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Western EuropeOctober 1 2012

Italy's banking leaders see chinks of light amid the gloom

Italy's banks are struggling. Many are weighed down by bad assets and an oversubscription to government bonds, while those with relatively healthy portfolios are battling against a difficult economy and the series of downgrades that has recently befallen them. Despite this, CEOs at the country's largest institutions remain optimistic.
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For those who were wondering where Alessandro Profumo, CEO of UniCredit from 1997 until boardroom wranglings forced his resignation in 2010, would direct his energy and talents, the answer came in early 2012. Since the shareholder's meeting of Monte dei Paschi di Siena, Italy's third largest bank, at the end of April, Mr Profumo has been its chairman. He stepped into what might be fairly described as the most challenging job in Italian banking: the Sienese institution, which was founded in 1472 and is the world's oldest bank, had recently posted €4.7bn losses for 2011. Moreover, with tight links to the city and local politics through its main shareholder, the Monte dei Paschi di Siena Foundation, which does charitable works in the region, its governance is complex and convoluted.

The challenge of bashing the accounts into shape at Monte dei Paschi di Siena and getting dividends flowing again is made tougher by the difficult wider context in which this must be done. Banking has changed hugely since Mr Profumo made his name turning Credito Italiano, a sleepy institution, into a dynamic major European player. And bankers must prepare for much more change, he thinks.

“Banking will be very different in the future because customers are much more risk averse than before and because earnings from interest margins are getting smaller, along with the balance sheet,” says Mr Profumo.    

Quick off the mark

Monte dei Paschi di Siena shareholders did not have to wait long for action following Mr Profumo's arrival. At the end of June 2012, the board announced a plan that aims to strengthen the bank's capital, improve its liquidity structure and reach sustainable levels of profit. Its network of 2900 branches will be slimmed by 400 and 4600 jobs will be axed from a payroll that stood at 31,200 at the end of 2011.

Early in August 2012, the bank revealed that austerity had also reached its corridors of power – some 200 directors and statutory auditors in group companies have been removed, which is expected to save the bank €1.5m over three years. Every little helps, but dousing hopes that the bank will soon be generating fat dividends, Mr Profumo told a local television station in the same month that Italy's banks will not again enjoy the profitability they had in the 1990s and early years of this century.

Then on August 28, 2012, the day the bank revealed huge first-half net losses of €1.6bn and announced that it would seek €3.4bn of state money to beef up its asset base, Mr Profumo was even more outspoken. The quality of the previous management had evidently not been good, he suggested at a local political gathering.

Some observers blame the Sienese bank's costly purchase of Banca Antonveneta, not long before the financial crisis broke, for its current troubles. While UniCredit turned down the chance to acquire Antonveneta because it was too expensive, Mr Profumo said that this was not the biggest mistake that management in Siena had made. That was stuffing its portfolio with €27bn of Italian government bonds.          

External factors

While internal challenges are those that seem to matter most at Monte dei Paschi di Siena, at its two larger competitors it is external challenges that are keeping the boardrooms occupied. For Enrico Cucchiani, CEO of Intesa Sanpaolo, there is reason to be more optimistic about the resolution of the eurozone crisis. But the challenging macroeconomic and credit environment in Italy keeps management on its toes.

“Looking forward, our main concern is the cooling down of the global economy, with clear repercussions on export-driven companies,” says Mr Cucchiani. He adds that rigour and prudence have been the watchwords at the bank and that management has been focused on building a strong balance sheet. In fact, Intesa Sanpaolo has core Tier 1 of 10.7% and liquidity ratios that exceed Basel III 2018 targets by 18%.

“We think our bank is weather-proof and rock solid and if turbulence continues we can absorb shocks of even greater magnitude,” says Mr Cucchiani.

