There’s an old saying in the medieval Tuscan city of Siena that explains the importance of lender Monte dei Paschi for the local economy: “Every Sienese is either a current, retired or aspiring MPS employee.”
The bank, which traces its history back to 1472, was the main backer of the city’s numerous cultural, musical and sports events, including the annual Palio di Siena horse race, which still attracts tourists from all over the world each year. Up until a decade ago, its sponsorships of the city were worth some €33mn a year.
“Monte dei Paschi was Siena,” says one former executive.
In some ways, it represented Italy too — an enduring symbol of the country’s role in sowing the seeds of the modern banking system. The foundation that once controlled the bank had close ties to Italy’s leftwing parties, with its board members appointed by local politicians.
Then it all came apart. The ill-fated acquisition of a rival in 2007 began a spiral into decline that has left it on life support for more than a decade. Billions of euros in state aid and multiple injections of capital failed to nurse it back to financial health and in 2017, it was nationalised in a €5.4bn government bailout.
This year, the Italian Treasury installed a new chief executive and attempted to revive it through yet another rights issue, its seventh in 14 years. The goal is to restructure the bank with a view to finally taking it private again. A first attempt last year was scuppered after Milan-based UniCredit and the Italian Treasury failed to agree the terms of the takeover.
Now, Italy’s new nationalist government might have a fresh chance at finding a buyer after the controversial €2.5bn capital increase, which includes €1.6bn contributed by the Italian state, was a surprise success.
Yet to finalise the rights issue and move forward with privatisation the government must rely on Brussels turning a blind eye to what experts and investors have defined as a blatant case of rule-bending by Italy and the bank.
As shareholders showed little interest in its latest capital increase, MPS convinced a group of banks to underwrite the full private investors’ share in exchange for a lucrative fee.
To further reduce their risk, these banks entered sub-underwriting agreements with other investors who agreed to mop up any unsold shares in their place in exchange for part of the banks’ fees.
That would seem to be in defiance of EU state aid rules saying the government can only take part in the capital increase if all investors — public and private — are subject to the same conditions.
Investors claimed the pool of banks and sub-underwriters had been offered substantial incentives in exchange for their backing, while Italian taxpayers were left to bear the full risk.
Even if the deal can be justified on a cost-benefit assessment, says Lucia Tajoli, an international markets and European institutions professor at Politecnico di Milano, “the fact that this is a violation of the rule book is undeniable”.
However, the European Commission hasn’t taken any action thus far, and Giancarlo Giorgetti, Italy’s new finance minister, said this week that the government planned “an orderly exit” from MPS. The bank declined to comment on this story.
“MPS was one of the strategic assets of our country, the current situation doesn’t allow any further mistakes,” says Walter Rizzetto, a lawmaker for the governing Brothers of Italy party. “As the bank looks for a new owner we must carefully supervise events and make sure MPS is financially sound for years to come.”
After 15 years of financial scandal, lacklustre rights issues, failed stress tests, and billions of euros in losses, both the EU and Italy just want to draw a line under the world’s oldest bank.
“It’s better to let this pass,” one other former MPS executive says. “Regulators will have a bigger problem if MPS ultimately fails and at some point somebody is going to have to explain how we got here . . . and those people sit in Frankfurt, Brussels and Rome.”
Fifteen bad years
The trouble began in 2007, when the Bank of Italy greenlit MPS’s takeover of local rival Antonveneta for €9bn. The acquisition was funded through a €5bn rights issue, a €1bn convertible instrument and billions in complex bonds.
“[The takeover] was the mother of all bad decisions,” says Pierantonio Zanettin, a senator for the liberal Forza Italia, a junior coalition partner and formerly a member of the Italian parliament’s committee inquiring into the banking and financial system.
“Any average book-keeper would have seen the numbers were not right,” says one of the two former MPS executives, who joined the bank’s management years after the takeover, “but the bank’s management at the time were not finance experts. As for the regulator, it’s hard to understand [how they didn’t see it].”
The takeover was authorised by the Bank of Italy when former prime minister and former European Central Bank chief Mario Draghi was at its helm. The Bank of Italy says the deal “was authorised because its terms were in line with the criteria envisaged by the rules at the time”.
“History will judge what happened next,” says Lorenzo Codogno, a former Italian Treasury director.
In 2012, the bank applied for state aid, citing its large exposure to government bonds, after a European Banking Authority’s stress test highlighted a €3.3bn capital shortfall.
After obtaining the support, the bank’s management corrected the accounts to show that losses actually stemmed from three derivative trades set up between 2006 and 2009 amounting to more than €730mn.
MPS paid $11mn in a court settlement over the hidden losses in 2016. Thirteen former bankers were sentenced to jail in 2019 for allegedly colluding in the cover-up, before being acquitted on appeal in May this year.
The affair is still considered one of the biggest financial scandals in Italian history. Populist politicians presented it as damning evidence that the entire establishment was crooked.
The irony is that the Italian state was initially reluctant to get involved with its banks in the immediate aftermath of the financial crisis. It opted not to intervene with public money to strengthen its banking system, then characterised by smaller lenders with substantial local networks and large retail lending activities.
At the time, EU rules did not prevent such interventions, but Italian government officials and regulators thought the move, in a country with very high public debt, would have been negative for financial markets. Officials also argued that, differently from many European peers, Italian banks did not hold “toxic assets” on their balance sheets.
“It was a grave mistake,” says Codogno, who now heads London-based consultancy LC Macro Advisors. “Had Italy injected money in MPS at that time and taken control of it, we would not be in this situation now.”
