By Silvia Aloisi and Stefano Bernabei
MILAN/ROME (Reuters) - Italy's scandal-hit Monte dei Paschi di Siena
Italy's third biggest lender was brought close to financial collapse by the euro zone debt crisis and is engulfed in a judicial probe over its costly purchase of a rival in 2007 and loss-making derivative trades it made in the deal's aftermath.
The bank, which took 4.1 billion euros ($5.5 billion) in state loans in February, has been told to beef up an already tough restructuring plan if it wants to win the European Union's approval for the bailout.
Brussels has also demanded that the Tuscan lender carries out a 2.5 billion euros capital increase in 2014. That is more than double the 1 billion euro originally planned by the bank and roughly equal to Monte dei Paschi's current market capitalization, making it a very challenging goal.
"At the moment there seems to be little interest in Monte dei Paschi among investors, either from a strategic or financial view point," Societe Generale analyst Carlo Tommaselli said in a report this week. "The execution risk ... is high."
EU Competition Commissioner Joaquin Almunia has said that if the bank, the world's oldest still in business, cannot raise the funds in the market, the government would have to convert its loans into shares in the bank, thus taking it over.
The possibility that the Italian treasury could take a stake in the bank was already contemplated under the terms of the government's bailout scheme. This states that if Monte dei Paschi cannot pay its annual nine percent coupon on the state loans, it will issue shares to the treasury.
The sheer size of the capital increase demanded by the EU, the third cash call for the bank since 2008 excluding the bailout, makes the prospect of Monte dei Paschi falling under direct government control a lot more likely.
Monte dei Paschi has lost nearly 8 billion euros in the past two years, and most analysts do not expect it to post a profit before 2015.
Without the bailout, its core Tier 1 ratio - a measure of a bank's financial strength - would fall to just 6.5 percent, well below a minimum of nine percent required by the European Banking Authority, analysts estimate.
The new restructuring plan is expected to include more cost cuts on top of the 4,600 jobs and 400 branches the bank is already shedding in a restructuring drive started by CEO Fabrizio Viola and Chairman Alessandro Profumo - brought in last year to turn its fortunes around.
The plan, to be approved on Tuesday, will also feature a gradual reduction in the bank's 29-billion euro Italian government bond portfolio, of which just under 30 percent expires by 2015, sources close to the matter told Reuters.
The bank is the only Italian lender among several European banks to have received state aid, but its woes have become a symbol of the deeper troubles of Italy's financial sector: an economy that has barely grown in more than a decade and opaque ownership structures often more focused on politics than business.
Known as "Daddy Monte" in Siena where it is the biggest private employer, the bank is controlled by a foundation at the centre of a web of local control and political patronage.
The foundation has had to cut its stake in Monte dei Paschi to 33.5 percent from 49 percent in the past 18 months to pay back creditors after running up big debts to keep a grip on the bank.
Two days after Monte dei Paschi approves its plan, three of the bank's former top managers will stand trial in Siena on charges they hid from regulators the true nature of a 2009 derivative trade with Japanese bank Nomura <8604.T>, which prosecutors allege was made to conceal losses.
(Editing by Giles Elgood)