Monte Paschi's financial secrets not so safe

MILAN Mon Jan 28, 2013 2:52pm EST

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MILAN (Reuters) - The loss-making trades at the center of a scandal at Italian bank Monte dei Paschi di Siena's were only uncovered when new executives unlocked a safe at the bank's historic headquarters in Tuscany.

A secret document about a derivative trade called Alexandria discovered in the safe in October prompted an internal probe that has, so far, uncovered losses of up to 720 million euros ($969 million) and prompted public fury over the alleged failure of the central bank and politicians to detect the deals.

"That discovery led us to start a review of all structured trades and then we were forced to release information in November because we requested an extra 500 million euros in state aid," chief executive Fabrizio Viola, who took office about a year ago, told reporters on Monday.

Viola said it took a while to discover the document as the safe was not in his office.

Overall, Monte Paschi is seeking a 3.9-billion-euro government bailout that its management insists is enough to cover the losses from the derivatives and structured finance trades and guarantee the future of the 500 year old bank.

The smoking gun for Viola, parachuted into Monte Paschi in January 2012 to help turn it around after a disastrous acquisition, was the secret document, which was a mandate agreement between the Siena bank and Japanese bank Nomura for a derivative contract dubbed Alexandria.

"I do not think that whoever put it there wanted to hide it. But there was no accounting of it in the operation," Viola said.

The review of Alexandria and two other structured and derivatives trades - Santorini with Deutsche Bank and Nota Italia with JP Morgan - is due to be completed by mid-February.

Viola said the document showed a clear link between the closing of the original Alexandria deal made with Dresdner in 2005 and subsequent repurchase agreements with Nomura to spread the loss by investing in 30-year Italian government bonds.

"The two operations appeared separate, but this showed they were linked. Today we know that there was an accounting error, deliberate or not," he said. "Probably these were done to spread over time losses incurred in the past and possibly also linked to other operations," he said.

"It is as if costs were accounted for as investments."

Founded in 1472, Italy's third-largest bank has a 37-billion-euros financial portfolio, the biggest among Italian banks as a proportion of total assets.

This includes 25 billion euros in mostly long-term Italian government bonds and a series of structured finance operations and interest swap deals, Viola said.

"I always said that the financial portfolio was the biggest problem at Monte Paschi. Both the size of the portfolio, compared to the size of the bank, and its structure were not adequate for a commercial bank," said Viola, who has overhauled Monte Paschi's top management in a just a few months.

Viola said he had found that almost all of the bank's 25-billion-euro Italian government bond portfolio, which has an average maturity of seven years, had been subject to interest swap deals whereby the interest rate was swapped from fixed to variable, hurting its profitability because of an incorrect bet that Europe's benchmark rate, Euribor, would rise.

"You can imagine the impact on profitability given that Euribor in January 2012 stood at nearly one percent and in December around 0.15 percent," he said.

Monte Paschi has only netted 65 million euros in the first nine months of 2012 from its government bond portfolio because of the fall in Euribor, against an estimated gain of around 1 billion euros a year if it had kept a fixed interest rate on it.

(Writing by Carmel Crimmins; Editing by Mark Potter)

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