What Montepaschi’s €8.8B 'Bail-In' Means for NPL Securitization

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A larger-than-expected “bail-in” of Banca Monte dei Paschi di Siena has placed the focus on other major Italian banks that have similar plans to seek government guarantees on their non-performing loan securitizations.

Bank authorities in Italy this week announced plans to inject about €6.5 billiion into Monte dei Paschi (or Montepaschi), as the nation’s third-largest bank has struggled to find buyers of its high-yield bonds backed by its large portfolio of legacy bad loans.

The higher price tag came after the European Central Bank determined that Montepaschi’s capital situation was more dire than believed, with a capital shortfall of €8.8 billion (US$9.22 billion), according to reports.   

The gap has been exacerbated by a run on deposits by customers as well as the apparent failure to gain enough investors in the bank’s senior debt that had been backed by guarantees from the Italian government. The capital squeeze is also being shored up by subordinate bond investors, who are in line to take a hit in accordance with ECB resolution guidelines, according to Moody’s Investors Service.

(Holders of Tier 1 subordinate bonds – which hold a bottom-run rating of ‘C(hyb)’ by Fitch Ratings – will get 75% of the face value of the bonds, with the option to swap for new-issue senior bonds at face value).

On Tuesday, Moody’s announced it was extending a review of Montepaschi’s base credit assessment rating, with the potential for an upgrade due to the relief provided by the recapitalization. But for the bank’s senior debt and deposit ratings, Moody’s may have to take into account an increase in potential “loss-give-failure” levels  with the loss of the subordinate bonds to absorb losses.

Earlier this month, a research report from BNP Paribas noted the Montepaschi would be a “key test” for the Bank Recovery and Resolution Directive (BRRD) adopted by the European Parliament in January 2016. Most notably, BNP said an “unpredictable” outcome could have consequences for retail investor-support for Italian banks, many of which rely on that sector to support their “modest” capital ratios.

The BRRD serves as a framework for resolving bank capitalization issues through burden-sharing rules involving government bailouts and bondholder haircuts.   

Banco Popolare di Bari was the first Italian bank in 2015 to issue government-backed bonds to divest of its bad loans. Montepaschi is the first bank expected to utilize the program while under the BRRD-driven bail-in guidelines. (A Portugese bank, Novo Banco –formed in 2014 to take on the assets and liabilities of the failed Banco Espirito Santo – was recapitalized under a domestic bridge-bank framework in December 2015).

“After the selective bail-in of senior bonds at Novo Banco, resolution authorities face a key credibility test with [Montepaschi],” BNP research analysts wrote on Dec. 12. That integrity relies on the consistent application of bail-in rules to other Italian and Eurozone bankers, as well as “subsequent compensation for retail investors,” the report stated.

 “An unpredictable outcome which does not enforce the ranking of liabilities in insolvency will compromise future investor participation in the recapitalization of weak banks,” BNP Paribas wrote. “It will also have an immediate negative impact on mid-sized Italian banks...which have modest capital ratios and whose Debt is widely held by retail investors.”

According to Fitch, Italian banks are burdened with more than €330 billion in bad loans. Several have planned sales of “sizeable” doubtful-loan portfolios in 2017 through the government’s guarantee program, including four medium-sized institutions - Banca Carige, Credito Veltellinese, Banca Populare di Vicenza and Veneto Banco.

Banca Carige, with €27.5 billion in assets as of September 2016, more than doubled is net loan loss provisions to €417.2 billion in the third quarter to reduce the NPL risk exposure.

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