LONDON/MILAN Banca Monte dei Paschi di Siena, Italy's third-biggest lender, has lost a quarter of its value after it emerged the bailed-out bank faced heavy losses on three complex derivative trades.
Below are details about the trades - codenamed "Alexandria", "Santorini" and "Nota Italia" - as released by the bank, sources involved with the deals, and other media reports:
Monte Paschi is set to book a loss of at least 220 million euros ($293 million) in its 2012 results from this 2009 derivative deal with Japanese bank Nomura.
Under the deal, Monte Paschi borrowed money from Nomura through a so-called repurchase agreement and used the money to buy government bonds.
In a repurchase, or repo, agreement, a company uses assets as collateral to raise funds and pledges to buy the assets back for a pre-agreed price at a later date.
Italy's Il Fatto Quotidiano newspaper said the transaction with Nomura included two 30-year repo deals.
Monte Paschi used the money to buy long-term, fixed-rate government bonds. The Italian bank then agreed with Nomura to swap the stream of money it would receive from the coupons paid by the government bonds for an income that would depend on a variable interest rate.
That variable rate was linked to an interbank interest rate known as Euribor. When Euribor fell, it triggered a loss for Monte dei Paschi.
A source close to the situation has told Reuters the deal with Nomura was aimed at restructuring a previous position in distressed structured credit assets, such as contracts based on mortgages and other-credit-backed assets.
Some banking analysts, who have examined reports of the trade, said it was designed to stagger a loss that Monte Paschi was about to incur on these distressed structured credit positions.
Il Fatto Quotidiano said the existence of the trade was only discovered by Monte Paschi's new management last October.
A derivative trade with Deutsche Bank is also thought to be under scrutiny, analysts and banking sources said.
Deutsche Bank said last week the trade had been subject to its rigorous internal approval procedure.
Like Alexandria, Santorini involved funding an investment in long-term Italian government bonds through repo agreements, with swaps that were intended to mitigate interest rate risk.
Created in 2006 and unconnected to any previous trades, Nota Italia was based on a derivative contract linked to insurance against Italian sovereign debt default.
Italian newspaper Il Sole 24 Ore said it was a way for the bank to sell sovereign credit default swaps to clients that might otherwise have been deterred by the concern that Monte Paschi would collapse if Italy ever defaulted.
The bank said it had recently restructured the investment to remove a derivative component linked to sovereign risk.
It was reportedly arranged through JPMorgan, although the U.S. investment bank declined to comment when contacted by Reuters earlier this month.