Italy: Banca Monte dei Paschi di Siena Capital Injection, 2017

In 2009, Banca Monte dei Paschi di Siena was one of four banks to participate in Italy’s broad-based capital injection program aimed at improving Tier 1 capital of healthy banks (Hoyos 2021; Menasci 2018). Under the program, MPS issued EUR 1.9 billion of Tremonti bonds—perpetual, subordinated, hybrid bonds—to Italy’s Ministry of Economy and Finance. In 2012, the European Banking Authority stress test identified a 1.7 billion capital shortfall in MPS’s Core Tier 1 capital requirement (9%). In response, the Italian government provided an ad hoc capital injection of EUR 4.1 billion by subscribing to newly issued Monti bonds. The proceeds covered the redemption of the EUR 1.9 billion Tremonti bonds (and 2012 interest payments), the capital shortfall, and a buffer (IMF 2013). In 2014, MPS repaid the Monti bonds through an additional capital raise (Menasci 2018).

By 2015, MPS was the third-largest bank in Italy and had the highest NPL ratio of Italian banks, at 34.8% (EUR 46.9 billion NPLs) (Legorano 2016; Menasci 2018). In January 2016, the Bank of Italy designated MPS as an “other systemically important institution” (O-SII), the EU equivalent of a domestic systemically important bank (Bank of Italy 2016a; BIS 2016).^FThe EU’s O-SII framework took effect in January 2016 under Article 131(1) of the Capital Requirements Directive (CRD) (BIS 2016). EBA guidelines establish criteria that national authorities use to designate O-SIIs along four categories: size, importance to the domestic economy, complexity, and interconnectedness with the financial system. Based on these criteria, the Bank of Italy designated MPS, UniCredit, and Intesa Sanpaolo as O-SIIs (Bank of Italy 2016a; BIS 2016). Under the CRD, national authorities may implement an O-SII capital buffer between 0% and 2% of risk exposures (BIS 2016). In January 2016, the Bank of Italy set the O-SII capital buffer at 0% to avoid overlap capital buffers that the designated banks already maintain (Bank of Italy 2016a). In addition to the 8% minimum total capital requirement, MPS was subject to a 2.5% capital conservation buffer (ECB 2016b). In July 2016, MPS was the only bank of 51 that had failed the EBA’s stress test, with a -2.23% CET1 ratio in an adverse scenario (Götz, Krahnen, and Tröger 2017; Menasci 2018).

In November 2016, the ECB approved a restructuring plan for MPS, which included a EUR 27.7 billion disposal of bad debts supplemented by a EUR 5 billion private recapitalization, coordinated by the Bank of Italy, which included a voluntary conversion of existing subordinated debt into equity (BMPS 2017; EC 2017c; Menasci 2018; Miglionico 2019). The Bank of Italy attempted to coordinate a private recapitalization but on December 21, 2016, the private recapitalization fell through in the wake of political uncertainty over Italy’s failed constitutional referendum and shares of MPS were suspended from trading on the Italian stock exchange (Menasci 2018; Politi, Arnold, and Sanderson 2016).

On December 23, 2016, the new Italian prime minister, Paolo Gentiloni, announced the rescue of MPS to ensure the viability of the bank “in support of the Italian economy and in a contest of full tranquility for its savers and its employees” (Treanor and Kirchgaessner 2016). The same day, the Italian government adopted Law Decree 237/2016, which authorized Italy’s Ministry of Economy and Finance to guarantee newly issued bank liabilities and provide recapitalizations, financed by up to EUR 20 billion of state funds (Cova et al. 2017).

The law decree aimed only at banks that needed to bolster capital requirements in response to adverse stress tests, as opposed to banks likely to fail (Miglionico 2019).

On December 23, 2016, the chair and the vice-chair of the supervisory board of the ECB sent a letter to Italian authorities stating that MPS’s CET1 ratio (as of September 30, 2016) was 11.5%, and, as of December 23, 2016, the bank was currently solvent and in compliance with the minimum capital requirements (as per Article 92 of Regulation [EU] No 575/201313) (EC 2016).

