euros as of the end of September and marked 95 percent of this down to market values. That left its combined exposure to Greece and Portugal state debt at only 10 million euros.

But it faces a 500 million euro loss at its Hungarian unit, — which will now get up to about 600 million euros of new equity — following Hungary's move to let domestic borrowers repay foreign-currency loans at below market rates.

It will write down its entire 312 million euros in Hungary-related goodwill and boost risk provisions there by 450 million, while fighting the new law. Treichl said Erste had ruled out prospects of quitting Hungary despite the upheaval.

Austrian peer Raiffeisen Bank International also plans to inject capital into its Hungarian unit as a result of the controversial law, its finance chief was quoted as saying last week.


(emphasis added)

We will say this: for one thing, the loss reported by Erstebank once again confirms  that there are still many write-downs to come for euro area banks. On the other hand, the bank's approach to write down all its sovereign debt exposure to the PIIGS and the potential losses from its CEE subsidiaries in one fell swoop is to be commended. At least the remaining risk is no longer incalculable for outside observers and the bank itself. The cloak has been lifted, which was the right thing to do.

Zerohedge had some more color on the Erstebank loss, specifically its exposure to derivatives in the form of CDS.


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