Italian banking-foundations-2014-02-05-1

Italian Banking Foundations
05 February 2014

Italian Reforms

Stakes for CoCos: killing 3 birds with 1 stone

Andrea Filtri
Equity Analyst
+44 203 0369 571

2010-12 confirming the un-sustainability of the current model
In Re-Foundation, 28 May 2012, we concluded that the crisis broke the symbiotic relationship
between Foundations and banks, making it financially unsustainable. The latter required capital
injections and reduced dividends, forcing the former to cut grants and distribute reserves.
Updating our study for 2011-12 we reconfirm our diagnosis as events evolved more negatively
than we had predicted. Asset value and grants are down 16% and 30% vs 2010, respectively, and
cash flow has been negative for 4 consecutive years. Taking banks‟ consensus DPS and keeping
other income sources stable, we calculate grants should fall by 39% to preserve capital levels.

andrea.filtri@mediobanca.com
Antonio Guglielmi
Equity Analyst
+44 203 0369 570
antonio.guglielmi@mediobanca.com

1998 Parliament’s debate identified the risks but the law left some issues unresolved
Digging in Parliament‟s archives, we retrace the debate which led to the Ciampi law which
provided the Foundations‟ legal framework. The crux of the fight was on the powers of the
regulatory authority (yet to be implemented), on forcing portfolio diversification, the disposal
of bank stakes and outsourcing investment management. This confirms to us: a) MPs had already
identified the crucial factors/risks of the new framework and; b) that the matters discussed are
still very relevant today, suggesting the current law did not address all issues.

Andrea Carzana
Equity Analyst
+44 203 0369 576
andrea.carzana@mediobanca.com

IMF, ECB and Italian Treasury all pointing to a reform of Banking Foundations
MPS, Carige, Banca Marche, CariFerrara, Tercas, BP Spoleto, Veneto Banca, Banca Cividale.
These are only some of the many banks under special supervision as the surge in bad debts is
jeopardising capital adequacy. They jointly hold over €300bn of assets or c.7% of industry‟s total
stock; a potential systemic issue. Their peculiar governance is representing an obstacle for their
recapitalisation. The issue is known abroad: Mario Draghi (ECB chairman), the IMF, Bank of Italy
and the Finance Minister called for a reform of Foundations. The latter is reported to support a
reform of the Foundations‟ law mandating portfolio diversification, prohibiting leverage and
control of a bank and investing in hedge funds and derivatives.
Converting equity stakes into CoCos: the transition towards full diversification
Foundations‟ investments need to generate stable and growing cash flows to fund grants. In ReFoundation we showed that bank stakes provided sub-optimal risk-adjusted returns vs a variety
of alternatives, suggesting change is due. We acknowledge the difficulty for Foundations to
abandon banks while these are still troubled and have depressed valuations. At the same time,
Foundations are under pressure to return to giving more grants. We propose a transitory solution
towards portfolio diversification: converting the Foundations‟ stakes into bank CoCos would: a)
increase the visibility of investment yield while; b) upgrading the governance of the Foundationbank model; c) leaving banks‟ capital adequacy unchanged. This is feasible as in Dec-13,
Parliament allowed tax deductibility of CoCo coupons for banks.
Win-Win-Win: EPS +14-30%, RoTE up 2-5 p.p., from buybacks below TE
We see the CoCo for equity swap as a positive evolution for all stakeholders. While it is neutral
to bailout risk, Foundations gain higher and visible yield (c.8.3%), banks gain on governance and
profitability and minority shareholders gain EPS and DPS accretion. We simulate the operation
on ISP and UCG, where Foundations own, on aggregate, 28% and 11% of ordinary shares. We
calculate this would lead to: a) 14% EPS and 5 p.p. RoTE boost at ISP and 30% EPS and 2 p.p.
RoTE hike at UCG, b) 1 p.p. higher div. yield, c) 3% investment yield premium for Foundations.
The positive outcomes for all stakeholders derive from the below-BV valuation of shares allowing
the accretive impact of the share buyback to more than compensate the earnings dilution from
higher interest costs of CoCos. Higher valuations could provide less appealing financials,
implying there is a window of opportunity to carry the swap out today, in our view. Had
Foundations held CoCos since 2001, they would have made €22bn extra profits after costs and
grants; 50% and 140% boost to the current total capital and 2001-12 cumulative grants. The deal
would gear up bank balance sheets by 0.6-2 p.p. to 3.3-4.5% TE/TA, in line with EU retail peers
and with no implications from bail-in regulation, hence at no compromise to the risk profile.

