Monte dei Paschi di Siena: from helping the poor to emptying state coffers

More than seven years after the Great Recession, the bailout saga continues. The failure of the Italian referendum on December 4, 2016 and the subsequent resignation of Prime Minister Matteo Renzi’s government sent markets into a tailspin and stopped Banca Monte dei Paschi di Siena’s (BMPS) restructuring plan in its tracks as understandably jittery investors refused to commit capital. With almost €47 billion in gross non-performing loans (NPLs), the beleaguered bank turned to Rome for a third potential bailout since the financial crisis.

On December 7, 2016, the Italian government announced its intention to purchase €2.2 billion in subordinated BMPS bonds currently held by retail investors. As of the morning of December 12, 2016, it was confirmed that the government decree to affect said transaction has been prepared but it has yet to be approved since a new government would have to be formed first. After a weekend of haggling, President Sergio Matteralla asked current Foreign Minister Paolo Gentiloni to form a caretaker government until elections are held. The new prime minister comfortably clinched a vote of confidence in the Chamber of Deputies on December 13 and is set to scrape through in the Senate vote expected to take place in the coming days.  On the same day, the new leader unequivocally stressed that the government would be ready to intervene to guarantee the stability of the financial system. Should a decree be approved in the near to medium term and the blessing of the EU be secured, the subordinated bonds will be purchased and would then promptly be exchanged for shares giving the Italian state a 40% stake in the bank.

While acknowledging that the political process for a bailout may well turn into a protracted fight, and especially after the European Central Bank (ECB) refused their request for an extension to raise the necessary capital, the bank’s top brass decided to double down on their original restructuring plan. Current CEO Marco Morelli hopes to highlight to retail investors that the voluntary conversion of their subordinated bonds would fetch a much higher premium than a forced conversion that would likely take place in a bankruptcy.  Moreover renewed efforts will be exercised to persuade institutional investors to return to negotiating table.  

BMPS shares rallied 11% last week after the announcement that a bailout may be in the works only to lose all those gains going into the weekend. The appointment of a new prime minister pushed shares up by almost 8% in the early hours of trading on December 12, 2016.

The road from “piety” to Santorini and Alexandria  

In the late Middle Ages, Franciscan Monks under the auspices of the Catholic Church founded and began operating a series of institutional pawnbrokers. These “Mounts of Piety” provided collateralized loans at affordable interest rates to the poor and more importantly countered the exorbitant rates charged by moneylenders of the day. In 1472, one of these institutions was founded in Siena. This institution continued to evolve over the years becoming one of Italy’s largest retail banks and a symbol of pride for its native Siena. The bank’s then largest shareholder, the Monte dei Paschi di Siena Foundation, which was spun out of the bank in 1995 following its public listing, prided itself on a reputation as “the ATM”, a title it earned thanks to the roughly €220 million it used to donate annually to its city almost a decade ago (the foundation’s stake in the bank has since been wiped out entering 2016 at a meagre 1.6% of capital).[1]

The storied bank’s current malaise traces its roots back to November 2007, when it made the ill-fated decision to acquire Banca Antoveneta. Under the leadership of then CEO Antonio Vigni, BMPS purchased Antoveneta from Spain’s Banco Santander for an eyebrow-raising €9 billion, or €9 million per branch. In hindsight, the transaction proved to be a textbook definition of empire-building as Mr. Vigni aspired to avoid being relegated to a regional player in a largely consolidating banking industry.

