UPDATE 2-S&P cuts Monte Paschi to junk

Wed Dec 5, 2012 2:12pm EST

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* S&P cuts Monte Paschi by one notch to BB+

* Bank already requested 3.9 bln euros of state aid (Adds details)

By Silvia Aloisi

MILAN, Dec 5 (Reuters) - Standard & Poor's became the second credit ratings agency to cut Italian bank Banca Monte dei Paschi di Siena to 'junk' status on Wednesday, saying planned state aid may not be enough to stop its capital and funding position from worsening.

Monte dei Paschi, the world's oldest bank and Italy's third biggest, was one of only four European lenders that failed to meet tougher capital requirements set by the European Banking Authority.

It is also the only Italian bank whose credit rating has been cut to below investment grade - first by Moody's in October, and now by S&P.

The downgrade to junk level forces some investment funds that hold Monte Paschi bonds to sell them, making it even harder and costlier for the bank to raise funds. S&P now rates the bank BB+.

The bank has requested 3.9 billion euros ($5.1 billion) in state aid but the scheme has been held up by negotiations with the European Commission - and both rating agencies say it may not be enough to make the bank financially solid.

Like Moody's, S&P said the bank's outlook remained negative, keeping pressure on the Tuscan lender as it battles a deep Italian recession.

"As a consequence of the deterioration in its financial profile and the tough economic and operating environment in Italy, MPS will likely face more difficulties than we previously anticipated," S&P said in a statement.

It said the bank's profits would likely continue to be squeezed in 2013, the disposal of non-core assets could take longer than expected and a planned capital increase by 2014 looked at risk.

S&P also said the proportion of bad loans at the bank was high, and its vast holdings of long-term Italian government bonds posed significant risks.

The negative outlook reflected "the uncertainties about the extent to which the capital support provided by the government will likely cushion the potential deterioration of MPS's financial profile."

Adding to the bank's woes, a government proposal on the terms of the state aid suffered an unexpected setback late on Tuesday when a parliamentary committee rejected it.

A source close to the Treasury said the government would re-submit the proposal shortly. Economy Minister Vittorio Grilli, who is also negotiating with the European Commission to win approval for the bailout scheme, said on Wednesday he hoped a solution would be found in the next few days.

At issue is whether the government will be forced to take a stake in the lender, which is set to post a net loss in 2012 for the second year running.

Monte Paschi's 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 hit the value of sovereign debt in Italy and elsewhere.

The bank is also still reeling from a 9 billion-euro cash acquisition of smaller peer Antonveneta in 2007, which stretched its finances just as the global financial crisis exploded. ($1=0.7652 euros) (Additional reporting by Francesca Landini and Giulio Piovaccari; Editing by Greg Mahlich)

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