CoCo for equity swap simulation
ISP

UCG

28%

11%

13,820

6,885

8.33%

8.33%

-18%

-10%

3,297

3,490

2015e EPS change, %

14%

30%

RoTE points change

5%

2%

2015e DPS change
(unchanged payout)

23%

19%

1.2%

0.7%

Foundations holding
Buyback/CoCo, Eur m
Coupon, %
Impact to 2015e adj. profits
Shares cancellation (m)

Yield change, %

IMPORTANT DISCLOSURE FOR U.S. INVESTORS: This document is prepared by Mediobanca Securities, the equity research department of Mediobanca S.p.A. (parent company of
Mediobanca Securities USA LLC (“MBUSA”)) and it is distributed in the United States by MBUSA which accepts responsibility for its content. The research analyst(s) named on
this report are not registered / qualified as research analysts with Finra. Any US person receiving this document and wishing to effect transactions in any securities discussed
herein should do so with MBUSA, not Mediobanca S.p.A.. Please refer to the last pages of this document for important disclaimers.


Contents

Confirming the diagnosis

3

A very actual, old debate

14

Pressure (to reform) is all around

20

CoCo: transit to portfolio diversification

24

Buyback neutral to capital ratios

27

Appendix

32

IMPORTANT DISCLOSURE FOR U.S. INVESTORS: This document is prepared by Mediobanca Securities, the equity research department of Mediobanca S.p.A. (parent company of
Mediobanca Securities USA LLC (“MBUSA”)) and it is distributed in the United States by MBUSA which accepts responsibility for its content. The research analyst(s) named on
this report are not registered / qualified as research analysts with Finra. Any US person receiving this document and wishing to effect transactions in any securities discussed
herein should do so with MBUSA, not Mediobanca S.p.A.. Please refer to the last pages of this document for important disclaimers.

Confirming the diagnosis
In Re-Foundation, 28 May 2012, we highlighted how Italian Banking Foundations
needed to change to earn sustainable investment returns to fund their grants. In
essence, we concluded that the Foundations-Banks model - based on stable,
concentrated equity shareholdings in banks, in exchange for high dividends to fund
grants - was no longer sustainable. We suggested Foundations should diversify
investment portfolios by selling the banks’ shares. Our analysis based on data up to
2010. Two years on, little has changed. On aggregate, the main Foundations’ assets
(excl. MPS) have fallen a further 16% (50% due to the bank exposure), with grants
down 30% 2010-12 and implying 30% real contraction vs 2001. From 2009, underlying
cash flows turned negative, denting 4% of Foundations’ assets. 2011-12 reported
figures came below our projections made two years ago. Taking BBG consensus on
banks’s DPS and holding other income constant, we calculate Foundations should cut
grants by 39% to preserve capital. This confirms our thesis of unsustainability of the
current model and the need to diversify investment portfolios to recover higher and
more stable profitability.

Retracing our own footsteps
Fair value/mark to market convergence implies fair representation of reality
In our previous report Re-Foundation, published on May 28th 2012, we have broadly explained how
the absence of uniform FV/MTM principle has allowed Italian Banking Foundations (Foundations) to
smoothen results out in the past. We recall that for several years Foundation‟s profits did not
reflect the economic change in the value of the portfolio. Rather, they derived from the adoption
of different accounting principles for the different types of investments and for the various
investment operations. In general, annual profits embed all realised cash flows, regardless of what
investment generated them. So, all dividends/coupons received from any investment will enter the
annual profit and will contribute to the grant pool. As for the recognition of deltas in mark to
market (MTM), these will only translate in the P&L if the Foundation realises this through active
buying/selling. By their nature, strategic stakes, composing the majority of Foundations‟ portfolios
are hardly traded. This implies that for the purpose of their activity, Foundations consider the bank
holding as a perpetuity, mostly focussing on the dividend yield generated rather than looking at the
short term fluctuations in share price. To put it simply, a strong appreciation in share price would
not translate in any extra revenues (unless shares were sold). The same principle will hold for other
investments, with the exception of diversified investments which carry no intangible value as
strategic stakes do, and will therefore be more actively traded. This has two main implications for
Foundations: a) unrealised capital gains/losses have been used to smoothen annual grant pools. b)
de-touching of accounting from reality has led Foundations to over/under spend. As a consequence
of the two implications above, capital resources of Foundations have been overstated for a number
of years. However, the divergence between reported and real value of capital is now really thin as
the two have converged. Chart 1 shows the evolution of the total Foundations‟ capital from 2000 to
2012 compared to the equivalent amount classified according to MTM principles. Over the 20052012 period, Foundations carried latent gains on their investments which progressively realigned to
their accounting values as markets retraced in recent years. The discrepancy between the two
methods reached a peak €31bn spread in 2006, i.e. 65% above the reported €47bn capital. This
positive gap progressively shrunk in the following years to almost 0% in 2011 and 4% in 2012. We can
therefore conclude that taking reported values is now a good starting point, as it closely reflects
the reality Foundations are facing in 2012.