Antovenata itself was carved out of the carcass of ABN AMRO after it was jointly acquired in October 2007 by Banco Santander, the Royal Bank of Scotland, and Fortis following an epic takeover battle with Barclays. Alarmingly, the Spanish bank booked an instant 60%, or €3.4 billion, capital gain on the transaction. BMPS partly financed the deal with a €5 billion capital increase and market observers at the time fretted about its “overstretched” balance sheet. Merrill Lynch advised Banco Stander on the original purchase of Antoneveta and then advised BMPS itself on its own subsequent purchase of the asset raising conflict of interest concerns. All told, court documents show that investment banks generated an astounding €200 million in fees advising BMPS on acquisitions and derivatives deals between 2008 and 2011.[2]

The financial crisis took its toll on the Sienese bank as it reported an astounding €14.7 billion in cumulative net losses between 2011 and 2014. In October 2012, shareholders approved a capital increase of €1 billion to help bolster the bank’s capital position to no avail: in January 2013, the bank received €3.9 billion in emergency loans from the Italian government and shareholders approved capital authorisations of up to €6.5 billion to help BMPS repay its benefactor should it be unable to do so organically. To make matters worse, around the same time the bank was rocked by revelations that it may have misled investors through several controversial derivative transactions that helped it conceal losses.

In what became known as “Project Santorini”, BMPS made a €1.5 billion bet in December 2008 on the value of Italian government bonds it had previously posted as collateral with Deutsche Bank. Essentially, BMPS took a long position in credit default swaps on Italian government bonds, which backfired as Italian 10-year yields went from 148 basis points in November 2008 to almost 570 basis points in November 2011. Ironically, this deal was originally designed to conceal €367 million in losses from an earlier equity swap deal also with Deutsche Bank [3]. Shortly afterwards, it was revealed that the bank had to book further losses on yet another derivative transaction, dubbed “Alexandria”,  this time with Japan’s Nomura. Both deals were allegedly approved by the Bank of Italy, which was headed by none other than current ECB president Mario Draghi up until late 2011. Nomura finally agreed to settle the Alexandria transaction out of court without admitting any wrongdoing. In the aftermath, BMPS was forced to restate its 2012 financial statements to reflect €730 million in losses from its derivative transactions but was able to report a profit in 2015 thanks largely to the €608 million settlement it received from Nomura.

In October 2014, an Italian court sentenced Mr. Vigni, former chairman Guissepe Mussari (who later went on to head the Associazione Bancaria Italiana, an Italian bank lobby) and former CFO Gianluca Baldassarri to a three year and a half jail sentence for misleading regulators regarding the Alexandria transaction [4]. Prosecutors successfully argued that the trio hid a document describing how the derivative was linked to the purchase of €3 billion worth of Italian government bonds and hence required a different accounting treatment. The document was found by the bank’s new management hidden in a safe in Mr. Vigni’s former office. The trio appealed and they will stand trial on December 15 along with eleven others from BMPS, Deutsche Bank, and Nomura.[5]

Adding further mystery and intrigue to this saga was the fact that David Rossi, former director of communications at BMPS had allegedly committed suicide on March 6, 2013 after jumping from a window on the third floor of the bank’s headquarters. Mr. Rossi’s wife claimed that he had informed his boss, former CEO Fabrizio Viola, two days prior to his death that he did not want to be ‘overwhelmed by this’ and wanted ‘assurances’. In a final twist, Mr. Viola stepped down as CEO on September 8, 2016, a mere week after prosecutors decided to drop charges of market manipulation against him. Another man who may have had intimate knowledge of the derivative transactions with BMPS was former Deutsche Bank chief risk officer William S. Broeksmit, who also allegedly committed suicide by hanging himself in his London apartment in October 2014.[6]

Capital, Capital, Capital!

According the bank’s financial statements, it paid almost €735 million in dividends between 2009 and 2012, right before it suspended its dividend payment. It is disgraceful that one of Europe’s least capitalized banks was allowed by regulators to pay a dividend in the first place.

