France and Belgium have come to the rescue of Dexia SA, the first government bail-out of a European bank in the euro sovereign debt crisis.
The lender to thousands of French towns, which also needed propping up after the 2008 financial crisis, will see its French municipal finance arm broken off and put under the ownership of French government banks.
The rescue plan also looks likely to involve a broader break-up, with the sale of healthier operations, such as its Belgian and Turkish banking businesses, as well as the creation of a state-supported bank containing toxic assets.
"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.
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% to an all-time low today as confidence in the group collapsed.
"Basically, what we're getting towards here is backdoor nationalization," said one London-based analyst speaking on condition of anonymity. "Everything that's happening now is just a case of how you split up the pie but really the pie is all going towards the state, effectively."
ING chief euro zone economist Peter Vanden Houte said if state intervention was limited to guarantees, then French and Belgian finances should not be hit too hard.
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 told Reuters.
The plan would effectively unwind the 1996 merger that brought together a French and a Belgian bank that both focused on lending to local public authorities.
A Belgian union said around 150 out of 400 jobs were at risk over plans to dissolve the bank holding company.
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.
Belgium's central bank said people with savings in Dexia Banque Belgique had no reason to withdraw their money.
Investors took little solace in the public reassurances.
Dexia shares closed down 22.5% at €1.08, having slumped 38% to an all-time low of €0.81 earlier in the day.
The closing price valued its equity at just under €2bn according to Reuters data - in contrast with a holding of €3.8bn of Greek sovereign bonds and the bank's total credit risk exposure to the country of €4.8bn, one of the largest among non-Greek lenders.
Dexia has already taken a €338m loss to cover a 21% 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 €6bn 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 €512bn, of which €60bn is in North America. So its exposure to the multi-trillion dollar US municipal debt market has the potential to reverberate across the Atlantic too.
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.
Dexia's controlling stake in Turkish lender Denizbank is seen as its most saleable asset, while its custody joint venture with RBS and its asset management unit could also attract buyers, analysts said.
