Bloomberg News

Monte Paschi Bondholders Face 60% Loss Risk: Corporate Finance

September 03, 2012

Monte Paschi Bondholders Face 60% Loss Risk

Siena, Italy-based Monte Paschi, which posted a 1.67 billion-euro quarterly loss last week, already asked the government for aid as provisions against bad debts surged 40 percent to 409 million euros. Photographer Giuseppe Aresu/Bloomberg

Investors in about 5 billion euros ($6.3 billion) of Banca Monte dei Paschi di Siena SpA’s junior debt face a more than even-money chance of suffering losses as bad loans pile up at the world’s oldest bank.

The cost of insuring 10 million euros of the lender’s subordinated debt is 2.75 million euros in advance and 500,000 euros a year, signaling an almost 60 percent probability of default, according to data provider CMA. That’s up from 1.7 million euros upfront on Jan. 1, and credit-default swaps on Monte Paschi’s senior and junior bonds are the worst-performing among 92 European lenders this year, Bloomberg data show.

Subordinated debt investors and shareholders should take losses to recapitalize the bank that was founded in 1472, according to Alberto Gallo, head of European credit research at Royal Bank of Scotland Group Plc in London. Siena, Italy-based Monte Paschi, which posted a 1.67 billion-euro quarterly loss last week, already asked the government for aid as provisions against bad debts surged 40 percent to 409 million euros.

“Some form of burden-sharing should be implemented, rather than using public funds first to recapitalize the bank,” Gallo said. “In the worst-case scenario, a resolution regime could be implemented in which sub-debt and equity holders take losses.”

Fourth Recession

Italy’s fourth recession since 2001 coupled with the austerity plan implemented by Prime Minister Mario Monti is hurting businesses, making it harder for them to repay debt.

Unemployment held at 10.7 percent in July as employers remain reluctant to hire amid a deepening crisis that has seen the nation’s debt spiral to more than $2 trillion. The country remains one of the most vulnerable to contagion from Europe’s troubles, which begin in Greece almost three years ago.

Monte Paschi’s loan book is “very fragmented and exposed to small borrowers,” according to a research note by Gallo.

Credit-default swaps insuring the bank’s senior debt rose 44 percent this year to 790 basis points, the most of any European bank, Bloomberg data show. That compares with a 24 percent increase at the second-worst performer and Spain’s second-largest bank, Banco Bilbao Vizcaya Argentaria SA.

A total of 4,726 credit-default swaps contracts protecting a net $972 million of Monte Paschi’s debt were outstanding as of Aug. 24, according to the Depository Trust & Clearing Corp.

Swaps Liquidity

A basis point on a swap protecting 10 million euros of debt from default for five years is equivalent to 1,000 euros a year. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

“Monte Paschi is always committed to fulfilling its obligations with each different category of bondholders from covered to subordinated ones,” according to a statement from the bank. “The CDS prices cannot be taken as a real probability of default at this moment due to the lack of liquidity.”

A total of 27 credit-default swaps covering a net $107 million of Monte Paschi debt was traded in the week ending Aug. 24, according to DTCC, which runs a central registry for the swaps market that captures most trading.

The bank is borrowing 3.4 billion euros by selling bonds to the state after failing to find private investors to close a 3.3 billion-euro capital shortfall identified by the European Banking Authority. It’s also one of the top 10 biggest users of the European Central Bank’s 1 trillion-euro longer-term refinancing operations, taking 29 billion euros of loans.

Capital Ratio

Monte Paschi’s core Tier 1 capital ratio, boosted by 1.9 billion euros of government funding, is 10.8 percent, and 8.85 percent net. The ratio is a key measure of a bank’s financial health.

That compares with a ratio of 10.7 percent for Italy’s second-biggest bank, Intesa Sanpaolo SpA (ISP), and 10.24 percent for the country’s fifth-largest lender, Unione di Banche Italiane SCPA, according to filings.

Monte Paschi may become the first Italian lender since the 1990s to have the government as a shareholder because it must give shares to the Treasury in lieu of interest on its borrowings if it reports an annual loss, according to a law approved this month. Italy sold bank holdings in the 1990s as it sought to improve lenders’ profitability and foster consolidation.

Irish Losses

Investors in the subordinated debt of Irish banks suffered about 15 billion euros of losses after the nation’s lenders collapsed under the weight of bad property loans. In Spain, the government was said to have balked at using European Union money to bail out Bankia group because it didn’t want to impose losses on junior debt investors.

Monte Paschi bondholders may escape losses because the bank’s financial health isn’t as “disastrous” as may first appear, according to Roger Francis, a credit analyst at Mizuho International Plc in London. The lender’s second-quarter loss mostly comprised a 1.6 billion-euro goodwill writedown, he said.

“Above a certain threshold of assistance, the EU will insist on burden sharing by sub-debt holders, which would likely include a halt to discretionary calls and coupon payments,” Francis said. “In terms of actual realized capital losses, I’d say that’s still a very low probability.”

Junior notes known as Tier 1 securities rank below senior bank loans and other bonds for payment and are first to get hurt in a default. Banks divide debt capital into tiers, depending on the ability of the bonds to absorb losses, with Tier 2 debt comprising more senior securities.

Average Returns

Monte Paschi’s six bonds included in the Bank of America Merrill Lynch EMU Financial Corporate Index were the fourth- worst performers in July, returning 0.22 percent compared with an average 1.61 percent for the index as a whole. Investors demand an extra 537 basis points in yield to hold the bank’s securities, more than double the 244 basis-point spread for the index, which contains securities from banks including ABN Amro Bank NV and UBS AG.

The spread on Monte Paschi’s 800 million euros of 7.25 percent bonds due 2015 narrowed to 603 basis points over the benchmark midswap rate, from a high of 775 on July 24, the week the company announced it may be forced to merge, data compiled by Bloomberg show. The bank ended its first half with 232 million euros of liabilities on its balance sheet, down from 241.5 million euros at the same point a year earlier, according to its earnings statement.

Bonds Maturing

Monte Paschi has 5.37 billion euros of bonds maturing this year, data compiled by Bloomberg show, rising to 19.6 billion euros in 2013. It’s rated BBB with a “stable” outlook by Fitch Ratings, while Moody’s Investors Service and Standard & Poor’s grade it one level lower at Baa3 and BBB-, both with “negative” outlooks.

“Significant pressure remains” on the lender’s profitability, asset quality and funding, Fitch analysts led by Christian Scarafia wrote in a June 29 report. Monte Paschi is more affected by external conditions because of its need to rebalance its funding “by de-leveraging during times of market stress,” according to the report.

Fitch cut its rating on Monte Paschi’s junior Tier 1 securities by three levels to CCC from B+ and its upper Tier 2 instruments to B- from BB- to reflect increased non-performance risk. “The receipt of government capital increases the risk of the non-payment of the coupons,” the analysts wrote.

“The bank will be less friendly toward sub bondholders in terms of call policy, and coupons that are non-mandatory may be suspended,” said RBS’s Gallo.

Monte Paschi “has 5 billion euros of subordinated debt available, which could create a substantial capital buffer to withstand potential future losses in its 144 billion-euro loan book,” he said.

To contact the reporter on this story: Hannah Benjamin in London at hbenjamin1@bloomberg.net

To contact the editor responsible for this story: Paul Armstrong at parmstrong10@bloomberg.net


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