A minor revolution occurred in Intesa Sanpaolo when, in November 2011, Corrado Passera, the long-standing and successful CEO, was named by Italy's technocrat prime minister Mario Monti as head of Italy's economic development ministry. Those who wondered whether Mr Passera's attention to costs at the bank would be forgotten have been reassured by Mr Cucchiani. In the first half of 2012 branches were closed and staff were shed, taking payroll to less than 100,000 employees and allowing the bank to report a cost-to-income ratio of 49.8%, against 52% at the end of 2011.

Intesa Sanpaolo's enthusiasm for savings was underlined earlier this year when it inaugurated its Savings Museum in the northern Italian city of Turin. The bank also has an interest in some aspects of sport and was main sponsor of the Italian team at the London 2012 Olympic Games. This was, says Mr Cucchiani, an expression of the bank's support for values that sport represents such as “healthy competition, respect for the rules, fair play… the same in sport as at the foundations of the best corporate culture”.

Forward thinking

Federico Ghizzoni, CEO of UniCredit, says that the weakening macroeconomic environment in some countries, particularly Italy, is challenging but he points to another area of concern. “Regulatory pressures present a challenge of their own, forcing banks to meet the requirements for higher capital ratios. Thus the combination of economic downturn in some regions and higher capital ratios required by regulators poses a double challenge for banks,” he says.

UniCredit was ahead of Monte dei Paschi di Siena in coming up with a new strategy. Its big shift, described as “a break with the past” and clearly a break with Mr Profumo's long period at the helm, came in November 2011 and aims at simplification – strengthening its capital base, improving its asset composition, making significant cost reductions in eastern Europe and relaunching its Italian operations, though the plan aims at cutting 6500 Italian staff (equal to 12% of its total payroll in Italy).

A rights issue worth €7.5bn was concluded in January 2012, not long before UniCredit announced a group net loss of €9.2bn for 2011. “Today, our balance sheet is much stronger and among the best in Europe,” says Mr Ghizzoni.  

On June 30, 2012, the bank posted half-year group net profit of €1.1bn and had a core Tier 1 ratio of 10.4%, against 8.4% at year-end 2011. After the first six months of the year, the group was slimmer by about 100 branches, out of 9500, and 3000 staff, out of almost 161,000. Similar to Monte dei Paschi di Siena and Intesa Sanpaolo, UniCredit is also looking to save costs by cutting staff and closing branches. But such a strategy is not risk-free.

Matteo Ramenghi an analyst at UBS in Milan, expects a 10% reduction in branches in Italy over the next four to five years but warns that downsizing networks carries significant risks. He thinks that larger banks will find it easier to exploit economies of scale and extract synergies in the short term, although the longer term is likely to see mergers and acquisitions between mid-sized institutions. “However, a more stable macroeconomic environment is necessary before another consolidation round kicks off,” he says.

In July 2012, UniCredit's board approved a new organisational structure that aims to make the bank more agile, quicker in taking decisions and closer to customers. Fine words that are doubtless near the top of most bankers' minds, but also something that the bank is turning into reality. On September 14, 2012, Mr Ghizzoni's bank launched UniCredit International, an initiative aimed at giving a hand to Italy's hard-pressed exporters. “We want to play our role in the recovery of the Italian economy, supporting even more strongly the export-oriented companies that can succeed in the globalised economy and trigger growth,” says Mr Ghizzoni.

Ratings conspiracy

Italian bankers are not only facing the challenges of troubled economies at home and abroad, and the considerable worries of a seriously uncertain financial environment, they are also embattled and besieged by the ratings agencies and a series of downgrades that has set some of them raging against what they see as little other than crude prejudice and plots to do them down.

Moody's triggered the conflict in May by downgrading 26 Italian banks, leading one top politician to rant about the “criminal design of ratings agencies against Italy and Europe”. The country's banking association, Associazione Bancaria Italiana (ABI), declared that it agreed with the head of the stock market watchdog who had said that such downgrades should not be passively accepted. ABI wondered what action it should take to defend legitimate interests that had been “seriously damaged by decisions of the ratings agencies”. A prosecutor in Puglia is investigating the agencies and there has been speculation that downgraded banks may take legal action.   

