UPDATE 1-Monte Paschi freezes coupon payments on hybrid debt
(Adds market reaction, banker comment)
MILAN, Sept 23 (Reuters) - Monte dei Paschi di Siena (MPS) has cancelled coupon payments on three hybrid loans coming due at the end of the month to meet European conditions for approving a 4.1 billion euro ($5.5 billion) state bailout.
Italy's third-biggest bank, brought close to collapse by the euro zone debt crisis, is set to unveil a turnaround plan this week after the EU told it to toughen up a previous set of restructuring measures.
The new plan is already known to include a 2.5 billion euro share sale imposed by Brussels, more than twice the 1 billion euro cash call originally pencilled in by the bank.
If the lender, which is also being investigated for its costly purchase of a rival in 2007 and for loss-making derivative trades, cannot raise the funds on the market, the threat of nationalisation looms.
Traders and analysts said the coupon freeze had been expected and was largely priced in. MPS's bond prices fell slightly on Monday, one trader said, noting however that volumes were very thin.
"We haven't seen a reaction yet, but frankly if anyone reacts to that with surprise, then they really haven't been paying attention," said a syndicate banker.
In a letter sent to the Italian government in July, EU Competition Commissioner Joaquin Almunia said payments to holders of hybrid and subordinated debt issued by Monte Paschi had to be "prevented to the maximum extent legally possible."
Alberto Gallo, chief credit strategic at Royal Bank of Scotland, said: "The real question is not why Monte dei Paschi stopped paying coupons, but why it was still paying them.
"Italy still lacks a bank resolution regime and its banks have not yet implemented burden-sharing for subordinated bondholders, unlike in Spain and Ireland.
"As a result, Italy's mid-sized banks appear the weakest in our stress-test analysis and may be vulnerable as the ECB's asset quality review approaches," Gallo said.
Some analysts said MPS's best option to avoid nationalisation could be a debt-for-equity swap, converting subordinated bonds into shares. MPS has around 5.5 billion euros of such outstanding debt.
The biggest outstanding subordinated bond - of about 2 billion euros and expiring in 2018 - was sold to retail investors to help fund the 2007 buy of Antonveneta. The bank also issued a 1 billion euro hybrid financial instrument called FRESH in 2008 to partly fund the purchase.
Monte Paschi said on Friday it would not pay the next coupon on Sept. 30 on its MPS Capital Trust II non-cumulative floating-rate guaranteed convertible FRESH preferred securities. It said it would also withhold coupons on its Antonveneta Capital Trust I and II non-cumulative floating-rate guaranteed trust preferred securities, due respectively on Sept. 21 and 27.
"The suspension of interest payment is permitted, under certain prerequisites, by the respective regulations (of the notes)," it said. ($1 = 0.7402 euros) (Additional reporting by Gabriella Bruschi in Milan, with Hélène Durand in London; Editing by Jane Merriman)
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