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WorldApril 1 2014

Italy's lenders pick up central bank bonus

Following a difficult few years, Italy's banks received a windfall from the central bank after the institution revalued its share 'capital', but other eurozone lenders claim that this gives Italian players an unfair advantage in the upcoming asset quality review.
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Italy's lenders pick up central bank bonus

As Italy’s leading banks report their 2013 results, the impact of a change in the value of their holdings in the the Bank of Italy, the country’s central bank, are becoming clear. For UniCredit it provided an uplift of €1.4bn, badly needed in a year in which the bank lost €14bn. But there are questions about how the revaluation was calculated and whether it provides Italian banks with an unfair advantage against their eurozone competitors ahead of the forthcoming asset quality review (AQR).

The revaluation was made possible due to the Bank of Italy’s ownership structure. Whereas most central banks are wholly owned by the state, a handful are held by commercial banks (see chart 1) and some of these, such as the Greek and Belgian central banks, are listed as well.

For many years, the question of the Bank of Italy's ownership and value was dormant, but it surfaced at the end of 2013 as commercial banks sought to strengthen their balance sheets and the government looked for ways to help them while also boosting treasury revenues.

New statute

Italy's 1936 banking law established the Bank of Italy with capital of 300m lira (about €156,000 in today's money) shared between essentially public sector banks and financial institutions. Since then, the central bank's reserves have increased enormously and the banking system has undergone large changes through privatisation and consolidation. Intesa Sanpaolo has become by far the biggest 'shareholder' in the Bank of Italy, holding 91,035 of the 300,000 'shares', followed by UniCredit with 66,342 (see chart 2).

Together, Italy's two largest high street banks thus own more than half of the banking regulator's 'capital', albeit nobody suggests that the Bank of Italy has been swayed by this in any of its policy decisions.   

On December 23, 2013, the Bank of Italy held an extraordinary meeting of its 'shareholders' to approve a new statute encompassing revalued 'share' capital. “As I told the senate's treasury and finance commission on December 12, the increase in the value of the bank's capital follows a request from the Ministry of Economics and Finance,” Ignazio Visco, the central bank's governor, told the meeting.

The government wanted action and speed was needed. A decree had already been issued on November 30, and on January 29, the law came into effect. The Bank of Italy's 'share' capital now amounts to €7.5bn. 

According to the Bank of Italy, the calculation was made using a dividend discount model. In a paper called 'Updating the valuation of Bank of Italy’s equity capital', the bank says: “Following financial principles, the value of an asset is equal to the net present value [NPV] of the income stream it generates.

"Accordingly, the value of shares of the Bank of Italy [BI] has been estimated using a ‘dividend discount model’ [DDM] in order to evaluate the NPV of the flow of future BI dividends under the current regulatory regime. This required a careful selection of the parameters of the model, such as the risk-free interest rate, the growth rate of the bank’s dividends, the beta coefficient of the shares of the BI, the equity premium, the liquidity discount… Overall, our analyses suggest that the value of the shares of the BI can be estimated in a range between €5bn and €7.5bn.”

By way of explanation in a footnote, the bank says: “In the baseline DDM model, the risk-free rate is equal to the average of the 10-year rate on the German bund in the past three months, the liquidity discount is equal to 20%, the growth rate of dividends is 5%, in an initial period, and 3% afterwards, the equity risk premium is 7% and the beta coefficient is equal to 0.4%”

Central banks held by commercial banks

A helping hand?

In a statement on February 3, the central bank noted that a 2005 law foresaw transfer of its share capital to the state but that subsequently nothing was done to put this into effect. While referring to the US's Federal Reserve and the Bank of Japan, the statement made no mention of major eurozone central banks, nor of the Bank of England.

The Bank of England was nationalised uncontroversially in 1946, transferring shares into the ownership of the treasury solicitor, giving shareholders public debt of a minimum maturity of 20 years that paid 3% interest. This combined with the exchange ratio made nationalisation better for UK taxpayers than a revaluation of the Bank of Italy seems for Italians. 