In addition to recapitalizations, the law decree authorized the MEF to guarantee newly issued debt securities in maturities of three months to five years (and covered bonds with maturities of less than seven years) between December 23, 2016, and June 30, 2017. Additionally, the MEF could use its discretion to provide guarantees in relation to central bank-provided financing through emergency liquidity assistance (Clifford Chance 2016).

On December 23, 2016, MPS requested liquidity assistance through state guarantees on senior liabilities. On December 29, 2016, the EC approved a maximum of EUR 15 billion in emergency liquidity assistance to MPS, conditional on Italy submitting a restructuring plan for MPS within two months of the guarantee’s implementation. MPS issued two state-guaranteed bonds in January 2017 (for EUR 7 billion total with one- and three-year maturities) and one in March (for EUR 4 billion, with a three-year maturity) (EC 2017c).

The recapitalization also included a four-year restructuring plan under which MPS would dispose of a EUR 28.6 billion portfolio of bad loans as well as incorporate other cost-cutting measures (EC 2017c). See Key Design Decision No.11, Restructuring.

Article 107 of the Treaty on the Functioning of the European Union prohibits member states from providing financial support that confers a selective advantage and undermines competition or distorts trade in the internal market (Mesnard, Magnus, and Margerit 2017a).

However, Article 32.4 of the EU’s BRRD authorizes member states to provide precautionary recapitalization to solvent institutions for the purpose of financial stability, under strict conditions (Mesnard, Magnus, and Margerit 2017a; World Bank 2017). Such aid includes capital injections that conform to the following criteria:

• Be priced such as not to confer a competitive advantage;
• Be precautionary and temporary in nature;
• Be proportionate to remedy the consequences of the serious disturbances;
• Not be used to offset the beneficiaries’ current or expected losses;
• Is conditional on final approval of the EC (Mesnard, Magnus, and Margerit 2017a).

The Italian government passed Law Decree 237/2016 on December 23, 2016, which provided for a state recapitalization into MPS, after MPS failed to recapitalize by the ECB’s deadline. The decree enabled the MEF to guarantee newly issued bank liabilities and recapitalize distressed banks, with parliament authorizing up to EUR 20 billion for the measures. Parliament passed the decree into law (Law 15/2017) on February 17, 2017 (Cova et al. 2017).

The recapitalization of MPS through this decree was subject to the EU’s BRRD. According to the BRRD’s rules, a precautionary recapitalization must include a degree of burden sharing by private debt and equity investors, be temporary in nature, and promote financial stability (Götz, Krahnen, and Tröger 2017). The Italian government’s Law Decree 237/2016 restricted burden sharing (or bailing-in) to shareholders and holders of hybrid and subordinated bonds (Italian Government 2016; Miglionico 2019).

Under the decree, the MEF could inject capital into banks, until December 31, 2017, subject to the following terms:

• The bank must have a capital shortfall identified in the adverse scenario stress test;
• The bank must have attempted and failed to raise private capital;
• The measure must have received an EC State Aid decision confirming its compatibility with the internal market;
• The bank must have already implemented burden-sharing measures;
• The issuance of new shares to the state must sufficiently dilute existing shareholders (EC 2017c; Götz, Krahnen, and Tröger 2017).

On July 4, 2017, the EC approved the precautionary recapitalization of MPS for EUR 8.1 billion. The approved recapitalization consisted of a conversion of junior bondholders into equity for EUR 4.3 billion and a capital injection by the MEF of EUR 3.9 billion. However, in order to compensate losses of retail investors from mis-selling, the MEF also paid MPS an additional EUR 1.5 billion to acquire shares from those investors, bringing the total State Aid to EUR 5.4 billion and reducing the overall private-sector burden-sharing to EUR 2.9 billion (EC 2017a; Mesnard, Magnus, and Margerit 2017b).

