Dexia SA's bailout comes three months after it passed stress tests. Belgium, France and Luxembourg will guarantee as much as 90 billion euros of interbank and bond funding for 10 years for Dexia and its Dexia Credit Local unit. [Jock Fistick / Bloomberg]

BRUSSELS - Belgium agreed to buy the local consumer-lending unit of Dexia SA, ending a 15-year cross-border experiment with France after the European debt crisis deepened.

The Belgian federal government will pay 4 billion euros ($5.4 billion) for the division and guarantee 60 percent of a so-called bad bank to be set up for Dexia's troubled assets, Finance Minister Didier Reynders said at a news conference in Brussels on Monday after a weekend of talks. Dexia will sell assets, including its Luxembourg unit and its French municipal lending arm, to give the bad bank capital to absorb future losses.

The dismantling of Dexia became inevitable after concern over European sovereign debt holdings caused its short-term funding to evaporate. Dexia's bailout, three months after it passed EU regulators' stress tests, brings the region's banking crisis from the continent's periphery to its center.

"Dexia is not an isolated problem," said Cor Kluis, a Utrecht, Netherlands-based analyst at Rabobank International. "The question for all investors in Europe is how politicians are going to handle this, and what they want to see is a coordinated and professional solution. That would be a good opportunity to restore calm."

The governments will guarantee as much as 90 billion euros of interbank and bond funding for 10 years for Dexia and its Dexia Credit Local unit. Belgium will provide 61 percent, France 37 percent and Luxembourg 3 percent of the backing. For Belgium, the guarantee equals about 15 percent of its gross domestic product, said Jean-Pierre Lambert, an analyst at Keefe, Bruyette & Woods in London.

"The three governments confirm they will take all the necessary measures to ensure the depositors' and creditors' safety," according to a statement from Belgian Prime Minister Yves Leterme's office following a meeting on Sunday in Brussels with French Prime Minister Francois Fillon and Luxembourg's Finance Minister Luc Frieden.

"Investors in Dexia shares will be left with a bad bank," Lambert said in a note to clients on Monday. "The proceeds of the sale of healthy assets will help Dexia Holding absorb the losses on the so-called 'toxic' assets. This is not a comfortable spot for Dexia shareholders."

Banking contagion

Rescuing Dexia has become critical to preventing contagion in the region's banking industry. Dexia's balance sheet, with total assets of about 518 billion euros at the end of June, is about the size of the entire banking system in Greece and larger than the combined assets of financial institutions bailed out in Ireland in the last 2 1/2 years.

Angela Merkel and Nicolas Sarkozy, racing to stamp out the euro debt crisis threatening to engulf the financial system, gave themselves three weeks to devise a plan to recapitalize banks, get Greece on the right track and fix Europe's economic governance.

"By the end of the month, we will have responded to the crisis issue and to the vision issue," the French president said in Berlin on Sunday at a joint briefing with the German chancellor before they dined in her office.

Standard & Poor's on Thursday downgraded the credit ratings on three units, Dexia Credit Local, Dexia Bank and Dexia Banque Internationale a Luxembourg, citing the group's limited access to wholesale funding markets. The ratings are on credit watch with "developing implications", S&P said.

Moody's review

Belgium's Aa1 ratings were placed under review for a downgrade by Moody's Investors Service because of rising funding risks for eurozone nations with high levels of debt and additional bank support measures that are likely to be needed.

The review will focus on the vulnerabilities of Belgian public debt in the current eurozone sovereign crisis and potential costs and contingent liabilities that the government may incur in supporting Dexia, Moody's said in a statement on Friday. Moody's will also assess how the risks for the growth outlook of the economy and the government's fiscal and economic plans may effect the country's debt trajectory.

Dexia Credit Local

For France, one of six countries in the eurozone with a AAA rating, the challenge is to rescue a portion of Dexia's operations without endangering its top credit ratings from Moody's and S&P.

A large chunk of the troubled assets are on the balance sheet of Dexia Credit Local, a French unit. Dexia Credit Local carries most of the bank's 95-billion-euro bond portfolio, which includes 21 billion euros of Greek, Italian, Portuguese, Spanish and Irish sovereign debt. Dexia's municipal lending units in Italy and Spain, which it agreed to dispose of to win European Commission approval for its 2008 bailout, are also on the French unit's balance sheet.

"The fair distribution of the burden is a very sensitive and crucial element in the negotiations," Leterme said on RTL radio on Thursday. "To save Dexia, we need a fair division of responsibility."

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