Dexia from the bottom up

October 6, 2011

Industry professionals who lived through a real muniland disaster when the auction-rate security (ARS) market exploded in 2008 have cocked a jaundiced eye at the news that the giant Belgian/French bank Dexia — a big guarantor of American municipal bonds — is on the verge of collapse.

The difference in magnitude of the two events is exponential; Dexia only backstops about $10 billion of U.S. muni bonds — many times smaller than the $400 billion ARS market that froze in February 2008 and helped precipitate the financial crisis.

Nevertheless, both shocks involved the problem of long-term municipal bonds called “variable rate demand notes” (VRDOs) which reset their interest rates every week. Even the rates on the most super-charged adjustable-rate mortgages don’t reset that frequently. Moreover, VRDOs are distinct in that if the buyer doesn’t like the reset rate they have the right to return the VRDO back to a liquidity provider, Dexia in this case, which stands ready to buy the bonds if the buyer doesn’t want them anymore. The possibility that Dexia doesn’t have the capital to buy the $9.6 billion in VRDOs is a big issue.

Reuters is reporting that Dexia has been voluntarily withdrawing from the U.S. market:

“Our exposure (to the U.S. muni market) has been diminished significantly, and that was a deliberate choice on our part,” Guy Cools, general manager of Dexia Credit Local’s New York branch, told Reuters on Tuesday.

Liquidity provided by Dexia once supported $54 billion of muni debt, according to Cools, who said that amount has now shrunk to $9.6 billion.

It seems more likely that the Federal Reserve Bank of New York encouraged Dexia to get out of the market. This is the same firm, after all, that had the ignoble distinction of borrowing the most from the Fed’s crisis lending facilities during the panic of 2008 and 2009. Let’s hope our bank regulators are enforcing simple prudential boundaries.

As it slips away from the U.S. market, Dexia still has serious problems in France. Reuters reported today:

Dexia “tricked” French towns into taking out complex loans that saddled them with crippling interest payments, mayors told a parliamentary hearing on Wednesday, ahead of an expected break-up of the crisis-stricken bank.

Several mayors have sued Dexia over these so-called “toxic” loans, which they say were presented as “fixed” interest-rate products pegged to exchange rates such as the euro-Swiss franc.

When the new rates kicked in, the local authorities saw their 4-percent borrowing rates shoot up in some cases to 15, even 24 percent, the mayors told the hearing at France’s National Assembly.

“Fixed rate, fixed rate, fixed rate — every time the same words,” said Xavier Martin-Le Chevalier, mayor of the northwestern town of Tregastel, holding up Dexia’s marketing documents. “There was indeed serious trickery.”

Now, no U.S. municipality has accused Dexia of trickery but I wondered who were the remaining issuers of the $9.6 billion of debt that Dexia said it still backstopped. The easiest way to get this information is to use the MSRB EMMA system and find the “VRDO” tab in the “Market Activity” section. There is a search function that allows you to find all bond issues with a specific liquidity provider, i.e. the institution who backstops the bonds.

I had tweeted out yesterday that with Dexia’s problems being so well-known, any reasonably strong bond issuer should have already refinanced away from them. When checking for bonds backstopped by Dexia today on EMMA, I found that 336 different bond issues had gone through their weekly interest rate resets while still tethered to the troubled firm.

Some interest rates had risen a lot: the interest rate on the bonds of the high school in Perris, California had shot up from 1 percent on June 1, 2011 to 3.75 percent this week. The maximum allowable rate for the high school bonds is 12 percent, basically a muniland subprime rate. Given the 2018 maturity of the Perris bonds and their credit ratings of Aa3/A1 they should be able to refinance into fixed-rate bonds with a current interest rate of about 2.4 percent — about 1.35 percent lower than their variable rate. Why aren’t their bankers helping them do this?

This made me curious about who the remarketing agents were for bonds that were still using Dexia as a liquidity backstop. I pulled the data on the 20 bonds that were paying the highest reset interest rate and here is what I saw:

Remarketing agent # of deals
Stone & Youngberg LLC 9
BNY Mellon Capital Markets 5
Goldman, Sachs & Co. 3
Loop Capital Markets 2
RBC Capital Markets 2

The remarketing agent is not always the same firm that helped underwrite the initial bond issue, but they should be intimately involved with the issuer now. No one in America can do anything to solve the problems of Dexia but the U.S. broker-dealers listed above should be pulling the stops out to get the last $9.6 billion of Dexia backed bonds refinanced.


FT Alphaville: Dexia still bringing stress to a town near you

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