France and Belgium rushed to the aid of Dexia SA on Tuesday, in what will be the first state rescue of a European bank in the euro zone sovereign debt crisis.

The lender to hundreds of French and Belgian 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 state 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-guaranteed pool of 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 percent to an all-time low on Tuesday as confidence in the group collapsed.

Basically, what we're getting toward 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 toward the state, effectively.

ING chief euro zone economist Peter Vanden Houte said if intervention was just guarantees, rather than cash injections, 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 center-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 about 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.

Reynders told reporters after the meeting that Belgium wanted Dexia to remain operating as a bank there.

Belgium's central bank said people with savings with Dexia in Belgium had no reason to withdraw their money.

Investors took little solace in the public reassurances. Dexia shares closed down 22.5 percent at 1.080 euros, having slumped 38 percent to an all-time low of 0.81 euros earlier in the day.

The closing price valued its equity at just under 2 billion euros ($2.7 billion) according to Reuters data -- in contrast with a holding of 3.8 billion euros of Greek sovereign bonds and the bank's total credit risk exposure to the country of 4.8 billion euros, one of the largest among non-Greek lenders.

Dexia has already taken a 338 million euro loss to cover a 21 percent 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 6 billion euro bailout in 2008. Bank-to-bank lending was once again under pressure on Tuesday with rates at their highest in more than a month.

Dexia's overall credit risk exposure is 512 billion euros, of which 60 billion is in North America. So its lingering exposure to the multi-trillion-dollar U.S. municipal debt market could reverberate across the Atlantic too.

ASSET SALES

A French government source confirmed that asset sales were at the center of the rescue proposal, with no plans for capital injections.

Dexia's controlling stake in Turkish lender Denizbank is seen as its most saleable asset, while its custody joint venture with Royal Bank of Canada and its asset management unit could also attract buyers, analysts said.

The spread between Belgian 10-year bonds and equivalent German bunds, a sign of the perceived risk of Belgium debt, pushed above 2 percent on Tuesday to a three-week high.

Data from Markit showed the cost of buying protection against a French sovereign default nudged historic highs, rising by 9.5 basis points to 199 basis points, against an all-time record of 200.5 bps set on September 22. Belgium's sovereign credit default swaps were trading 20.75 bps wider at 292.5 bps, just 6 bps off their own record.

Dexia is not the only European bank facing a need for capital as regulations become tougher, profits sag and lenders face losses on sovereign bonds if the euro zone crisis is not resolved.

Banks face a 148 billion euro capital shortfall under a base case and a 227 billion shortfall under a stressed scenario, according to analysts at JPMorgan, who say Unicredit , Deutsche Bank , Lloyds Banking Group , Societe Generale and Barclays each face a deficit of over 7 billion euros under its stress assessment.

If banks are unable to raise the capital privately, government ownership of the sector could jump to 22 percent from 7 percent now, JPMorgan analyst Kian Abouhossein said in a note.

European bank stocks <.SX7P> ended down 4.0 percent, with Dexia the weakest in the sector.

(Additional reporting by Philip Blenkinsop, Robert-Jan Bartunek, Julien Ponthus, Christian Plumb and Andrew Perrin at IFR; Editing by Gary Hill)