In any event, the formula devised by former finance minister Fabrizio Saccomanni (in the government of prime minister Enrico Letta, which ended in February 2014) and Mr Visco has aroused the interest of competition authorities who want to know if Italian banks are being given unfair help.

Asked by The Banker what its effect would be on Intesa Sanpaolo, Carlo Messina, the bank's CEO, replied: “We decline to comment.” Mr Messina's silence was probably due to the fact that Intesa Sanpaolo was shortly to announce its 2013 results and a strategic plan, due as The Banker went to press. For UniCredit, which announced its results and a 2013 to 2018 plan on March 11, the revaluation of its Bank of Italy stake provided a gain of €1.4bn, on which it paid €200m of tax. 

Mr Messina noted that 2014 brings an AQR and a stress-test. “We hope that these will be carried out using the most rigorous criteria,” he says. Appointed to the top job last September, Intesa Sanpaolo's CEO is confident that the bank will come through with flying colours. Another of the challenges he faces this year is a return to profitability and a return on equity target of 10%. Presenting Intesa Sanpaolo's figures and corporate plan two weeks after UniCredit, a Milanese neighbour, gave Mr Messina the opportunity to see how his main Italian competitor was dealing with 2013's numbers and the planning for the future.

Top five Shareholders of Bank of Italy

Losing streak

Before UniCredit's announcement, Matteo Ramenghi, an analyst with UBS, noted that the AQR is currently the main issue and that the aim of banks and the regulator for a good outcome “may imply some near-term pain” and he expected particularly prudent provisioning in 2013's accounts. He thought that any tailwind such as capital gains from stakes in the Bank of Italy would “be sacrificed to boost problematic loans coverage” and that there would be an acceleration of disposals of non-performing loans.

UniCredit probably did rather more than Mr Ramenghi expected. After a balance sheet review, it has now fully written down goodwill allocated to Italy, central and eastern Europe, and Austria. At €13.7bn, loan loss provisions last year were 46.8% higher than in 2012 and UniCredit's cash coverage ratio on impaired loans now stands at 52% which, it says, is by far the highest in Italy and in line with the best in Europe.

UniCredit's balance sheet showed default of €47.6bn on customer loans of €503.14bn at the end of last year, with a further €34.8bn impaired. However, the bank moved a year ago to spin off an €87bn non-core portfolio that includes some non-performing loans and other commercial banking exposure. Unveiling its five-year plan, UniCredit noted that international investors in bad loans are increasingly looking at Italy. Indeed, US private equity funds have expressed interest in Release, a bad bank owned by Banca Popolare, Italy's fourth largest bank. And Intesa Sanpaolo is reported to be considering establishing one.

Announcing their annual results and strategic plans, Italy's two banking leaders were in the news in March, as was troubled Monte dei Paschi di Siena (MPS), the country's third biggest bank, although its difficulties have meant that it is rarely far from the spotlight. The bank is due to make a €3bn call on shareholders, an operation delayed until after May 12 by its largest shareholder, in disagreement with management.

The Sienese institution was due to announce its 2013 results the same day as UniCredit but eventually did so the following morning. Alessandro Profumo, MPS's chairman, may wish that he was back at UniCredit of which he was previously chief executive. While improving on 2012, MPS nevertheless lost €1.4bn last year, a result “influenced by the continuing difficult economic climate”. MPS owns 2.5% of the Bank of Italy.

Yet, perhaps the worst is past. Commenting on an improvement in business confidence in February, Paolo Mameli, Intesa Sanpaolo's senior economist, said: “Leading indicators point to a positive, albeit very gradual, trend consistent with consolidation of an upturn.”

Italians, their government, bankers and shareholders in the country's banks are be crossing their fingers for some economic sunshine after such a long wintry period.

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Read more about:  Western Europe , Italy , Regulations