05 February 2014 ◆ 3

Chart 1 - Foundations asset: MTM vs accounting value, Eur bn
(MTM-reported)/reported, % (rhs)

Asset book value (€, bn)

Asset mark to market value (€, bn)
90

0.70

80

0.60

70

0.50

60
50

0.40

40

0.30

30

0.20

20

0.10

10

0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: ACRI, Mediobanca Securities

2012 grants back to 2001 levels: 30% real contraction; -30% nominal one vs 2010...
Chart 2 shows the evolution of the cumulative Foundations‟ grants from 2001 to 2012. As we
commented in our report “Re-Foundation” published in May 2012, up until 2007, Foundations have
been able to satisfying the growing demands from their communities through the continuous growth
of grants. Indeed, grants rose by c.70% 2001-07, from €953 to €1.624. However, in 2008, financial
crisis hit banks and their ability to pay dividends, ultimately impacting Foundations‟ cash flows and
ability to fuel grants. In the 2007-10 period, grants were down 18%. The contraction endured more
than proportionately, with 43% contraction 2007 to 2012 and 30% 2010-12. This implies in 2012
Foundations are back to the grant levels of 12 years before, a 30% real contraction.
The contractions have been already amply cushioned by the heavy use of reserves (stabilisation
fund) by Foundations, suggesting the underlying drops would have otherwise been much more
severe.
Chart 2 - Total grants per year (€M)
1700

Grats

1624

Gran ts/ MTM cap ital

1600

3.5%
1624

3.0%

1500

2.5%

1432

1400

1333

1.5%

1232

1200

1170

1.0%

1100
1000

2.0%

1324

1300

1069

1044
953

929

949
900

0.5%
0.0%

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Source: Mediobanca Securities, ACRI



…as Foundations keep holding tight on ‘their’ banks...
The free fall of grants, which has reached the lowest level in twelve years, has once again
demonstrated our thesis of unsustainability of the Bank-Foundation model. Despite this, by looking
at how the relationship Bank-Foundation has developed in the past two years, little has changed.
Indeed, we notice that, after twenty years from the first reform, Foundations still have a firm grip
to „their‟ original banks. Chart 3 shows the distribution of the 88 Foundations in 2010 and in 2012:


15% is still over 50% control in 2012, vs. 17% in 2010;



31% is above the 20% stakeholding in 2012, vs. 40% in 2010;



50% is above the 5% stakeholding in 2012, vs. 56% in 2010;



25% has no stake in the saving banks in 2012, vs 20% in 2010.

The small decrease in the banks‟ stakes owned by Foundations is not the consequence of the active
selling of shares, but is mostly due to the dilution suffered in the banks‟ capital increases of 2011
and 2012 (UCG, ISP, PMI, UBI, Banco Popolare, MPS) imposed by the lack of free resources.
Chart 3 - Foundation’s stake into saving bank, 2010 (lhs) and 2012 (rhs)
Foundation with > 50% stake
of the saving bank

Foundation with > 50%
stake of the saving bank

Foundation with no stake of
the saving bank

15

20

18

14
21

Foundation with <5% stake
of the saving bank
Foundation with stake of the
saving bank between 5% and
20%

Foundation with no stake of
the saving bank

13

14
17

22

22

Foundation with <5% stake of
the saving bank
20%
50%

saving bank between 20%
and 50%

Source: ACRI

…while on the other side, banks’ dependence on Foundations keeps on falling
Chart 4 shows the evolution of the capital of all Italian banks (light blue) and Foundations (dark
blue) and the incidence of the latter on the former. For Foundation-originated banks, the idea
underlying is that initially the two were one and the same; as time went by and banks emancipated
and grew, the two factors diverged. As we are using the total capital of all Italian banks, this
includes the one of Popolari, cooperative and private banks which did not originate from a
Foundation. Nevertheless, given the relative size of Foundation-originated banks, we believe the
relative evolution of the two factors still has some relevance for our analysis. The chart confirms
this intuition, showing:


High initial ratio – a decade ago, Foundations‟ capital stood at 1/3 of bank‟s capital, a
high ratio in relative and absolute terms suggesting, in our view, the relatively low degree
of emancipation of the banking sector at the time.



Banks lapping Foundations – from 2000 to 2012 banks have increased their capital by 98%
(92% from 2000 to 2010) and Foundations by only 19% (42% from 2000 to 2010). The
difference in Foundations‟ capital growth rate between 2000-10 and 2000-12 suggests that
in the last two years of our analyses Foundations have eroded a relevant part of their
capital, precisely 16% of €50bn 2010 capital.




