Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

Banca Monte dei Paschi di Siena SpA's new Chief Executive Officer, Marco Morelli, is taking few chances with his most important step yet in rescuing Italy's third-largest and most-troubled bank. Failure at this step could well prove terminal.

The 4.3 billion-euro ($4.6 billion) offer to buy back subordinated debt in exchange for equity, part of a big recapitalization plan, comes on relatively generous terms and shows this painstaking process has been designed to avoid lawsuits and be a success. Taking individual investors out of an illiquid nightmare they should never have been sold and into liquid equity is key for the bank to move on.

This voluntary deal offers face value for the Lower Tier 2 senior subordinated debt -- that's clearly meant to ensure retail investors are not suffering unduly, as the price is above where the secondary market was trading. An offer of about 85 percent of face value for the Upper Tier 2 junior subordinated securities, which is where institutional investors are largely positioned, is also generous.

The best price, relatively speaking, at 20 percent of face value, is for the Tier 1 equity-like perpetuals. These might normally trade not far above zero, so this should encourage selling of these very illiquid securities by investors who were willing to take on higher levels of risk.

Up From Zero
Prices picked up from almost nothing as Monte Paschi recovery plans took shape
Source: Bloomberg

The offer doesn't involve the bank's senior debt holders, who normally expect a cushion from the perils of restructuring. Including them would have created fertile ground for a slew of lawsuits, which hopefully can now be avoided.

The deal leaves room for a cornerstone investor, likely a sovereign wealth fund or large private equity player, as the government's forbidden under European Union rules to bail out any of its banks. The rescue has to be done with private money. It looks like there's enough incentive here for these big pools of private money to stick around as long-term capital. If they do, and if the whole arrangement proves successful, then this will be a very important baby step on the road for Monte to get back on its feet.

Front Loaded
Monte Paschi's bond swap mostly targets the bank's perpetual securities. Its looming, mostly-senior other debt obligations are a separate headache
Source: Bloomberg
P = Perpetual

That should please both the Italian government and the Bank of Italy, as it means the Atlante bank bailout fund, which was set up with mostly private contributions, may not be needed in this instance. That would leave its firepower free to be deployed elsewhere to support Italy's beleaguered banking industry.

Monte Paschi shares fell about 7 percent. While that reflects investors' aversion to the dilution that will follow, it's actually also a sign they expect the deal to go through. In time the stock should fare better as the bank will have much less debt.

Monte's Slide
Monte Paschi's lagged European stocks all year as its difficulties mounted
Source: Bloomberg

It's a good deal for retail investors. Their shift out of arcane debt securities is being offered on respectable terms, and will take some of the heat out of the fraught bank mess in Europe's fourth-biggest economy. As equity holders, they'll be free to cash out or stick around for the rest of Monte Paschi's long ride. This should be a rocky one, as this bank has many obstacles left.

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