The Full Details Behind Monte Paschi's €5 Billion Bail Out

After the close on Friday, the European Banking Authority did what it does every other year: it released the results of what it calls a "stress test" which is simply an annual exercise in boosting confidence. Case in point, the 2016 edition did not even "test" for Europe's two biggest threats, namely negative interest rates or "Brexit." It also did not test any banks from Greece or Portugal, knowing well what the results would have been. However, in order to retain some credibility, the same test which in previous years passed such failed institution as DexiaBankia and Novo Banco, had to fail one bank, and this year the honors fell to Italy's Monte Paschi.

However, as we reported earlier on Friday, the EBA only failed Monte Paschi after the bank announced it had obtained a private bailout from a consortium of banks. The Monte Paschi bailout, a €5 billion capital increase, was unique in several ways, not least representing 5.6x BMPS's market cap.

In a nutshell, the plan can be summarized in the following three steps:

  1. Increase the coverage ratio for Bad debt
  2. Transfer all the existing stock of Bad debt (sofferenze) into a securitization vehicle. The senior tranche will be covered by government guarantees, Mezzanine will be bought by Atlante fund and the equity tranche will be transferred to existing shareholders and deconsolidated.
  3. A €5bn capital increase to remove the negative capital impact from the operation and maintain capital level at the current level of 11.8%.

So far so good, but as Barclays' Marta Bastoni puts it: "one problem is fixed but not easily repeatable."

As Bastoni further writes in a July 31 note, "while the announced capital plan has the advantage of removing risks connected to the transferred NPLs from the balance sheet, and is a private solution, the €5bn capital increase represents 5.6x MPS’s market cap. We see this plan as a small positive for the sector as it reduces the total amount of provisions needed to write-down NPLs to a “market level”. However, we believe that it will be difficult to replicate the MPS plan on a large scale, and with ongoing lack of clarity on an ECB target outcome, we believe that uncertainty over the capital position of thesector as a whole remains."

A key role in the securitization-driven bailout will be played by Italy's paltry, €5 billion bank bailout fund, Atlante, first introduced in April, which will be the buyer of the risky €1.6 billion "mezz" tranche. However, with that particular investment, Atlante will be effectively drained, left with just about €1 billion in "dry powder," not nearly enough to prevent or even materially delay the ongoing Italian bank crisis.

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