Foreign acquisitions and crisis-driven rights issues diluting the link – we note significant
upward steps in the growth of banks capital, particularly in 2005 and 2011, and relatively
smoother growth for Foundations. Apart from the scale of the chart, the reason is that in
2005 UCG‟s acquisition of HVB brought the bank‟s capital within the „perimeter‟, while in
2009 and 2011 the banks‟ rights issues attracted new resources. In the latter case, while
banks reinforce capital, Foundations increase their equity and market risks in their
portfolios. Unless bank share prices significantly re-rate, the consequence of such
operations is a strengthening of banks‟ capital and the increase in risk of Foundation‟s
portfolios.

Chart 4 - Bank’s capital vs. Foundation’s capital (€bn)
Italian Ban ks Capital

Fo u ndations capital

Fo u ndations capital/Bank capital (rh s)

300

35%

250

30%
25%

200

20%
150
15%
100

10%

50

5%

-

0%
2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Source: ACRI, Bank of Italy

Falling revenues and profits erode profitability
Chart 5 plots the evolution of the revenues on the Foundations‟ total assets and of the return on
assets (ROA) versus their respective adjusted versions (lhs) and the difference in the evolution of
revenue and profit margins reported and adjusted. Adjusted factors account for recurring items
only (core revenues: dividends, interest, pure trading profit; and core profits: core revenues minus
core costs and taxes) and for the market value of total assets (as opposed to reported assets). We
note:


Returns and profitability keep falling, 2011 the worst year – over the last twelve years,
Foundations reported average revenues/assets and profits/assets of 5.2% and 4.5%,
respectively. This result shows a deterioration in the last two years. Indeed, in the decade
2001-10 Foundations registered average revenue/assets of 5.6% and profits/assets of 5.1%.
By contrast, in the period 2011-12 the two profitability indicators collapsed to 3.1% and
1.3%, respectively.



Profits falling more than revenues – on the right hand side of the following chart, we
show how the gap between returns and profits has widened for Foundations, multiplying by
5-6 times in the last decade. This indicates that initially, returns from investments would
largely feed down to profits. The increase can theoretically be due to: a) growing costs
denting profitability, b) increasing provisions, c) increasing taxes. We exclude the latter
option as Foundations operate in a quasi-tax free regime. Years of banks‟ extra dividends
and years of particularly tough returns could require special provisions to be put on the
side and released to smoothen bottom line. Finally, higher cost absorption would impair
profitability explaining the delta.




Average ROA 2009-12 at 2.6%, more than half the 2001-08 return of 5.4% - The average
return on asset Foundations generated in the 2001-08 period stood at 5.4%, more than
twice the 2.6% ROA generated in the following 4 years. The picture looks even more
gloomy when calculated using adjusted figures.

Chart 5 - Revenues and ROA over assets vs adjusted figures,% - revs/assets-ROA vs adj. equivalent, %
9%
8%
7%

1.8%

Revs/assets
Revs/assets adj
ROA
ROA adj

revs/assets - ROA

(revs/assets - ROA) adj

1.6%
1.4%
1.2%

6%

1.0%

5%

0.8%

4%

0.6%

3%

0.4%

2%

0.2%

1%

0.0%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012


Statutory bodies’ costs constrained, but total costs rising to 12% of annual grants
Chart 6 shows the incidence of statutory bodies (dotted line) costs and total costs (blue line) of
Foundations on grants. Statutory bodies costs on Foundations‟ activity on average stood at 1.7% for
the 2003-12 period. This grew to 1.8-1.9% in 2011-12, signaling statutory bodies have constrained
their remuneration with the falling grants. Running the same analysis on total costs, we find instead
that these marked a 10.8% average incidence over the 2003-12 period, but showed an increase to
14-18% of grants in 2011-12, implying lower flexibility to contain costs in periods of low grant
availability.
Chart 6 - Statutory bodies and total cost over grants 2001-2012
19%

2.0%
1.9%

17%

1.8%

15%

1.7%

13%

1.6%
1.5%

11%

1.4%

9%

1.3%

1.2%

7%

To tal co st/ Grants (lhs)

Statuto ry bo dies/ Grants (rhs)

5%

1.1%
1.0%

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012


Negative cash flows since 2009 eroding stability funds and capital
Chart 7 below shows our top-down analysis of sustainability of the Foundations‟ system. We aim at
identifying how core profits (real cash, tangible flows made of dividends, interest on investments


and trading profits, hence excluding cosmetic operations of sell and buyback ad other profit
management operations) compare to reported profits and to grants approved (cash outflows).
Looking at Chart 7 and comparing it with Re-foundation, in which we covered the time period 20012010, we note:


€7.3bn over representation of cash flow in 2001-12, only +€0.3bn vs 2001-10 Over the
last 12 years, only in 2008 and 2011 reported profits undershot core profit. In every other
year, reported profits overshot resources available to spend. On the rhs chart below we
show in dark blue the annual spread between the two factors. We estimate €7.3bn from
2001 to 2012, up only €0.3bn in 2011-12.



