UPDATE 2-Italy probes Merrill, Dexia in Puglia derivs case
* Two bank employees also under investigation
* Up to 103.3 mln euro seized in probe
* Puglia probe among Italian inquiries into derivatives (Adds Dexia Crediop statement)
BARI, Italy, Feb 3 (Reuters) - Italian prosecutors are investigating Merrill Lynch and Belgium's Dexia SA (DEXI.BR) in an inquiry into derivatives losses from 870 million euros ($1.22 billion) in Puglia regional bonds, authorities said on Wednesday.
The Puglia investigation involving Merrill Lynch, a unit of Bank of America Corp (BAC.N), and Dexia's Crediop unit is among a raft of inquiries throughout Italy after local governments racked up hefty losses on derivatives contracts.
Tax police in Puglia, in the heel of the Italian "boot," have seized up to 103.3 million euros, that includes banks' assets as potential damages payments, as well as an installment payment.
The inquiry stems from bonds the region issued in 2003-2004 in a restructuring of its health sector debt through Merrill Lynch.
The deal called in part for an interest rate swap that switched bond issues from a variable rate to a fixed rate. It also changed capital payback from a single "bullet" repayment at maturity to an amortising scheme, the statement said.
The banks are being investigated for failing to bar employee misconduct. Daniele Borrega, Merrill Lynch's Italy representative at the time, is under investigation for aggravated fraud, the statement said.
A judicial source said Claudio Zecchi, a Dexia Crediop executive in Rome at the time, is also under investigation for aggravated fraud.
Prosecutors have asked that Merrill Lynch be barred from contracts with public bodies for two years. A hearing has been set for March 10.
Merrill Lynch had no immediate comment.
Dexia Crediop said in an emailed statement it had not underwritten with the Puglia region any derivative operation, adding it adopted required organisational measures since 2003.
Economists last year estimated that Italy's cities and regional bodies had an exposure to derivatives of about 40 billion euros, with losses of more than 6 billion euros.
The highest-profile inquiry involves a 1.68 billion euro bond by Milan, Italy's financial and fashion capital. The city has lost more than 300 million euros on the deal. (Writing by Ian Simpson; Editing by Tim Dobbyn) ($1=.7137 Euro)