Following the financial crisis, the country experienced several local bank crises as non-performing loans surged and profit margins eroded. MPS handed out some €45bn in loans across the years that have never been repaid, and in 2014 the bank reported a record net loss of €5.4bn.
In 2015, four local banks in Italy were put into resolution and retail savers were completely wiped out. Luigino D’Angelo, a pensioner who died by suicide after losing a lifetime’s savings in one of the bank’s defaults, became the symbol of the social cost of the EU’s new “bail-in” rules, where shareholders, depositors and bondholders can lose everything.
“The principles behind the EU bail-in rules are absolutely agreeable, but it was a mistake to fail to understand that in Italy’s case you had a large part of the population exposed to the banks’ debt,” says Codogno.
“The rules should have been applied with some sort of differentiation across Europe but whoever had to take these aspects into account, didn’t,” he adds.
Two years later, Banca Popolare di Vicenza and Veneto Banca, headquartered in the rich Veneto region, were declared insolvent. Bondholders and deposits were spared and some of their assets and liabilities were taken over by the country’s largest lender, Intesa Sanpaolo, for a token payment of €1.
The collapse of the Veneto banks served as an alarm bell inside government about larger, systemic institutions. “Those were local banks, and the impact on the community, on public opinion, on the confidence in the country’s banking system was devastating,” says one former government minister. “Imagine what the impact of the resolution of MPS, the country’s third largest one, a systemically important one, would have been.”
Yet the state has little to show for the €20bn in state aid and private capital pumped into MPS across the past 15 years.
“All that money only served to repay loans and partially cover losses,” says one of the former MPS executives. “Yes, branches were closed and the headcount was reduced but no profound restructuring plan was ever devised.”
One last chance
That is set to change, say former government officials and former MPS executives. Luigi Lovaglio, a highly respected turnround specialist, was appointed in February by the government then led by Draghi to execute the capital increase and restructure the bank before selling it.
Lovaglio, who formerly headed UniCredit’s Polish unit, spent the summer visiting investors across Europe to illustrate his three-year plan for the bank, hoping to obtain their backing for the €900mn tranche intended for private investors.
At one point Italian asset manager Anima, which has an existing commercial partnership with MPS, told Lovaglio it would be willing to contribute up to €300mn in exchange for an improvement of the terms of their existing commercial agreement.
Under EU state aid rules, the government must participate at identical conditions to private investors who cannot therefore be offered such incentives. Lovaglio insisted he would succeed in convincing other investors.
Those who met him in Milan and London said he assured them the outcome of the capital raise would be different from the previous six. This time, he told them, there was profit to be made.
Funds and asset managers did not believe it. They entirely snubbed the rights issue, which would have risked barring the state itself from contributing the €1.6bn it had committed.
To avoid running foul of state aid rules, Italy could only participate proportionally, by investing €1.78 for every €1 of private money.
By early October, the rights issue seemed in trouble. The pool of eight banks arranging the deal, including Bank of America, Mediobanca, Citibank and Credit Suisse, refused to guarantee they would mop up the unsold shares without seeing prior irrevocable commitments from third parties for at least part of the outstanding €900mn.
Anima, for its part, pulled its initial offer after talks with MPS over the commercial agreement ran dry.
Several bankers suggested MPS explore other options to raise capital or, perhaps, delay the rights issue citing the complicated macro environment. But Lovaglio and the Treasury were determined to press on and made a last-ditch effort to find a way around the rejections.
In the days before October 17, when MPS finally launched the rights issue, negotiations between the Tuscan lender’s management, investment bankers and potential investors became tense, at times even frantic.
Finally, a workaround was reached. The group of banks arranging the deal, together with Milan-based asset manager Algebris, agreed to underwrite the full private investors’ share in exchange for an extremely lucrative €125mn fee.
They had also found “first allocation investors” or sub-underwriters that committed to buy part of the leftover shares, also in exchange for a fee, effectively offloading part of the risk from the pool of banks. Many of these sub-underwriters had prior interests in MPS.
The largest was French insurer Axa, which has a commercial partnership with MPS. The insurer contributed €200mn, becoming the single largest contributor to the capital increase.
The Financial Times reported last month that in exchange for supporting the capital increase, the French insurer and MPS began re-discussing the terms of their existing partnership. In a statement, Axa said: “There has been no change in our relationship with MPS, no commitment, no amendment to our agreements.”
In an earnings call last month, Lovaglio hailed a “new chapter” for the Italian lender. “MPS will now be able to fund the reduction of staff costs by 20 per cent and it will make the most of its potential, improving its financial results,” he said. More than 4,000 staff applied for a voluntary exit scheme, which will be funded with €1bn from the capital increase.
Still, to some investors, the stench of cronyism surrounds the rights issue. One short seller even urged the European Central Bank to block the rights issue. Others made contact with Brussels officials to flag the violation of EU state aid rules.
Yet in spite of their complaints, the European Commission has stopped short of opening an investigation into MPS. Some onlookers fear a lack of response will undermine the existing banks’ resolution rules, under which governments should not prop up failing banks at all costs.
But to some, the ends justify the means, especially if it means bringing the saga of MPS to something close to a resolution. The latest capital raise is definitely “a systemic operation rather than a market one,” says Zanettin, the Forza Italia senator. “But it’s fair that it ultimately goes through and MPS is finally privatised.” Bail-ins, he points out, “can end up costing taxpayers even more”.