Falling approved grants and increasing volatility – Grants approved have decreased in the
two-year period 2010-12 lowering the 2001-12 average at €1.22bn vs. €1.27 in 2001-10. In
addition, the volatility of grants approved has increased by 1% in the last two years
increasing the 2001-12 standard deviation/mean ratio to 20% vs. 19% in the period 2001-10.



Negative net cash flow since 2009 – In the right hand side chart we show in light blue the
spread between core profits and grants approved. Since 2009, when banks started to cut
dividends, the net cash flow has gone negative and it has remained so in the following
years. We calculate €0.7bn cumulative positive cash flow in 2001-12, half of what we have
calculated during the period 2001-10 (€1.5bn), and corresponding to 2% of the initial €36bn
total endowment of 2001. The picture is worse if we make the same analysis over the
period 2010-12. Since the cash flow has gone negative for the first time, Foundations
generated a cumulative negative cash flow of €2.1bn which translates in a 4% erosion of
the €49.4bn total endowment of 2009. Finally, 2011 and 2012 generated average annual
negative cash flows of €400m, comparing to +€361m in 2001-08 and €154m in 2001-10.

Chart 7 – Core profits vs reported profits and grants approved
Core profits-grants approved

Core profits

Grants approved (€ m)

-

0.0%
2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

-1,000

878

1,196

482

835

-296
-200

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012


Insufficient diversification dented the real value of endowments by 43 p.p in 12 years...
The lhs side of Chart 8 shows the comparison of cumulative performance of Foundations‟
comprehensive value of capital vs the major asset classes, rebased to 2000. Over the twelve years,
the MTM value of Foundations‟ assets was down c.25% v.s 7% underperformance in the decade 200010 (2000-04 and 2011-12 estimated by MB, 2005-10 using the value provided by ACRI). By contrast,
Italian inflation was up 37 p.p., government bonds and R.E. 140 p.p., commodities 290 p.p.. We
believe the evolution of Foundations‟ asset values suggests a split in three segments:
1.

-504

0.5%

-767

-500

-532

1.0%

500

575

-

1.5%

-578

2.0%

1,000

-109

1,500

77

500

2.5%

110

3.0%

2,000

1,000

364
221

3.5%

702

4.0%

2,500

849

1,500

164

4.5%

3,000

1,253

5.0%

1,415

2,000

3,500

822
917

Reported profit (€ m)

Reported - core profits

161

Core profit/ MTM capital (rhs)

Eur m

2000-05: equity and govies – Foundations performance is the average of the performance
of equity and government bonds, suggesting a balanced exposure to the two asset classes,
in our view.


2.

2006-10: banks underperformance realign Foundations to equity – with the advent of
the financial crisis, the high exposure to the banking industry prevailed, with Foundations
asset value converging to the equities performance and underperforming it as banks lagged
behind other sectors.

3.

2010-12: low diversification led to underperformance vs. global equities – with the
improvement of global financial stability following the central banks‟ interventions, global
equities experienced a relief rally, which however, has only partially benefitted banks. As
shown in the rhs of Chart 8, Italian saving banks have underperformed the MS Global Equity
Index by c.50%. Given their high equity concentration of Italian banks in their portfolios,
Foundations partly missed the global equity rally.

From the above, we conclude that Foundations have not been able to keep to the mandate of the
law:
a.

Real value destruction - overall Foundations have dented the real value of their assets,
underperforming the inflation rate by almost 43 p.p.. Only in 2006 and 2007, at the peak of
the financial bubble benefitting bank prices, Foundations showed a positive cumulative
performance vs Italian inflation. This betrays the law‟s goal of real value preservation.

b.

Lack of diversification – the high correlation of Foundations‟ returns with equities and the
underperformance vs this riskier asset class during the financial crisis confirms Foundations
maintained a high overall portfolio concentration in the banks. This is the main factor
entailing the poor cumulative performance of Foundations and the high volatility of
returns, in our view.

Chart 8 - Returns comparison: Foundations vs asset classes– MS World Equity Index vs. ITA banks (2000=100)
325
Cmmdty

300
275

Govies

250

Equity

ITA banks

160
140
120

225

R.E.