The law decree provided for the MEF to subscribe to MPS’s capital following a bail-in of subordinated creditors (EC 2017c). The MEF previously administered capital injections into MPS through the broad-based Tremonti bond program in 2009 and the ad hoc Monti bond program in 2013 (IMF 2013).

As part of the EC’s recapitalization approval, the EC called for MPS to appoint a monitoring trustee, independent of the government and MPS, to supervise compliance with the commitments outlined in the EC approval document during the restructuring period (2017–2021) (EC 2017c). In 2017, pursuant to this mandate, MPS hired Degroof Petercam Finance, a Belgian private bank, as the monitoring trustee (BMPS 2018).

On December 23, 2016, the day after MPS disclosed the failed private capital raise, the Italian prime minister announced the rescue of the bank, beginning first with ensuring availability of liquidity. The prime minister said that through the precautionary recapitalization, “Italy’s third largest bank [MPS] will finally return with force to operate in support of the Italian economy and in a contest of full tranquility for its savers and its employees” (Treanor and Kirchgaessner 2016). The prime minister did not provide an estimate for the cost of the bailout, stating that it would be large enough for MPS to meet capital requirements (Treanor and Kirchgaessner 2016).

The EUR 8.1 billion precautionary recapitalization included the mandatory conversion, as a policy of State Aid rules, of all EUR 4.5 billion subordinated bonds into new shares with voting rights (BMPS 2018; Miglionico 2019). The conversion of these subordinated bonds was part of the BRRD’s burden-sharing rules and stipulated in the law decree at a pre-determined conversion rate. MPS’s floating rate equity-linked subordinated hybrid issues were converted at 18% of the nominal value, Tier 1 issues at 75%, and Tier 2 at 100%. Between the conversion of subordinated bonds and the MEF’s recapitalization, existing shareholders were substantially diluted, owning only 2.5% of MPS shares post-recapitalization (EC 2017c).

To compensate victims of mis-selling (retail investors owning 2008–2018 subordinated bonds), MPS acquired their converted shares in exchange for new senior MPS bonds (BMPS 2018; Miglionico 2019). The senior bonds paid a low interest rate of just 0.657%. The MEF then acquired those shares from MPS with EUR 1.5 billion in cash, increasing its stake in the bank to 68.3% (BMPS 2018). The mis-selling controversy revolved around MPS selling subordinated debt to retail investors without appropriate disclosures of potential risk (Miglionico 2019). The law decree justified the compensation to end or prevent mis-selling litigation (EC 2017c).

In the 2017 recapitalization, the MEF subscribed to new issues of ordinary shares, in contrast to the MEF’s prior recapitalizations into MPS in 2009 and 2013 (IMF 2013; IMF 2020).

In 2009, the MEF acquired newly issued Tremonti bonds from MPS and three other banks as part of Italy’s broad-based capital injection program aimed at improving Tier 1 capital of healthy banks (Hoyos 2021; Menasci 2018). Tremonti bonds were perpetual, subordinated, hybrid bonds with noncumulative coupons that could only be paid back if the bank posted positive net income (IMF 2013; Menasci 2018). MPS received EUR 1.9 billion for its Tremonti bonds. In 2012, the EBA stress test identified a 1.7 billion capital shortfall in MPS’s Core Tier 1 capital requirement (9%). In response, the Italian government provided an ad hoc capital injection of EUR 4.1 billion by subscribing to Monti bonds. The proceeds covered the redemption of the EUR 1.9 billion Tremonti bonds (and 2012 interest payments), the capital shortfall and a buffer. Monti bonds shared similar characteristics to the Tremonti issues, but carried a higher coupon payment, (starting at 9% and increased 50 bps each year to a maximum of 15%), and payment was not conditional on profitability. If MPS did not have a distributable net income, it would pay the coupon through new issues Monti bonds or stock (IMF 2013). In 2015, MPS repaid the Monti bonds through a new capital raise, repaying the coupon through stock issues, which gave the MEF a 4% stake in the bank (Menasci 2018).

