By Silvia Aloisi
SIENA, Italy (Reuters) - Italy offered up to 2 billion euros on Tuesday to plug a capital gap in the bank Monte dei Paschi di Siena, the second time in three years the cash-strapped state has had to bail out the world's oldest bank.
The bank, founded in 1472 as a charity to lend to the poor of Tuscany, expanded rapidly in the last few decades, becoming Italy's third largest lender with a vast branch network. It's second bailout would leave it dependent on nearly 4 billion euros in expensive state aid.
It was first forced to seek help after it overstretched itself right into the subprime crisis of 2008-09. In a deal that has since become notorious, it paid more than 9 billion euros cash to buy smaller peer Antonveneta from Spain's Santander at the end of a bitter cross-border takeover battle in 2007.
Prosecutors investigating the price paid for Antonveneta raided Monte Paschi's head offices and the homes of former executives in May.
Monte Paschi has since been hit harder than peers because of large holdings of Italian government debt, which has declined in value. The bank holds some 25 billion euros in government bonds.
Rome said it was ready to underwrite special bonds issued by the bank to plug a capital shortfall estimated at between 1.3 billion and 1.7 billion euros, higher than the 1 billion euros investors had been expecting.
The government would also replace 1.9 billion euros of similar high-yielding bonds the bank issued in 2009, which it has yet to repay to the state, bringing the total state support to a maximum of 3.9 billion euros.
Banking analysts say the rescue does not yet mean Italy is headed down the path of Spain, which had to beg the EU's bailout fund for up to 100 billion euros to save its banks after failing to sustain them by drip-feeding smaller capital injections.
Other major Italian banks, such as Intesa Sanpaolo and UniCredit have managed to shore up their capital base through cash calls carried out in the past months.
"In our view, the measure appears tailored to Monte Paschi and we see no read through to other Italian banks," analysts at Bank of America Merril Lynch said in a note.
The bailout came as the bank's new CEO Fabrizio Viola and chairman, ex-UniCredit boss Alessandro Profumo, were holding a board meeting in its home base Siena, set to approve a tough restructuring to try and save the business.
A group of employees demonstrated outside the bank's headquarters, a 13th century fortress in mediaeval Siena.
They distributed a leaflet calling for cuts to managers' pay and accusing CEO Viola of "unacceptable and irresponsible behavior".
The Italian government said in a statement the state aid was needed "given the impossibility of Monte Paschi ... to resort to private solutions to strengthen its capital due to current highly volatile market conditions".
The European Commission, which vets all EU state aid programs, had yet to approve Italy's backing for Monte Paschi.
The government's loans come with high interest costs that could wipe out the bank's ability to pay dividends for years to come, analysts said.
The European Banking Authority said at the end of last year Monte Paschi needed to fill a 3.3 billion euro gap to bolster its capital base. The bank has plugged much of that gap through better capital management, asset sales and other measures.
Monte Paschi, controlled by a cash-strapped charitable foundation with strong political ties to the city of Siena, has resisted the option of going through a capital hike which would dilute the foundation's stake.
The foundation has already had to cut its holding to 36 percent from nearly 50 percent to repay creditors.
The special bonds that the Italian state is preparing to buy from Monte Paschi are similar to previous instruments known as 'Tremonti bonds' that the bank used in 2009 when it was hit by the global financial crisis.
In a note on Tuesday, Italian broker Mediobanca said the coupon on such a bond, whose details are yet to be unveiled -could severely erode earnings "leaving little room for internal capital generation and shareholders' remuneration".
"This solution was inevitable but it will be costly and impact their profit," said Carlo Tommaselli of Societe Generale, estimating a coupon on the bonds of around 10 percent, potentially costing the bank nearly 400 million euros a year.
That means that the bank may have to resort to a capital increase in the medium-term, unless it can generate enough profits and market conditions improve markedly. Or it might have to let the state take a stake further down the road, according to a source with knowledge of the situation.
"A market solution would have been best. A capital increase may have been difficult to absorb but a debt-for-equity deal would have been perfect," a London-based analyst said.
(Additional reporting by Valentina Za, Lisa Jucca and Stefano Bernabei; Writing by Lisa Jucca; Editing by Peter Graff)