200
175

100
80

IT infl

150
125

Equity

100

60
40
20

75

Foundations

50

-

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

* equity: MS World index

...coupled with highly volatile investment returns
Chart 9 shows the year on year evolution of the MB performance indicator aggregated for the five
largest Foundations (Cariplo, CSP, CRT, CRV, CRP) from 2002-12. From 2002 to 2007 Foundations
experienced growth in their MB performance indicator (see Appendix):

2008 has been the year of rupture with an average 30% real value destruction. 2009 and the
temporary euphoria of the national bailout of banks partially recovered the previous year‟s tragedy,
but 2010 and 2011 reiterated the 2008 issue. 2012 has returned a better MB performance indicator,
practically flat (-0.4%). This shows how volatile Foundations‟ investment performance has been over
a decade.


Chart 9 – Evolution of the MB performance indicator*, 2002-12, % aggregate level
30%
20%
10%

0%
-10%

-20%
-30%
2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Source: Mediobanca Securities, company data
* see appendix

Bank stakes main culprit for Foundations’ loss in investments’ worth
In this analysis we estimate the split of the annual evolution of market value of investments of
Foundations between the bank stake, the net cash flow generated (revenues – costs – grants - taxes)
and the other investments. We adopt the following methodology:
1.

We start from the first available market value of investments provided by the five largest
Foundations;

2.

We then calculate the delta market value generated in each year as the sum of the delta
market values generated by the bank stakes and by other investments, plus the earnings
retention (net cash flow=NCF);

3.

We then attribute performance to the different factors as follows:


We either take the reported change in value of the bank stake or we estimate the
average yearly holding of shares in the bank by dividing the Foundation‟s reported
market value of the bank stake by the average bank‟s share price;



We then apply the performance of the bank‟s share price in year t to the average
number of shares held and compare it to the same value in year t-1 to obtain the
performance contribution from the exposure to the bank;

We estimate the performance generated or lost by other investments by subtracting to
the overall delta in market value the performance generated by the saving bank and
the NCF.
We summarise the aggregate results as follows:




16% value destruction in 2011-12, half due to the banks stakes – we calculate the
aggregate MTM value fell by €3.7bn over 2011-12, for 18% fall on 2010 (-16% on reported
figures). A half of this is attributable to the banks‟ stakes, c.10% to negative cash flow and
40% to the evolution of other investments;



Bank stakes lost €8bn value since 2001, €1.9bn in the last two years...: the evolution of
the value of the cumulative bank stakes is in the light blue bars in Chart 10. We calculate
that cumulatively, the bank exposure meant €8bn loss in value for Foundations, i.e. 35% of
the €23bn market value of all investments in 2001YE. 2008 was the year of collapse, with
€9.6bn cumulative losses, aggravated by the increase in the concentration of portfolios
towards these assets through the capital increases launched by banks in the period.



other investments and NCF only compensated 23% of the bank value destruction: The
dark blue bars show the evolution in performance of non-bank investments. We calculate a

05 February 2014 ◆ 10

cumulative gain of €0.6bn over the period 2001-12 vs €2bn over the 2001-10 period. This
sharp collapse has happened in 2011 where total other investments generated a loss of
€1.3bn. Given this negative performance in 2011, non-bank investments have offset only
8% of the losses taken through the bank exposure, vs. 25% offset during the period 2001-10.
Accounting also for the retained NCF, total offset of bank exposure amount to 23%, well
below the 55% level reached during the period 2001-10. We note a weak correlation
between the bank stake and other investments, implying other investments not only did
not offset the bank stake fluctuations, but partially magnified their impact to the
fluctuation of overall investments‟ worth.


2001-06 banks up €3.4bn, other investments up €5.8bn: we calculate that in the precrisis period, banks generated cumulative performance for €3.4bn, i.e. 16% of the 2001
cumulative initial market value for Foundations; similarly, other investments grew by
€5.8bn.



2007-12 banks down €11bn, other investments down €5bn: the period 2007-12 saw
value destruction for €11bn on the banks stakes and €5bn for other investments, with a
total loss of €16bn, i.e. 47% of the peak aggregate market value of investments reached at
the end of 2006. The relative magnitude of losses reflects the risk concentration of
Foundations on banks during the crisis – increased through rights issues - and the sector
specific issues banks suffered from, in our view.