During the 2017 recapitalization, both the EUR 4.5 billion equity conversion of junior bond holders and the EUR 3.9 billion MEF subscription were in the form of newly issued ordinary shares with voting rights (BMPS 2018; Miglionico 2019).

After failing the EBA’s 2016 adverse scenario stress test, MPS came up with a plan, as discussed with the ECB, to raise EUR 5 billion in private capital (Bank of Italy 2016b). The EUR 5 billion private capital raise was designed to cover the sale of all of MPS’s bad loans, EUR 3 billion for the sale of bad loans and EUR 2 billion to increase the coverage ratio of unlikely-to-pay loans (Bank of Italy 2016b). By December 2016, MPS only managed to raise EUR 1 billion—achieved by repurchasing subordinated securities with new shares—and ECB did not extend the deadline for MPS capital raise. Thereafter, MPS requested a precautionary recapitalization from the Italian government, to be implemented through the new decree. At the same time, the ECB raised capital requirements for MPS from EUR 5 billion to EUR 8.8 billion in light of the worsening liquidity position of MPS (Mesnard, Magnus, and Margerit 2017b). The EUR 8.8 billion capital figure accounts for EUR 6.3 billion needed for an 8% CET1 ratio and EUR 2.5 billion for MPS to reach a total capital ratio of 11.5% (Bank of Italy 2016b).

On July 28, 2017, following the EC’s approval of the MPS recapitalization, MPS received a capital injection of EUR 8.1 billion: EUR 4.3 billion from the conversion of Tier 1 and Tier 2 bonds into equity and EUR 3.9 billion provided by the MEF through share subscriptions. In total, the MEF contributed EUR 5.4 billion, with the inclusion of EUR 1.5 billion in compensation to retail investors who the government determined had been victims of mis-selling. Retail investors of MPS’s 2008–2018 Upper Tier 2 notes received senior bonds in exchange for their notes converted into equity. Following the recapitalization and compensation arrangement, MEF’s ownership in MPS increased from 4% to 68.2%. MPS asset sales in 2017 accounted for the difference between the initial capital requirement of EUR 8.8 billion and the recapitalization of EUR 8.1 billion (Miglionico 2019).

Pursuant to article 24 of the law decree, the MEF’s recapitalization came directly from the state budget (EC 2017c).

On July 29, 2016, the results of the EBA’s stress test showed that MPS had failed the adverse scenario. On the same day, in consultation with the ECB, MPS announced a plan to sell its bad loan portfolio and raise EUR 5 billion in capital. MPS had pledged to raise private capital by the end of December 2016. On December 23, 2016, MPS announced that the capital raise had failed. The same day, the Italian government approved the law decree, providing for state recapitalizations and liquidity guarantees. Through the decree framework, MPS requested liquidity assistance and a precautionary recapitalization. The EC quickly approved up to EUR 15 billion in emergency liquidity assistance on December 29, 2016, conditional upon Italy submitting a restructuring plan for MPS within two months of the implementation of the guarantees. Italy submitted an initial draft of the restructuring plan in February 2017 before submitting a finalized restructuring plan, necessary for the recapitalization, on June 28, 2017 (EC 2017c). On June 28, 2017, Italy also notified the EC of the precautionary recapitalization plan. The EC approved the restructuring plan and recapitalization on July 4, 2017 (BMPS 2018; EC 2017c; Mesnard, Magnus, and Margerit 2017b). On August 1, 2017, MPS converted all EUR 4.5 billion subordinated bonds into new shares and on August 11, the MEF subscribed EUR 3.9 billion in new shares (BMPS 2018). MPS announced in November 2017 that it had acquired a portion of the converted shares, using MEF funds, as compensation to eligible retail investors that were victims of mis-selling (BMPS 2018).

The recapitalization coincided with MPS’s commitment to a restructuring plan wherein MPS would sell off its EUR 26.1 billion portfolio of NPLs by the end of 2021 (Miglionico 2019). The sell-off involved transferring these assets to a privately funded special purpose vehicle (SPV) with financing from the Atlante II fund (Miglionico 2019). Atlante was set up by the government of Italy and financed by large Italian banks (Treanor and Kirchgaessner 2016).