This trend is unfortunately not unique to BMPS or Italy, for that matter. At a panel discussion in February 2016, Hyun Song Shin, economic advisor and head of research at the Bank of International Settlements (BIS) noted that accumulated dividends for a sample of 90 EU banks between 2007 and 2014 amounted to €196 billion vs. cumulative retained earnings of €310 billion. This implied that capital levels would have been at least 63% higher at the end of 2014 had banks not paid dividends. Italian banks actually paid more in dividends than the cumulative retained earnings they generated during this time frame (€28 billion vs. €25 billion in retained earnings). [7]

Time and again the BIS has extolled the virtues of higher capital levels. In a working paper in April 2016 it noted that a 1% increase in equity-to-total assets was associated with a 4% decrease in the overall cost of deposit and debt funding which in turn would spur faster credit growth. This finding debunks the conventional mantra regarding the potential monetary policy trade-off between increasing bank lending to spur growth on one hand and ensuring the financial viability of individual banks on the other.  The BIS explicitly stressed that “both the macro objective of unlocking bank lending and the supervisory objective of sound banks are better served when bank equity is high”.[8]

Central banks have only their misguided policies to blame for the clear breakdown of the transmission mechanism between loose monetary policy and bank lending.

The 2016-2019 Business Plan: Panglossian goals

BMPS’ current business plan calls for a massive recapitalisation of its balance sheet and the securitisation of the bulk of its non-performing loan book. The recapitalisation plan targeted a capital injection of €5 billion which the bank intended to largely raise through the swapping of existing subordinated notes for new equity. In this respect, the bank was able to secure roughly €1 billion from institutional investors. However, the likelihood of convincing the retail investors, holding roughly €2.2 billion in subordinated debt proved impossible.

Other fund raising avenues were to come from a private placement and as a last resort from a public offer. Conversations between management and several investors revealed that much of the success of this plan hinged on the adoption of the December 4 referendum. Given its failure, it comes as no surprise that the Italian government decided to fill the hole. According to media sources, the bank was in talks with the Qatari Investment Authority for a €1.4 billion investment. The wealth fund has since backed down as it opted to wait for the formation of a new government.

The securitisation plan entails the sale of roughly €28 billion in gross non-performing loans to a series of securitisation vehicles for €9 billion, a steep discount to gross exposures. One of the securitisation vehicles is guaranteed by the Italian government through its Guarantee on Securitization of Bank Non-Performing Loans (GACS) program and is slated to repurchase up to €5 billion through the sale of senior tranches on the underlying loan pool. The Atlante Fund, a private vehicle sponsored by a hodgepodge of 67 investors with the goal of ‘rescuing’ the Italian banking system, will repurchase a further €1.6 billion through the sale of junior mezzanine notes. Interestingly, Quaestio Capital Management, the fund’s manager released a statement on October 6, 2016 stating that it is not ‘assessing a possible investment in the bank’s [BMPS] capital’.  A large state-sponsored securitization program sounds eerily familiar. Fannie and Freddie anyone?

Many other objectives of the Business Plan would leave even the most optimistic investors sceptical. Net income is targeted to exceed €1.1 billion in 2019 and Return on Tangible Equity (ROTE) is expected to surpass 11%, from its current level of 6.2%. Such a lofty goal in the post-Lehman era is wishful thinking. It is based on the assumption that mortgages will increase by 2.5 times over the next three years and that loan loss provisions will be drastically reduced. A post-restructuring NPL coverage ratio of 40% is still abysmal.

Investors should also brace themselves for the potential for contagion in the Italian banking industry. The failure of BMPS’ recapitalisation plan to gain traction post-referendum does not bode well for its much larger rival UniCredit. Italy’s only “systematically important financial institution” plans to raise €13 billion in capital to shore up its ailing balance sheet: €10 billion is slated to come from new capital and about €2.4 billion will come from the sale of a 32.8% stake in Poland’s Bank Pekao. The fact that it holds an estimated €80 billion in gross NPLs (22% of the entire Italian banking system NPL total) makes the task even more daunting.

Faced with all these challenges, extreme volatility, uncertainty, and even more bailouts may be in store for Europe’s zombie banks. With low to zero growth, stretched fiscal budgets, and a frightening wave of nationalism threatening to rip the continent apart, time is running out for policymakers in Brussels and Frankfurt to find solutions.

