M&A Deals of the Year
Introduction   Apple and partners-Nortel   Google and Motorola Mobility   Access Industries -Warner Music   Cumulus Media-Citadel   Comcast-NBC Universal   H&R Block-TaxAct   Caterpillar-Bucyrus   Ares and CPPIB-99 Cents Only Stores   Grupo Bimbo-Sara Lee baking assets   BHP Billiton-Petrohawk   Peabody Energy-Macarthur Coal   Selling off Bank of America   Dish Network-Blockbuster   Amgen-BioVex   KKR et al.-Samson Investment   Pearson-Connections Education   Alleghany-Transatlantic   Breaking up Dexia

The glow quickly faded.

Three weeks after Dexia SA won a robust bill of health in July's European Union-wide bank stress tests and proclaimed it had no need to raise new capital, the Paris- and Brussels-based group posted the worst quarterly loss in its 15-year history. By early October, the governments of Belgium, France and Luxembourg had stepped in to rescue the first euro-zone lender to succumb to the Continent's sovereign debt crisis.

Determined to keep Dexia from going under, the three governments opted to save and then break up what was once the world's largest municipal lender. "At the end of the process, Dexia will probably be left with some banking activities. But it will look more like a bond hedge fund," predicts Dirk Peeters, a banking analyst with KBC Securities in Brussels.

Although the Benelux governments had already come to Dexia's aid three years earlier under different circumstances, the stakes were much higher this time, bringing Europe's banking crisis from its periphery to the core.

In 2008, Dexia was brought to the brink of collapse by troubles at its New York-based bond insurance unit, Financial Security Assurance Holdings Ltd. (which it later sold to Wilbur Ross' Assured Guaranty Ltd.). That October, the Belgian, French and Luxembourg governments responded with a €6 billion ($7.6 billion) capital injection and up to €150 billion in state guarantees.

The bank's latest troubles erupted in the summer of 2011 when a once-risky but workable business model -- borrowing short-term in wholesale money markets to relend to local governments -- came undone.

Dexia's €4.03 billion record second-quarter shortfall included €338 million in after-tax write-downs on Greek bond holdings. At the time, Dexia said U.S. investors' concern about the European debt crisis had restricted its ability to borrow dollars.

As Greece scrambled to avoid defaulting on its sovereign debt, prompting European leaders to step in with a €109 billion bailout, it was probably inevitable that a global player such as Dexia, reeling from its exposure to Greek government debt, would be among the lenders hardest hit.

In public, at least, Dexia's executives did not address the Greek threat to its balance sheet and instead clung to an accelerated asset disposal program that went beyond commitments made to EU regulators in return for their approval of the 2008 bailout.

On Sept. 27, 2011, Dexia chairman Jean-Luc Dehaene declared that the company was exploring "various strategic options" to raise capital but denied rampant rumors it would ever consider a breakup.

That all changed on the morning of Oct. 10, when Dexia's government shareholders unveiled a rescue plan cleverly designed to avoid injecting new capital. In one stroke, they ended the 15-year cross-border experiment dating back to the 1996 merger between Crédit Local de France SA and Crédit Communal de Belgique SA, the biggest municipal lenders in their respective countries.

The rescue came in the form of a three-way, €90 billion guarantee of a so-called bad bank to be set up for Dexia's troubled assets, with Belgium footing 60.5%, France 36.5% and Luxembourg 3%. (It's not yet a done deal, since the European Commission has temporarily approved only half the guarantees as it probes whether the funding complies with EU single-market rules.) Belgium also agreed to buy Dexia's local consumer-lending unit for €4 billion.  

Despite predictable squabbling between the Belgians and the French as well as infighting among Belgian politicians, the countries' leaders put up a united front, pledging to "take all the necessary measures to ensure depositors' and creditors' safety."

To pump capital into the bad bank, they embarked on the formidable task of auctioning healthy assets. The first step came quickly with the Dec. 20 agreement to sell the Luxembourg operations to Qatari-backed Precision Capital in a deal valuing the target at €730 million. Other assets on the block include Istanbul, Turkey-based Denizbank SA and Dexia's 50% stake in RBC Dexia Investor Services, a joint venture with Royal Bank of Canada.

Long after Dexia ceases to exist, the name will undoubtedly recall the first European bank bailout directly attributable to the sovereign debt crisis. There are bound to be a number of others.

European governments looking to rescue Dexia's counterparts may well take a cue from their Benelux peers in finding a welcome -- and workable -- alternative to fresh capital injection.