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Monte’s Inferno

22 June 2012 By George Hay

The citizens of Siena are used to white knuckle rides. On July 2 each year, the medieval Tuscan town hosts the Palio, a world-renowned horse race in which 10 brightly coloured jockeys and their mounts thunder three times round the central Piazza del Campo. But this year, the really gripping action will take place a week earlier, up the road at the Palazzo Salimbeni. And it will involve the local bank.

Monte dei Paschi is unique in European finance. Established in 1472, it is the world’s oldest bank. And it does much more than take deposits and make loans. Its largest shareholder, the Fondazione Monte dei Paschi di Siena, supports local artistic, social and commercial interests. MPS dividends pay to train horses for the Palio and maintain a stunning collection of renaissance art. The bank even produces its own highly drinkable Chianti.

Yet in European finance MPS has become notorious for flunking pan-European bank stress tests. The most recent examination in December identified a 3.3 billion euro capital hole – more than the lender’s current market value – to be filled by 30 June. MPS has waited until the last minute to say exactly how it will do so.

The bank’s problems started with one outlandishly bad deal. In 2007 it bought rival Antonveneta from Santander for 9 billion euros – a third more than the Spanish lender had valued the business a few months earlier. This stretched MPS’s balance sheet just as the financial crisis was gathering speed. Sienese public prosecutors, who raided the bank’s head office and homes of former executives in May, are investigating the price paid for Antonveneta.

In Siena, the bank’s travails are causing havoc. To conserve capital, MPS has been forced to cut its dividend – the foundation’s main source of income. Worse, the foundation stretched itself to support the bank’s capital raisings in 2008 and 2011. In an effort to avoid dilution, the foundation borrowed 1 billion euros secured against its MPS shares. But as the shares tumbled – they’re down 75 percent over the last year – the foundation was forced to restructure its debt, reducing its shareholding from 50 percent to 36 percent.

It’s tempting to blame all MPS’s problems on Antonveneta. But the bank then committed a possibly even bigger howler by stocking up on high-yielding Italian sovereign debt. In December 2008, MPS had 5 billion euros of so-called “available for sale” (AFS) assets, most of it Italian government debt. Now it has about 25 billion euros. Tumbling Italian bonds have undermined MPS’s balance sheet: using Basel III measures, its core Tier 1 capital ratio at the end of 2011 was just 3 percent, according to analysts.

Many Italian bankers think this kind of analysis is absurd. Basel III will not be in full force until 2018, and current rules do not require mark-to-market losses on AFS assets to be deducted from capital. Using the old rules, MPS comfortably exceeds the 9 percent core Tier 1 pass mark for the December stress test conducted by the European Banking Authority (EBA).

However, fears of a possible Italian default have given investors the jitters. So MPS needs capital. Following the conversion of hybrids and some disposals this year, the capital hole has probably halved to around 1.5 billion euros. MPS’s new chairman, ex-UniCredit boss Alessandro Profumo, has three options when he and chief executive Fabrizio Viola map out the new strategy on June 26.

The first is to ignore the EBA. Profumo could concede he will miss his target but present detailed disposal plans outlining how he will get there by a new deadline. If the Bank of Italy agrees with MPS, the EBA is powerless to intervene. But other banks would cry foul, and confidence in MPS would erode further.

Alternatively, MPS could try to find private capital. But another rights issue is probably impossible in the current climate, and sovereign wealth funds are wary of the euro zone. Besides, further diluting the foundation’s stake would add to local political tensions.

That leaves the state. MPS could announce the sale of 1.5 billion euros of contingent convertibles to a buyer like Cassa Depositi e Prestiti, the state savings bank. Or it could ask the government to revive a 2008 programme for supplying capital to needy banks – the so-called “Tremonti Bonds”. But selling CoCos would require paying a high coupon which MPS can ill afford. And given that MPS also already has 1.9 billion euros of expensive, non Basel III-compliant Tremonti bonds which it is supposed to pay back by 2014, it will be reluctant to increase its holding.

Like a canny Palio racer, Profumo may yet find a way to keep the MPS show on the road. If he chooses a fudge, he could be helped by an Italian government loath to add to its high public debt, and a euro zone that does not have limitless bailout funds. But he will be well aware that most previous executives have been unseated by the challenge.


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