BANCA MONTE DEI PASCHI DI SIENA SPA MILAN/ROME (Reuters) - - Italy's Monte dei Paschi di Siena (>> Banca Monte dei Paschi di Siena SpA) faces a 2.1 billion euro (1.67 billion pounds) funding shortfall that could force it to seek a merger, after a European banking review revealed serious weak points in the Italian financial system.
The historic Tuscan lender, which was founded in 1472 and carried out a 5-billion euro capital increase as recently as June, said on Sunday it had hired Citigroup and UBS as advisers to consider strategic options.
One source close to the matter said these could include a merger, another cash call and asset sales.
The result of the Europe-wide stress tests laid bare the extent of the economic crisis in Italy, where the banking system has been caught in an increasingly dangerous spiral with the country's massive public debt. The European Central Bank found 15 Italian lenders collectively overvalued their loans by 12 billion euros, accounting for a quarter of the overvaluation of loans across the 130 banks the ECB looked at.
The Bank of Italy said that the chronic weakness of the economy, which is struggling to emerge from the longest recession since World War Two, had been the main factor behind the stress test result for Italian banks and warned that without improvement, lenders would continue to struggle.
"If growth doesn't return, it will be very difficult to have a solid banking system in the long term," Fabio Panetta, a member of the Bank of Italy board, told a news conference.
Monte dei Paschi, which has racked up 9.3 billion euros of losses over the past three years, revealed the biggest outstanding capital shortfall of any of the 130 banks in the ECB's stress tests, which were designed to prepare the continent's banks for unexpected systemic shocks.
Nine Italian banks in total failed the test, the most of any country, although five of these made up the shortfall through capital increases during 2014 and another two managed to fill the gap with supplementary measures.
Alongside Monte dei Paschi, Genoa-based savings bank Carige (>> Banca Carige SpA) reported a shortfall of 814 million euros, bringing the total for the Italian banking system to 2.9 billion euros.
Italy's two biggest banks, UniCredit (>> UniCredit SpA) and Intesa Sanpaolo (>> Intesa Sanpaolo SpA), passed comfortably and the central bank said it was reassured about the banking system's overall solidity.
It made clear it was keen for a solution, including a merger, to the lingering weakness at Monte dei Paschi, which has been struggling to emerge from the debacle of its costly acquisition of rival lender Antonveneta in 2007, just months before the global financial crisis erupted.
"We would be extremely happy with any situation, any outcome which would make the bank stronger," Panetta said.
The result of the test could reawaken market concerns about the wider stability of Italian financial markets, which were at the centre of the euro zone debt crisis of 2011 until the ECB's pledge of support calmed fears.
"The fact that a lot of Italian banks have failed could put the Italian government bond market under renewed pressure on Monday morning," said Richard Edwards, head of trading and research firm HED Capital in London.
"COLLAPSE OF THE ITALIAN ECONOMY"
Panetta said the scenario assumed in the stress test, including three years of serious recession from 2014-2016, would be tantamount to the "collapse of the Italian economy" and that there was "almost zero" chance of it happening.
The stress test, which included a "sovereign shock" element to reflect the impact of a weaker economic outlook and market volatility on government bond holdings, hit Monte dei Paschi hard because of its larger-than-average Italian bond portfolio which totalled 24 billion euros at the end of June.
But the bank's troubles reflect a wider crisis in the stricken Italian economy, which has left banks struggling with mounting quantities of bad debt. Problematic loans at Monte dei Paschi account for 18 percent of all loans -- the second highest of any Italian bank reviewed by the ECB but only the 13th highest across the euro zone.
The ECB also found that Monte dei Paschi had overvalued its assets by 4.246 billion euros.
"Monte Paschi came out so bad because they are unable to generate any core earnings," said Alberto Gallo, credit strategist at Royal Bank of Scotland.
"The stressed sovereign portfolio certainly has an impact but if they were profitable they could absorb the losses."
Monte dei Paschi was the only Italian bank that had to be bailed out by the government, bagging 4.1 billion euros in state aid in 2013 that it has since mostly paid back.
It is not clear that the bank would be an attractive target for a buyer. A senior banker told Reuters earlier this week that Italy would need to pay another bank to take on Monte dei Paschi rather than the other way around.
The bank's shareholder structure is fragmented after its former controlling shareholder, the Monte dei Paschi banking foundation, had to cut its stake to 2.5 percent to repay debt.
The biggest single investor is now York Capital Management with 5 percent, while Latin American investors Fintech and BTG Pactual, which bought into the June rights issue, have 4.5 percent and 2 percent respectively. French insurer Axa has 3.7 percent.
The Italian Economy Ministry said it was confident the shortfalls would be made up through the market.
Monte dei Paschi has been selling assets, closing 500 branches and cutting 8,000 jobs to boost its finances, which were drained by the Antonveneta deal, the euro zone's debt crisis and a scandal over loss-making derivatives trades.
Two other banks, Banca Popolare di Milano (>> Banca Popolare di Milano) and Banca Popolare di Vicenza
(Additional reporting by Alessandra Galloni, Giselda Vagnoni in Rome, Valentina Za in Milan, Sudip Kar-Gupta and Alexander Smith in London and Laura Noonan in Frankfurt. Editing by Mike Peacock and Crispian Balmer)
By Silvia Aloisi and James Mackenzie
