It looks as if, for now at least, Europe’s next banking crisis has been averted. Over the weekend a rescue plan emerged for Italy’s Banca Monte dei Paschi di Siena, the struggling Italian lender which was the worst performing of all Europe’s banks in the recent EBA EU-wide stress tests.

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The rescue plan has three steps the first two of which involve increasing the coverage for bad debt and transferring bad debt into a securitisation vehicle. The final step is the recapitalisation of the bank specifically, a €5 billion capital increase to remove the negative capital impact from the bad debts rearrangement.

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After the completion of the recapitalisation, it is estimated that the bank will have a non-performing loan ratio of 18%, compared to the current ratio of 34%. Bad debts will be removed from Monte Paschi’s balance sheet, and the remaining NPLs will have a coverage ratio 40%. While this should calm fears about the state of Italy’s fragile banking system, shareholders will be almost entirely wiped out. Analysts at Barclays estimate shareholder value will be diluted by at least 81% following the recapitalisation.

Monte Paschi’s restructuring: Three main steps

The first phase of Monte Paschi’s restructuring is to increase the NPL coverage ratio. For the €27 billion of bad debts on the bank’s balance sheet, the coverage ratio should increase from 61% in Q2 2016 to 67% via a securitization program. Further, the group will raise the coverage for NPLs that remain on the balance sheet (€18.1 billion) from 29% to 40%.

Step two is a securitization of the bad debts. As analysts at Barclays explain:

“The €27bn of gross Bad debt will be transferred to the MPS special vehicle. The vehicle will have to issue funding on a net basis, so on the €9.2bn of Net NPLs. As a result of the securitization there will be no part of the structure that remains on MPS’s balance sheet.

The securitization vehicle will be composed of three tranches:

  • Senior tranche: €6bn of investment grade notes that in the plan will be covered by government guarantees (GACS). The group has already arranged a €6bn bridge loan facility to ensure the deconsolidation of the NPLs, and at the same time gives them the flexibility of time to arrange longer term-issuance.
  • €1.6bn Mezzanine tranche: to be bought by the Atlante fund
  • €1.6bn Junior tranche: will be entirely assigned to current shareholders, who will see the share premium being erased, and replaced by the note.”

The Atlante fund is the €4.3 billion Italian government’s banking fund designed to participate to the subscription of the upcoming capital increases of Italian banks seeking recapitalizations. As well as buying the €1.6 billion tranche of securitised bad debts, Atlante will also be granted warrants on underlying newly issued shares for an amount of up to 7% of the capital post money, and an exercise price in line with the rights issue.

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The third and final step of the recapitalisation is a €5 billion capital increase. This cash injection will be used to cover the capital needs arising from other steps of the plan. €2.2 billion will be used to increase the coverage ratio on NPLs that are to remain on the bank’s balance sheet. €1 billion will be used to increase the coverage ratio for bad debts to 67%, and €1.6 billion will be used to de-consolidate the equity tranche of the vehicle.

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In theory, on completion of the balance sheet restructuring and recapitalisation Monte Paschi will be left with a CET1 ratio 8.2% based on Q1 2016 figures. The size of the capital increases 5.6 times the bank’s current market cap.

Monte Paschi’s restructuring: Three main steps
Monte Paschi’s restructuring: Three main steps