Chart 10 – Foundations’ aggregate market value evolution: banks vs other investments
41,000

€m
Marke t valu e

36,000

Savin g Ban k

31,000

Oth e r In ve stments

26,000

21,000

6,000

17,142

11,000

23,284

16,000

Mkt value
Bank
NCF
Other
Bank
NCF
Other
Bank
NCF
Other
Bank
NCF
Other
Bank
NCF
Other
Bank
NCF
Other
Bank
NCF
Other
Bank
NCF
Other
Bank
NCF
Other
Bank
NCF
Other
Bank
NCF
Other
Mkt value

1,000

01

02

03

04

05

06

07

08

09

10

11

12

Source: Mediobanca Securities, company data

05 February 2014 ◆ 11


Radical change is still needed
Replaying the simulation...
We learnt above that the Foundations‟ investment did not preserve their value in real terms over
the last decade, with a further deterioration in 2011-12. This confirms our conclusions on
Foundations‟ investments of Re-foundation. There, we estimated the alternative evolution of
Foundations‟ investments worth under three hypothetical scenarios of evolution of banks‟ dividend
streams. We showed the difficulty for Foundations to protect their assets with the status quo of
investments.
After two years, we re-run the same analysis to verify how reality has unfolded vs our three
hypothetical scenarios depicted two years ago.
We calculate the market value evolution under each DPS scenario by assuming:
a.

flat evolution of non-DPS revenues vs 2010 values;

b.

constant grants (those paid in 2010, therefore discounting a progressive fall in real grants,
after inflation) and compensating for the zero growth assumption on non-bank dividends;

c.

3% increase in annual operational costs.

On bank dividends, we contemplate the following three scenarios:


Flat dividend: this scenario assumed banks would keep on paying annual dividends in line
with those of 2010.



Consensus dividend: the dividend projection was based on the consensus estimates for the
2012-15 DPS. Later years assumed a 5% annual growth for the following two years and 3%
annual growth thereafter. This scenario resembled the slow recovery trajectory, in our
view.



Bull market: the „bull market‟ option was admittedly optimistic. We supposed banks would
revert to the golden years, when they paid high dividends to shareholders. This scenario
contemplated 2012 revenues at Foundations equal to peak revenues generated by
Foundations from 2005 to 2008. For later years, we projected 5% annual growth until 2015
and by 3% thereafter. This scenario implicitly assumed not only that banks would overcome
macro obstacles to profitability, but also that they would offset the additional regulatory
burdens that were progressively being introduced.

Our exercise admittedly excluded boosts to the market value of Foundations‟ assets from price
appreciation, and limited this to the „retained‟ portion of cashflows generated by the bank. Our
goal was in fact not to predict the actual evolution of the Foundations‟ worth, but rather to see if,
and under which circumstances, maintaining the asset allocation stale could support their statutory
goals.
...2011-12 proved harsher than our most cautious scenario
Chart 11 shows the projection in the evolution of the market value of Foundations we had shown in
the “Re-foundation” report with the addition of:
1) 2011 and 2012 MTM value of Foundations capital;
2) The potential 2013-16 scenario using DPS Bloomberg consensus as a rollover of the previous
„consensus‟ scenario.
We highlight the following:

05 February 2014 ◆ 12



2011 and 2012 went below our worst case scenario – the evolution of the aggregate MTM
of Foundations‟ capital was below the 2010 level and it undershot the trajectory of the
most cautious „flat dividend‟ scenario we depicted two years ago.



2013-16 trajectory to confirm the hard times – we re-run the consensus exercise of two
years ago, updating it for the current market estimates on banks‟ DPS into 2016. The
trajectory depicted is below the previous „dividend flat‟ scenario and would confirm a
meagre cash inflow for Foundations going forwards.



Small dividends imply unsustainability of Foundations – the flat dividend scenario,
representing a Japanese-style evolution for the European economy, projects a relentless
fall in Foundations‟ worth into 2030 with a 2-3% annual loss in the absolute value of
Foundations‟ investments. This marks the unsustainability of the current asset allocation of
Foundations as the implications for Foundations‟ stakeholders would be either the full loss
in the support they have been used to receive, or a marked fall in the annual grants to the
local community, before the erosion of inflation.



39% decrease of grants in 2012-16 needed to preserve current capital level – We have
calculated the dividend Foundations will receive from banks in the period 2013-16 by
taking DPS Bloomberg consensus for the next four years. We maintained all the other
source of income (trading income, interests, etc..) stable at the 2012 level and applied a
3% increase in annual operational costs. This scenario would imply Foundations would need
to cut grants by 39% over 2013-16 to maintain their capital stable at the 2012 level.

