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1.5 Billion Euros Dexia Loans Used to Buy Shares in ... Dexia

Dexia, the stricken Franco-Belgian lender that has been at the center of recent market turmoil, loaned €1.5 billion ($2.06 billion) of fresh capital to its two largest institutional shareholders which then used the cash to buy Dexia shares before 2008, the Financial Times has learnt.

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The unorthodox funding move, which raised the Belgian regulators’ concerns at the time, amounted to Dexia borrowing money from itself to finance a capital increase. This is illegal in most jurisdictions and is now banned in the European Union, but did not break Belgium’s existing laws.

The arrangement artificially increased Dexia’s capital levels, which are closely watched by regulators and investors to gauge a lender’s financial strength.

The loans came to light after Dexia was earlier this month forced to apply for its second bail-out in three years, the first bank to require state aid as a result of the euro zone crisis.

Dexia Bank Belgium, a wholly-owned subsidiary of the listed Dexia entity that was seeking funds, loaned Holding Communal, an arm of Belgium’s powerful municipalities, €1.2 billion which was largely used to participate in two Dexia capital increases in 2006 and 2008. Arco, which invests on behalf of a Belgian trade union, borrowed €275 million purely for the cash calls.

The two parties jointly owned 35 percent of Dexia shares, and continue to be represented on its board.

In a further twist, Dexia accepted its own shares as collateral for the loans. The arrangement meant that any falls in the bank’s share price left it potentially nursing large losses. Dexia’s market capitalization has fallen from €21 billion in 2006 to about €1 billion today.

“Byzantine doesn’t even begin to describe this structure,” said one person briefed on the situation.

Belgian regulators, who were subsequently made aware of the transactions, repeatedly urged Dexia Belgium to pass on the loans to another lender to defuse what they saw as an unsatisfactory arrangement.

“Auto-financing is illegal under Belgian law, even if in this case, strictly speaking it was a subsidiary which was providing the loan to the shareholders,” said a spokesman for the Belgian Financial Services and Markets Authority. The BelgianNational Bank said it could not comment on a specific institution but that it was aware of the loans.

Carlos Bourgeois, Holding Communal’s chief executive, acknowledged money borrowed from Dexia Belgium had gone to buying Dexia shares, but told the FT that it was not the full €1.2 billion, estimating the figure at around 60 percent. Arco confirmed it had used Dexia Belgium as a bank to finance its Dexia stake, but stressed that extensive legal advice had been sought, that the loans were made at market rates and that other lenders had been tapped for smaller amounts.

Dexia declined to comment. Dexia Bank Belgium said it could not comment on matters relating to individual customers.