December 22, 2016 / 1:18 PM / in 7 months

Monte dei Paschi endgame can still be made fair

3 Min Read

Monte dei Paschi di Siena bank CEO Marco Morelli attends a news conference in Milan, Italy October 25, 2016.Alessandro Garofalo - RTX2QCBO

LONDON (Reuters Breakingviews) - Monte dei Paschi has one foot in the grave, but there are still good and bad ways to proceed. Italy's third-biggest bank failed to fill a 5 billion euro regulatory hole and is now set to convert debt into equity, keeping government money to a minimum. The trick is to limit compensation to those private creditors that deserve it.

It's not terribly surprising that MPS's attempt to sort itself via non-state means failed. The bank needed to raise half its tangible equity, and nearly 10 times its market capitalisation. A plan to strong-arm bondholders to switch 4.3 billion euros of securities into equity was a modest success: it raised 2 billion euros. But because the bank failed to find a new anchor investor willing to put money in amid Italy's current political uncertainty, the bondholder swap is now null and void.

The question now is how much state capital is required, and how fairly bondholders are treated, as when Italy puts state money in they will need to take losses under European state-aid rules. Italy should resist the temptation to excessively protect retail investors, as Portugal did with Banco Espirito Santo. MPS could convert all its 4.3 billion euros of subordinated bonds into equity, thus keeping the state capital to less than 1 billion euros. That's sensible given Italy's high debt, equivalent to 133 percent of GDP.

The next question is what price the new shares are issued at. With MPS trading at 5 percent of its 10 billion euro cleaned-up tangible book value, a lower assumed price would mean creditors own most of the bank and potentially recover their money. The bonds' current price of as little as 40 percent of par suggests investors worry the actual outcome will be more painful.

How Italy proceeds will have political ramifications. The radical 5-Star Movement has been calling for full repayment of retail bonds, so if this doesn't occur it could help them in next year's elections. A halfway house would be to give all creditors 100,000 euros, thus protecting poorer bondholders and providing a bail-in that could satisfy Brussels.

Both of these are still bailouts that hurt other taxpayers, though, and 5-Star's support hinges more on issues like weak growth. The best way to proceed is to bail everyone in and pay creditors back based on whether it can be shown they were mis-sold. MPS doesn't deserve special treatment, and shouldn't get it.

On Twitter twitter.com/Unmack1

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