Lessons for shareholders

While the onus is on the authorities, and notably the ECB, to ensure that European banks remain adequately capitalised, shareholders have an important role to play as well.

Profits retained by banks help solidify their capital base. It thus follows that any profits that banks do not spend on dividends will add to capital. Unfortunately, we have seen European banks being allowed to pay billions of euros in dividends following the financial crisis when many of them ultimately proved or are proving to be undercapitalised. Relying squarely on the Common Equity Tier 1(CET 1) ratios as a measure of the soundness of a bank is not sufficient. Studies have shown that, after controlling for accounting differences (IFRS vs. US GAAP), risk weights (applied to bank assets) used to calculate risk weighted assets (the denominator for the CET 1 ratio) at European banks are significantly below their American peers largely due to different supervisory approaches (Basel I vs. Basel II measurement tools), regulatory policy decisions, and modelling decisions by the banks themselves. This could very well result in a US bank and its relatively less healthy European counterpart reporting similar CET 1 ratios.

Moreover, investors should also pay close attention to the portfolio of NPLs banks report. Typically, banks ‘set aside’ provisions to cover losses they estimate from their loan portfolio. These provisions are then compared to NPLs in order to determine coverage ratios. Coverage ratios of 100% are not entirely feasible since banks will recover a portion of their NPLs over time, but should nevertheless be sufficient to cover the risk inherent in the loan portfolio. Case in point, coverage ratios at BMPS were 61% in the €28 billion loan portfolio it intends to offload in its restructuring plan, meaning that the bank expected to recover at least 39% or €11 billion of that portfolio. However, these NPLs will be sold for merely €9 billion to securitization vehicles (i.e. implying a lower recovery rate of approximately 32%) which is a testament to how woefully insufficient its loan loss provisions were.

Taking these factors into consideration along with conventional governance issues such as board independence will help investors make more informed decisions at general meetings, particularly when it comes to approving a bank dividend. Shareholders should strive to vote against dividends at banks that are undercapitalized and should pay particular attention to any bank attempting to reinstate a dividend in the post-Lehman era.

As tempting as dividends seem being an integral part of a potent shareholder value maximization philosophy, banks should never be allowed to pay a dividend if it eventually leads to bailouts and several rounds of dilutive capital issuances. They should rather focus on what they were created to do in the first place: lend responsibly; and shareholders should hold them to account.  



1 Sanderson, Rachel. "Siena Faces Life after 500 Years of Monte Dei Paschi Largesse." The Financial Times (2016): n. pag. Web. <>.

2 Martinuzzi, Elisa, and Vernon Silver. "Bank Born Out of Black Death Struggles to Survive." Bloomberg News (2013): n. pag. Web. <>.

3 Durden, Tyler. "Deutsche Bank Charged By Italy For Market Manipulation, Creating False Accounts." ZeroHedge (2016): n. pag. Web. <>

4 Planigiani, Gaia, and Jack Ewing. "Monte Dei Paschi Di Siena’s Former Executives Sentenced to 3.5 Years in Prison." The New York Times (2014): n. pag. Web. <>

Sirletti, Sonia, and Sergio Di Pasquale. "Ex-Deutsche Bank Executives Among 13 Charged in Paschi Probe." Bloomberg News (2016): n. pag. Web. <>

Durden, Tyler. "An Inside Look At Two "Unrelated" Banker Suicides Reveals A Fascinating Rabbit Hole." ZeroHedge (2016): n. pag. Web. < >

Hyun, Song Shin, 2016. Bank Capital and Monetary Transition, Bank of International Settlements: Panel remarks at The ECB and its Watchers XVII conference, 2-3.

8 Gambacorta, L., Hyun Song Shin, 2016. Why Bank Capital Matters for Monetary Policy, Bank of International Settlements, Working Paper No. 558, 7-9.