ABI allied itself with other Italian business associations in July 2012 to attack Moody's following its decision to downgrade Italian sovereign debt two notches from A3 to Baa2, putting it just two notches above junk status. They described Moody's decision as destabilising. ABI and the four other associations accused the ratings agencies of judgements that are inequitable and called into question their governance and independence.

ABI and its allies are seeking action from the European authorities to eliminate rules that presently require ratings to be given and they want the private sector to remove reference to ratings requirements in its contracts. They called for an “immediate and effective reaction”. They are still waiting.

More bad news

Three weeks later, Standard & Poor's downgraded 15 banks, including Monte dei Paschi di Siena, to BBB- and a group of co-operative banks, which include the relatively large Banca Popolare di Milano, to non-investment grade. This led to more complaints and questions about why loss-making banks in the UK and France have higher ratings. The answer, in good part, is sovereign risk.

Moody's July downgrade was the second that Italy had received from the ratings agency this year, and was bad news for Italian banks. Intesa Sanpaolo's balance sheet at the end of June shows an increase of about €20bn in its holdings of sovereign debt, due mainly to purchases of Italian government bonds. The bank's portfolio of Italian sovereign debt at June 30 amounted to a massive €80.4bn, of a total of €94.2bn. UniCredit's exposure to Italian sovereign debt was €41bn at the end of June. International deposits have fled from Italian banks, falling from $941bn in 2007 to $489bn earlier this year. It is these figures that are making ratings agencies edgy.

Moody's cited Italy's weakening gross domestic product (GDP) and rising unemployment as the reason for the downgrade, and the country's economy is indeed sickly. With GDP expected to decline by about 2.5% in 2012, Italy is mired in recession, and despite the optimism for an upswing next year that Mr Monti anticipated in August 2012, few are betting on it. The economic climate is stormy, austerity is biting and, hit by higher taxes and concerned about jobs, Italians are spending cautiously.

Staying positive

Bankers such as Mr Cucchiani and Mr Ghizzoni seem to be on target when pointing to the adverse scenario in which they are working as the main challenge. As this situation drags on, the corporate sector will suffer further and non-performing loans will rise. In its half-year report, Intesa Sanpaolo recorded total net non-performing loans (doubtful, sub-standard, restructured and post due) of €26.1bn, which was 15% higher than at the end of 2011. UniCredit's figure was €43.7bn, which represented 7.9% of total customer lending. At €16bn, Monte dei Paschi di Siena's non-performing loans were 11.1% of its customer loan book at the half-year point. Mr Ramenghi at UBS expects an increase of about 25% in non-performing loans in Italy this year. 

Brighter news from Frankfurt and Berlin on the euro, and a rally in Italian bank shares in August and the first half of September, brought some cheer, but stability still seems far away, GDP growth a mirage, austerity a harsh reality and resolving the Greek conundrum still an uncertain prospect. The second half of 2011 seemed fraught with difficulty and the same period this year will be equally tricky. Yet top men at Italy's big three banks can see some light.

“I'm a firm believer that in times of difficulty and discontinuity there are great opportunities for the fittest and daring,” says Intesa Sanpaolo's Mr Cucchiani. For him, his bank's solidity, agility, rigour, entrepreneurship, professionalism and customer focus are a winning combination.

Nearby in Milan at UniCredit, Mr Ghizzoni sees the current environment as presenting clear opportunities for banks such as his with strong balance sheets to strengthen and build customer relationships, to simplify structure, reinforce risk culture and trim costs. “There is a real opportunity to refocus around core strengths,” he says.

Even in troubled Siena, the situation is not entirely black for Mr Profumo. “A medium-sized bank such as Monte dei Paschi di Siena has a potential advantage being sufficiently large to have economies but sufficiently small to have a lower cost of complexity in achieving rapid change,” he says. And the fact is that the Sienese bank has been reduced to such a low point that things can only get better.

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