• Volumes surge sevenfold as Italy discusses supporting banks
  • European agreement on bank aid likely to require bond losses

Credit traders are buying more protection on Banca Monte dei Paschi di Siena SpA debt amid concern that a potential rescue plan for Italian lenders will lead to losses for bondholders.

Credit-default swaps covering a gross $95 million of Monte Paschi debt changed hands in the week ended July 8, more than seven times the average in the previous four weeks, according to Depository Trust & Clearing Corp. Prices on Wednesday signal a 56 percent probability of default on junior bonds in five years, data from CMA show.

The Italian government is in talks with European leaders about using state funds to shore up capital at banks such as Monte Paschi that are likely to fail stress tests this month because of bad debts. An agreement will probably require the imposition of losses on shareholders and junior creditors because of regional rules designed to protect taxpayers.

“Most people think a bail-in could happen for the subordinated bonds,” said Filippo Alloatti, a senior credit analyst at Hermes Fund Managers Ltd. in London, which oversees 24 billion pounds ($32 billion) of assets. 

The upfront cost of credit-default swaps insuring 10 million euros ($11 million) of junior Monte Paschi debt for five years is 3.6 million euros, up from 2.8 million euros a month ago, according to CMA. That’s in addition to 500,000 euros annually.

Novo Banco

Still, demand for swaps may be curtailed by the failure of the instruments to pay out after Portugal imposed losses on some senior bondholders of Novo Banco SA in December, Alloatti said. 

“In some parts of the market there is a fair degree of skepticism around default swaps as a hedging tool,” he said. 

The Italian government will likely try to shield retail investors, while bailing in other junior bondholders, said Luigi Pedone, a credit analyst in Milan at Syz Asset Management, which oversees about 16 billion euros. Italian Premier Matteo Renzi is seeking to spare smaller bondholders partly to avoid hindering his chances of winning an October referendum.

Monte Paschi has about 10.7 billion euros of bonds with an initial investment designed to attract ordinary families, data compiled by Bloomberg show. Nationwide households own almost half of the most junior Italian bank debt, which is first in line for losses, according to Bank of Italy data.

Siena, Italy-based Monte Paschi’s 379 million euros of 5.6 percent junior notes have fallen more than 20 cents this month to 68 cents on the euro, according to data compiled by Bloomberg. They rose 3 cents on Wednesday.

“The subordinated debt certainly looks like it’s pricing in some level of burden-sharing,” said Alexander Pelteshki, a money manager at Kames Capital Plc in Edinburgh, which oversees 58 billion pounds of assets.

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