Banca Monte dei Paschi di Siena has launched an offer to convert bonds into shares (debt-to-equity-swap). Specifically, it is a public purchase offer on subordinated bonds, for a total value of 4.289 million. In other words, MPS is asking for the "support" of its creditors to get back on its feet, and try to complete the 5 billion euro recapitalization plan.
WHICH BONDS ARE WE TALKING ABOUT?
According to the press release issued by MPS, the offer concerns 11 subordinated bonds (Tier I and Tier II). They may be converted into bank shares by applying a conversion rate of 100%, 85% and 20% depending on the bond concerned. It means that by converting the bonds, a consideration in shares will be obtained which will be worth, respectively, 100%, or 85%, or 20% of the nominal value of the bond. At the time of writing, the conversion value is higher than the market value of the bonds; there is therefore a "conversion bonus" (sometimes very substantial, equal to tens of percentage points, even if for arbitrage reasons the amount of the bonus could be reduced quickly).
POSSIBLE STRATEGIES
At this moment, those who own the MPS subordinated bonds involved in the transaction have the following options in their hands:
1) sell the security at the current market price (if it can find a buyer);
2) convert the bond into shares;
3) do not convert the bond into shares.
In the first case, if the purchase was made after the issuance, perhaps at very low prices, it is a good selling opportunity – in other words, it is a risky trade gone well. If, on the other hand, the security was purchased upon issue, it probably means that a loss will be incurred, but recovering a large part of the invested capital.
Let us now analyze the other two possibilities in light of a necessary premise: MPS's situation remains complex and the bank's future is far from guaranteed. The probabilities of a possible bail-in (with all the consequences of the case) or of a liquidation of the institute, always remain high. Therefore the current conversion offer can in no case be seen as the definitive solution to the problems of MPS, but rather as the necessary condition for the restructuring process to go ahead. In other words, if the operation were not successful, the probabilities of finding the necessary capital to restore the bank would drastically decrease and the probabilities of a bail-in or liquidation would specularly increase.
The outcome of the operation depends on your own choice and that of others. For this reason, we have brought up a little game theory, trying to provide an analysis tool to subordinated bondholders who have to choose how to behave. It is a scheme of possible events, which crosses the decisions of the individual with those of the mass of other bondholders, comparing the risks and opportunities of each decision. We reiterate that the following diagram should be seen as an analysis tool, and like all tools it has limits: use it, but don't overestimate it, because it is not an oracle...
The schema is organized as a matrix. On the rows there are the possible actions of the holders of the bonds in question (convert/not convert), while on the columns the actions of the other holders of subordinated bonds (heavy conversion/low conversion). The central cells summarize the probable outcome for the bondholder, explained in more detail below.
Let's see in more detail the four cases corresponding to the (numbered) cells of the matrix:
1) Mps is likely to go ahead, but you have become shareholders in a bank with an uncertain future and a volatile share price, which could do very well or very badly in the future - it is difficult to say how much good or how bad - therefore the return on the operation is very uncertain;
2) in all likelihood MPS will be subject to bail-in, in which case the shareholders' capital is the first to be reaped;
3) if enough capital is raised, it is possible (possible, not sure) that as a retail investor you will not be touched, and that the security will be repaid regularly – it is the classic free-riding;
4) MPS will probably be subject to bail-in, but, as a retail investor, it is possible that whoever takes care of the bail-in, i.e. the Bank of Italy, decides on a discretionary basis not to involve the category of retail investors, to avoid, for example example, the panic on the financial markets and limit the impact on Italian families.
This is the picture, using shreds of game theory. To decide, however, it is essential to get an idea of the probability of success of the conversion. For example (we emphasize “for example”), if this probability were very high the following would follow:
A) if the decision is "I do not convert into shares", there would be an excellent probability of the regular repayment of the security (cell 3.) and, with a decidedly lower probability, an involvement in the bail-in, with a potential Bank of Italy safety net 'Italy (cell 4.); the weighted result would be relatively good compared to the following case B;
B) opting instead for "Convert into shares", there would be a high probability of an equity risk (cell 1.), and a low probability of involvement in the bail-in without any help from the Bank of Italy (cell 2.); the weighted result is not attractive, so that alternative A ("I don't convert") probably dominates over B ("I convert").
However, if the probability of mass conversion were very low, the picture would change completely and B could dominate over A. Be aware that there are rumors that the bank expects a conversion of subordinates equal to a third of the total: therefore a first rough estimate of the probability of conversion to mass can be 1/3.
The decision to convert or not also depends on the amount of subordinated Mps that you own compared to the rest of the portfolio (is the percentage weight a lot? Is it perhaps all the savings? Or is it a small share, on which you can also bear high risks? ), as well as of course from one's own personal situation. The idea of a partial conversion (eg half of the capital) should also be considered. In short, it is necessary to think coldly, bearing in mind that there are no pre-packaged solutions. And it will hardly be a triumphal march.
Source: Advise Blog
