On July 29th Monte dei Paschi di Siena (MPS; total assets of €164.4bn) failed the EU-wide stress test of the European Banking Authority (EBA). MPS’s board approved an emergency plan to sell €27.7bn in gross non-performing loans (NPLs), some to the backstop fund Atlante, which will be reinforced with new contributions from banks and pension funds. By the end of 2016 MPS will conduct a rights issue of up to €5bn.
MPS was by far the stress test’s worst performer, posting a common equity tier 1 (CET 1) ratio (a measure of financial soundness) of -2.44% by end-2018 in the “adverse” scenario, which envisages a deep contraction in both EU and Italian real GDP during 2016‑18. In this scenario, MPS’s losses would hypothetically more than exhaust its high-quality capital, leaving it insolvent. By comparison, the European Central Bank (ECB) had prescribed an indicative CET 1 ratio of 5.5% in the adverse scenario.
|“Fully-loaded” CET 1 capital ratio, 2016 EU-wide stress test|
|Bank||End-2015||Baseline scenario, end-2018||Adverse scenario, end-2018|
|Monte dei Paschi di Siena||12.07%||12.24%||-2.44%|
|Source: European Banking Authority.|
|Macroeconomic assumptions for the Italian economy, 2016 EU-wide stress test|
|Baseline scenario||Adverse scenario|
|Real GDP growth||1.5%||1.4%||1.7%||-0.4%||-1.1%||0%|
|Ten-year government bond yield||1.8%||2%||2.1%||2.9%||3%||3%|
|Source: Bank of Italy.|
MPS raced to reassure investors and regulators by approving a private-sector transaction to unload €27.7bn of its €45.3bn in total gross NPLs and by raising fresh capital. The government pressed hard to arrange the deal, particularly in convincing banks and professionals’ pension funds to make new contributions to Atlante, raising their exposure to NPLs. Public intervention might have required a junior credit bail-in according to EU state aid rules, making such an option politically impracticable.
The broad contours of the deal are:
- provisions for the €27.7bn in gross NPLs will be increased, facilitating their sale to a securitisation vehicle at a price of 33% of book value, or €9.2bn;
- a €6bn senior tranche of securitised NPLs will be sold under the government’s NPL securitisation guarantee scheme, Garanzia sulla Cartolarizzazione delle Sofferenze (GACS); €1.6bn in mezzanine notes will be underwritten by Atlante; and €1.6bn in tradeable junior notes will be assigned to shareholders; and
- by end-2016 a rights issue underwritten by several investment banks will raise up to €5bn in fresh capital to improve provision coverage for MPS’s remaining NPLs.
MPS shares rose on the news, but it is unclear whether the plan will restore investor confidence, and so whether the rights issue will succeed. Crucially, the rights issue is likely to be scheduled after the government’s constitutional reform referendum in October-November.
Impact on the forecast
We maintain our view that financial sector weakness is a serious risk to the broader health of the economy, but that Italy will avoid a full-blown banking crisis.