ECB Bail-inDIESELBOOM’s template has just struck again, as Italy’s oldest bank Monte Paschi has just announced it will halt all coupon payments on Tier 1 bondholders, effectively bailing in $650 million in bondholders notes to recapitalize the bank!

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As Bloomberg reports, Monte Paschi bondholders just received a $650 million haircut:

Banca Monte dei Paschi di Siena SpA said it suspended interest payments on three hybrid notes after European authorities demanded bondholders contribute to the restructuring of the bailed out Italian lender.

The world’s oldest bank said in a statement that it won’t pay interest on about 481 million euros ($650 million) of outstanding hybrid notes issued through MPS Capital Trust II and Antonveneta Capital Trusts I and II. Under the terms of the undated notes, the Siena, Italy-based lender is allowed to suspend interest without defaulting and doesn’t have to make up the missed coupons when payments resume.

In the new world we’re in advises Bloomberg, governments impose losses wherever possible in order to keep the TBTF banks afloat:

“In the new world we’re in, bondholders pick up the tab when they can be forced to,” said John Raymond, an analyst at CreditSights Inc. in London. “State aid rules impose losses where possible.”

While the Monte Paschi bail-in for now is limited to Tier 1 bondholders, the bank made it clear it likely will not be able to continue paying Tier 2 bondholders much longer either:

While the bank is halting payments on the bonds that make up its Tier 1 capital, the most-junior layer of debt capital instruments, it also has the equivalent of about 2.6 billion euros of more-senior Upper Tier 2 debt in three issues in euros and pounds.

While Monte Paschi is making payments on these notes, it isn’t clear that it will be able to go on doing so, said Raymond.

Do you suppose that the ISDA will rule that a bondholder bail-in qualifies as a default, resulting in the payout of CDS contracts?

The cost of insuring against losses on Monte Paschi’s subordinated debt rose, with credit-default swaps covering 10 million euros of the bank’s junior bonds for five years costing 2.1 million euros in advance and 500,000 euros annually, according to data provider CMA. That signals a 49.5 percent probability of default within that time.

Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.