UPDATE 3-Moody's cuts Italy's Monte Paschi to junk on capital fears
* Moody's cuts Monte Paschi to Ba2, outlook negative
* Bank already requested 3.4 bln euros in state aid
* Monte Paschi CEO says astonished by downgrade
* Moody's says bank turnaround plan has execution risks
MILAN/ROME, Oct 18 (Reuters) - Moody's cut the rating of Italy's third largest lender, Banca Monte dei Paschi di Siena , to junk and said it may need more state aid, triggering a share selloff and drawing a rebuke from the bank's top executive.
Monte Paschi, the world's oldest surviving bank, was the only Italian lender to fail the European Banking Authority's stress tests and is the first of the five systemically important Italian banks to fall below investment grade.
Moody's said the bank's outlook remained negative, keeping pressure on the Tuscan lender as it tries to navigate a deep Italian recession and the euro zone debt crisis.
"I cannot hide my astonishment at the timing and the reasons for the decision," CEO Fabrizio Viola said in a phone interview with Reuters, ruling out the need for further state aid in the short and medium term on top of the 3.4 billion euros the bank has already requested.
The downgrade from Baa3 to Ba2 means some investment funds that hold Monte Paschi bonds will be forced to sell them, making it even harder and costlier for the bank to raise funds.
"It is just a matter of time before they will need to ask for more aid. Their non-performing loans are very high, 40 percent of their sovereign bond portfolio has a maturity of more than 10 years and they have also seen a deposit outflow," said Royal Bank of Scotland credit strategist Alberto Gallo.
"The bank is going through a slow-motion nationalisation."
Yet, Viola said Moody's decision would have no immediate impact on the bank's funding because of its positive liquidity and said retail funding had improved in the third quarter.
"Capital is no longer an issue," said Viola, who said the bank was not planning to bring forward a 1 billion euro cash call scheduled for the end of 2014.
The bank denied on Thursday it had started sounding out Swiss lender UBS and other banks for the capital hike.
Moody's rates Italy's sovereign debt Baa2, three notches above Monte Paschi.
Monte Paschi's 5-year credit default swaps - the premium investors have to pay to insure themselves against the risk of default - widened some 2.5 percent on the day to 470/490 basis points. Its shares were down 5.3 percent at 0.23 euros by 1222 GMT against a flat European banking index.
The Moody's decision on Monte Paschi could also throw the spotlight on other Italian peers. While top banks Intesa Sanpaolo and UniCredit have returned to the wholesale debt market, No.4 lender Banco Popolare had to withdraw a senior bond issue last week due to low demand.
Siena-based Monte dei Paschi, which was already exchanging money for Tuscan and foreign merchants before Christopher Columbus discovered the Americas, requested 1.5 billion euros in state loans in June to plug a capital shortfall under a scheme that is still awaiting EU approval.
The bank had already received state help in 2009 in the form of 1.9 billion euro of special bonds sold to the Treasury.
However, Moody's said overnight there was a "material probability that the bank will need to seek further external support." This would probably be more government help, Moody's said, without saying how much would be needed.
Moody's said Monte Paschi's weak asset quality would continue to deteriorate due to Italy's recession, noting problem loans had risen to 17 percent of its loan book - above the 13 percent average of Italian banks rated by the agency.
"Monte Paschi's weak profitability and fragile asset quality exacerbate its weak funding position, leaving it unable to access capital markets and in consequence making Monte Paschi highly reliant on the European Central Bank," Moody's said.
Monte Paschi's fundamental weakness stems from its above average holdings of Italian state bonds relative to assets, which like peers it had to mark down as the euro zone crisis hurt the value of sovereign debt in Italy and elsewhere.
Adding to the bank's woes was Monte Paschi's decision to pay 9 billion euros in cash for the acquisition of smaller peer Antonveneta in 2007, which stretched its finances just as the global financial crisis exploded.
The bank's main shareholder, a cash-strapped foundation with strong political links to the city of Siena, took on big debts to keep a grip on the bank, only to be forced to sell its stake in a downward market when time ran out.
Monte Paschi holds 25 billion euros in Italian debt. It has cut its exposure to ECB loans to 29 billion euros from 33.5 billion euros in June, Viola said.
Yet, Chairman Alessandro Profumo has already said Italian banks may need to roll over the cheap ECB funds to avoid a credit crunch in two years' time.
Monte Paschi hired Profumo, formerly at the helm of Italy's biggest bank by asset UniCredit, to help spearhead a turnaround.
Monte Paschi has drawn up a tough business plan, which envisages 4,600 job cuts and the slashing of its loan book. But Moody's said the restructuring was "subject to significant execution risk."