How Monte Paschi Could Raise Funds as Bank Stress Tests Loomby
Options include public backstop, debt-for-equity swap
Italy trying to avoid major losses for bank’s creditors
Italy’s Banca Monte dei Paschi di Siena SpA will probably get the lion’s share of investor attention when European bank stress tests are published on Friday. The examination by Europe’s banking authority could show that the lender needs as much as 3.5 billion euros ($3.8 billion), according to Credit Suisse Group AG analysts.
Here’s how it could raise the money:
European Central Bank President Mario Draghi supported a public backstop for non-performing loans on Thursday, becoming the most powerful euro-area official yet to concede that Italian banks need extraordinary assistance. Monte Paschi, the world’s oldest bank and Italy’s third-largest lender, is in discussions with officials over creating a new fund backed by private investors that would buy its bad loans, a person with knowledge of the plan said last week.
That’s important because Monte Paschi has Italy’s biggest pile of non-performing loans relative to its balance sheet. Earlier this month, the ECB directed it to offload more than 14 billion euros worth over three years.
Getting rid of the loans would shrink the bank’s balance sheet and boost its capital ratio. A state-backed fund would probably offer a higher price than private distressed-debt funds, which typically pay 20 to 30 cents of face value, analysts say. Selling the bad loans at current market values and making provisions for them would require 4 billion euros of capital, according to Kepler Cheuvreux analysts. The bank has made provisions for 49 percent of the value of the loans, so it would need to sell them at about half of face value on average to avoid losses.
Italian Prime Minister Matteo Renzi wants to provide state funds to frail lenders. Countries including the U.K., Ireland and Spain moved to rescue their banking systems during the financial crisis by taking equity stakes in banks or setting up so-called bad banks to purge the system of toxic assets. Italy could also buy up special-purpose bonds from banks. In 2013, it purchased 4 billion euros of "Monti bonds,” named for then-prime minister Mario Monti, from Monte Paschi. The bank used that money to tide it over while it raised capital through rights issues in 2014 and 2015.
However banking rules have become much tighter since, typically requiring creditors to take a hit first when banks are rescued.
German Chancellor Angela Merkel and Jeroen Dijsselbloem, who leads the group of euro-area finance ministers, have publicly opposed direct state aid. Still, Merkel may allow Renzi wiggle room to avoid further instability in the European financial system, three German government officials who asked not to be identified said on Thursday.
Forcing creditors to convert their bonds into shares would instantly increase Monte Paschi’s common equity Tier 1 capital ratio, the main measure of financial strength watched by regulators. However, that would mean bondholders lose their guaranteed coupon payments and full repayment at maturity to become shareholders with unpredictable returns. Monte Paschi’s stock has fallen 75 percent this year.
The bank has more than 5 billion euros of junior debt that could potentially be turned into equity, allowing it to raise capital without going to the markets for fresh funds.
That scenario would be a vote killer for Renzi because it would impose losses on the small-scale investors, who own almost half of the junior bank securities in Italy. A bail-in of junior bondholders at four small Italian banks in November led to a nationwide selloff of bank debt and the suicide of one investor who lost his life savings. A deal for partial compensation was reached later.
European officials may allow Italy to compensate small investors to limit the political fallout, the German officials said.
This would be a similar but gentler method of raising capital, involving sweetening the share offer to bondholders or protecting the more vulnerable creditors, bankers say.
“Proposing debt-for-equity swaps could be a good bargaining chip with the EU,” said Riccardo Cumerlato, the former head of liability management at Mizuho International who now runs an independent advisory business. “Italy could say ‘let us help the banks to an extent and we’ll get the rest through bondholders.’”
Greek banks completed debt-for-equity swaps last summer, raising about 3 billion euros. Monte Paschi bondholders might accept that transaction if the bank is willing to give them more shares than the face value of their holdings, according to Keefe, Bruyette & Woods analysts.
The risk remains that asking creditors to swap tends to cause panic, according to Stelios Manetas, the head of liability management at BNP Paribas SA, which ran the swap at Greek lender Eurobank Ergasias SA last year.
Selling new shares is one of the most straightforward ways to raise money, but it would be difficult for Monte Paschi because its previous rights issues have already seared risk-taking investors. The value of its stock has fallen more than 80 percent since the bank raised 3 billion euros in May last year. The shares are currently trading at about four times next year’s expected earnings, compared to a multiple of about 9 for the Stoxx 600 Banks index.
Investors shunned share sales by Italy’s Banca Popolare di Vicenza SpA in May and Veneto Banca SpA in June and state-orchestrated rescue fund Atlante had to step in and buy almost all of the stock. Banco Popolare discounted its shares by 29 percent when it raised cash last month.