MONTE DEI PASCHI (BMPS) READY TO ISSUE TODAY A NEW TIER2 BOND DUE 2029 , WITH A 10.5% COUPON: WOULD YOU BUY IT?

Monte dei Paschi di Siena would have already failed if -in 2017- Italian State had not intervened with an injection of money. Today the bank is more solid than then, but still not enough to rule out the possibility of other losses for shareholders and bondholders.

The Bank has been suffering from low profitability for several years now. Since 2011, the bank's interest income has always fallen, year after year, falling by a total of 67% in 8 years. Since 2011, the bank has closed only two balance sheets in profit: 2015 and 2018, which -put together - have yielded just under 700 million euros. This is an insignificant result compared to the 21 billion euros in total losses recorded over the last 10 years. Only two years ago, the bank expected to close 2019 with a profit of almost 600 million euros. Now however, the goal is to be able to do a little better than 2018 (around 300 million): practically , their 2019 goal has been halved.

However, balance sheet devaluations have been a necessary evil to make the bank more solid.

The Cet1 and Total capital ratio indicators at the end of 1Q 2019 were similar to those of the main Italian banks. Indeed, the Cet1 indicator stood at 13.3%, the best figure among the main competitors: only two years ago it was 8.2% and in 2011 it was 10.3%.

That said, the bank is not yet completely safe. Even after write-downs, the Non Performing Loans represent, for BMPS, 9% of the total credits granted . For Unicredit, for example, the value is 3.2%.- 3.3%. Moreover, among these NPL ‘s , defaulted loans (“sofferenze” ), for Mps are 3.7% of the total loans. It is even worse than Carige and the average of Italian banks (2.1%).

And, last but not least, the Texas Ratio is still at 95% .

As you know, T.R. is calculated by dividing the value of the lender's non-performing assets (NPL + Real Estate Owned) by the sum of its tangible common equity capital and loan loss reserves: A Texas Ratio of more than 100 % (or 1:1) indicates that non-performing assets are greater than the resources the bank may need to cover total losses on those assets.

Yet, as a result of the indications of the ECB to Italian banks ( December 2018) , MPS must reset the NPLs within 7 years. This is the first great issue for Monte dei Paschi.

The sale of these loans at prices around 20% -25% of the nominal value could result in losses that could reduce the Cet1 ratio .

Secondly, even if the bank has sold one third of the BTPs inside its balance sheet, their weight is still significant (around 150% of the bank’s capital  ). The huge amount of BTP inside the balance sheet is another problem for the bank. Of course, there’s no imminent danger for now, as the BTP-Bund spread has decreased considerably in these two months… but if fears over Italian public debt were to return, for every 1% increase in the spread , there could be a reduction in the Cet1 index of 0.4%-0.5%.

In short, the CET1 solidity indicator, which for the moment is well above the minimum level imposed by the European Central Bank, could fall dangerously , if the 2 systemic risks we have been talking about were to materialize .

My personal opinion is that for at least 12 -18 months these risks should not materialize, because 1) the ECB is about to start its new QE program in the fall of 2019 and 2) I trust NPL’s disposal strategy put recently on the table by the bank will success. This is the most probable scenario. but I’ can’t be sure at 100% it will become reality .

Finally, to answer the initial question of the article: considering the best risk/reward trade-off, I think that 10.5% coupon it's not bad for the new sub bond issued by Monte dei Paschi, but I'd rather buy the old MONTE 4% 2022 senior bond ( with less than 3 year duration ) than buying the new 11% T2 bond (10 year duration) . 

Generally speaking, the issuance of new tier2 bond protects even more of the old senior bonds, because sub. bonds represent an additional capital buffer,  able to absorb future devaluation of assets. For this reason, we can say that every increase of the bank's Tier 2 capital always increases the intrinsic value of existing senior bonds ( "senior" bondholders are more guaranteed in the event of heavy losses of the bank. )

If you buy MONTE 4% 2022 at 102.40 you get a 3.15% yield in a 3 year scenario.

It's not bad, isn't it?

 P.S. : today July 17th , MONTE 1.5% 2029 is pricing below par (98/100 - 99/100 is the bid-ask spread ) i.e. below the issue price: perhaps the issuer made a mistake in pricing the yield so low on the primary mkt , a reoffer yield practically equal to the old tier 2 MONTE 5.375% 2028 in the secondary market ...