The restructuring plan also included significant cost cutting measures and a shift to core domestic markets where MPS pledged to:

• Reduce the number of branches by 30% from 2,032 in 2016 to 1,432 in 2021 (EC 2017c);
• Reduce headcount by 22% from 25,566 in 2016 to 20,065 in 2021 to achieve staff expense reduction of EUR 261 million (18%);
• Reduce other administrative expenses by EUR 207 million (26%), which includes cost cutting on logistics, security, energy management, IT, and real estate;
• Divest or deleverage or its subsidiaries in Belgium and France (EC 2017c).

Under the plan, MPS would also dispose of its EUR 28.6 billion portfolio of bad loans to reduce its gross nonperforming exposures (NPE) ratio from 34.5% in 2016 to 12.9% in 2021 by:

• Selling EUR 1.2 billion in unsecured small exposures to private investors;
• Selling EUR 1.4 billion in leasing exposures to private investors;
• Transferring EUR 26.1 billion of its main NPL portfolio to an SPV for a price of 21% of its gross book value, implying a loss of EUR 3.9 billion (EC 2017c).

The SPV would be financed through a sale of EUR 3.3 billion in senior notes with a market-conform guarantee by the government as well as senior mezzanine (EUR 0.5 billion), junior mezzanine (EUR 1 billion), and junior (EUR 0.7 billion) notes underwritten by specialized investors (EC 2017c).

With respect to the bad loans, MPS achieved its commitments, disposing of the EUR 26.1 billion NPL portfolio in 2018 and an achieving a EUR 13 billion reduction in NPE between 2019 and 2020, which brought the gross NPE ratio to 4% in 2021 (below the 12.9% target) (EC 2022b). MPS also managed to achieve the commitments with respect to reducing total branches and total operating costs. By 2021, however, MPS fell short of the commitments to reducing employees to 20,065 (21,244 actual) and achieving a cost-to-income ratio of 50.6% (72% actual) (EC 2017c; EC 2022b).

In September 2016, MPS appointed a new CEO and general manager (EC 2017c). As required under EU State Aid rules, and conditional upon the approval of the recapitalization, MPS agreed to a salary cap on senior management—10 times the average salary of MPS employees in 2016—until December 31, 2021 (EC 2017b; EC 2017c).

On the basis of the EC approval, during the restructuring period (2017–2021), MPS would refrain from making non-legally-binding payments on capital instruments issued by the EC’s State-Aid approval date (July 4, 2017). Additionally, MPS would not call or buy back such capital instruments without EC approval. MPS could, however, make coupon payments to capital instruments held by the state, provided that it would not trigger non-legally-binding payments to other capital instruments (EC 2017c).

The recapitalization plan did not provide for regulatory relief. By the end of 2016, MPS’s CET1 and total capital ratios stood at 8.2% and 10.4%, respectively. During the first quarter of 2017, MPS reported CET1 and total capital ratios of 6.5% and 8.9%, respectively (EC 2017c). The ECB required MPS to maintain the following capital ratios during the restructuring period. See Figure 2.

As a condition for the EC’s approval of the recapitalization, the MEF planned to sell its stake in MPS by December 31, 2021 (Goff 2021). In 2021, the MEF entered into negotiations to sell MPS to UniCredit. In July 2022, after the negotiations fell through and the MEF requested an extension to the sell-off deadline. In August 2022, the EC approved the extension (EC 2022a; Za and Fonte 2022). The date of the new deadline was not specified, though insiders revealed it had been pushed back several years (Za and Fonte 2022). As part of the extension, the MEF agreed that MPS would make additional divestments and job cuts to increase profitability (Za and Fonte 2022). In November 2023, the MEF sold 25% of its stake in MPS for EUR 920 million (Fonte and Za 2023).