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All junior Monte dei Paschi bonds to be bailed in: European Commission source

The European Commission, Italian government, ECB and the management of Banca Monte dei Paschi di Siena SpA have cut an informal deal for the bank's bailout involving the conversion of all the lender's outstanding junior bonds into equity, a source from the Commission told S&P Global Market Intelligence on June 1.

The parties have been in talks since Monte dei Paschi, the oldest extant bank in the world and Italy's fourth-largest, applied for state aid under European rules in December 2016.

"The burden-sharing is the key criteria for precautionary recapitalization," said the EC source, asking to remain anonymous because the talks are still confidential. "All the junior debt will be turned into equity," the person added, noting that senior bonds will not be wiped out.

A formal decision is likely to be announced "in the coming weeks" as the process of having the €8.8 billion bailout approved by the EU bodies unfolds. "It could be four weeks or five weeks," said the source.

Some €4.2 billion of subordinated paper may be converted to shares, but the government would spend €2 billion to compensate retail investors who have been allegedly missold the risky bonds, according to a Bloomberg News report from May 19.

Before the Italian state can buy into the bank, becoming its largest shareholder, the ECB must confirm the bank's solvency. It has done so already, but must reconfirm that judgment, the source noted.

The injection of funds will be accompanied by a "far-reaching restructuring plan" that includes the disposal of its entire portfolio of bad loans on market terms, as well as a pay cap for its senior management, the EC said the same day.

"This solution is a positive step forward for MPS and the Italian banking sector," European Competition Commissioner Margrethe Vestager said.

Under EU law, a bank can only be bailed out by the state if its failure would pose a risk to the whole financial system and if it fails a so-called stress test subjecting its balance sheet to a hypothetical economic downturn. Monte dei Paschi meets those two conditions, having fared badly in a 2016 ECB benchmarking exercise.

Italy has set aside €20 billion to prop up its ailing banking sector, a considerable sum of which is earmarked for Monte dei Paschi.