This analysis suggests that the current portfolios of Foundations are not granting the recovery in
value of the assets, potentially putting at risk the financial sustainability or the one of future
grants. This suggests a change on the investment portfolios is required to preserve the Foundations‟
role as primary actors in the country‟s private, national welfare and charitable sector, in our view.
Chart 11 – Market value evolution from 3 bank DPS scenarios, 2001-30e
40,000
35,000
30,000
25,000
co n sensus

20,000
15,000
10,000

Mkt Val avg 01-12
co n se nsus dividend

5,000

flat divide n d
bu ll divide n d

2030

2029

2028

2027

2026

2025

2024

2023

2022

2021

2020

2019

2018

2017

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

-

2016

2013-16 co n se nsus

p

Source: Mediobanca Securities, Bloomberg ACRI

05 February 2014 ◆ 13

A very actual, old debate
Digging into the Parliament’s archive we found that in 1998 - at the time of the discussion of
the Ciampi law on Foundations, which gave a definitive legal framework and a role to
Foundations - MPs debated harshly before approving the law. The private nature of Foundations
and their disposal of bank stakes was taken for granted. Much of the debate was about the
powers of control and guidance of the regulatory authority and on whether there should be
external monitoring and enforcement of portfolio diversification. Hot topics were: a) the forced
or incentivised divestment of bank stakes and the deployment of the proceeds, b) the degree of
independence in managing investments and the potential restrictions in certain investments
types, c) the powers of a potential regulating authority. The Lower House bill was tougher on
these matters, while the final agreement reflected a watered down compromise which included
the institution of a regulatory body which is yet to be formed, leaving the Finance Ministry as
the temporary, but still empowered authority of reference. We propose a summary of the two
year long debate to confirm that the issues we treated in this and in previous notes are deep
rooted, had already been identified in the debate 15 years ago and remain very actual. This
suggests the law did not resolve all the issues identified, in our view.

Ten years of legislative innovation behind today’s structure
The transformation of the Italian banking sector happened through a series of progressive
transformations of the legal framework regulating banks (see the table below).
1990 - Amato law: from public entities to joint stock companies - The privatisation of banking
Foundations was initiated in 1990 by Giuliano Amato. The Amato reforms produced a separation of
credit business from philanthropic activities. All banking business was spun off and passed to the
Savings Banks, already established as profit-making companies involved in private commerce and
regulated by the Civil Code and banking standards as applied to ordinary banks. The activities
concerned with social, cultural, civil and economic development remained with the newly-created
Foundations. The law conceived Foundations to be trustees for the capital raised from
privatisations and required them to maintain majority ownership of the banks.
1994 – Dini directive: incentives to reduce control on banks – introduced law 474/94. This
removed the requirement for Foundations to retain control of the banks and provided fiscal
incentives to Foundations which would diversify their portfolios by selling down their stakes.
1998-99 – Ciampi law: removing the umbilical cord - Law no. 461/98 (a.k.a. the "Ciampi" law),
together with decree, no. 153/99, required Foundations to relinquish any remaining control in their
respective banks - an obligation still in force today except for Foundations which have net assets
with a book value under €200m in 2002 or are located in special statute regions. The reform fully
defined the juridical framework of Foundations, providing their specifications under civil and fiscal
aspects. The decree also forbid Foundations from appointing their board members in the banks‟
boards and required them to have separate organs for their strategic, administrative and control
functions.
2001 vs 2003 – A definitive identity for Foundations – In 2001, Giulio Tremonti, minister of
Finance, sponsored law 448/01, which limited the private nature and the statutory autonomy of
Foundations. These reacted by appealing to the Constitutional Court which in September 2003
reaffirmed Foundations as "private, legal entities having statutory and management autonomy" and
as being "among the members of an organisation of a free society".

05 February 2014 ◆ 14

Year

Operation

1990
1993
1994
1994
1996
1997
1998
1998
1998
1998
1998
1998
1999
1999
1999
1999
1999

Amato Law
Privatization
Dini Directive
Privatization
Privatization
Privatization
Ciampi Law
Privatization
M&A
M&A
M&A
M&A
Privatization
Privatization
M&A
M&A
M&A

Banks

1999

M&A

2000
2001
2001
2001
2001
2003
2005
2006
2007
2007
2007
2008
2008
2008
2009
2009
2009
2009
2009
2010

M&A
SPI & Banco di Napoli
Tremonti law
M&A
SPI & Cardine
M&A
UCI & Rolo Banca 1473
M&A
BdR
Constitutional Court ruling 300 and 301
M&A
UCI & HVB
M&A
SPI & BIN
M&A
ISP & Carifirenze
M&A
UCG & CAP
M&A
MPS & Biverbanca
RI: €3bn 'cashes'
UCG
Shareholders
UCG
M&A
MPS & Antonveneta
Zero cash DPS
UCG
Zero cash DPS
ISP
€0.01 DPS
MPS
RI: €4bn
UCG
RI: €1.9bn T-bond
MPS
New mgt
UCG

2010

New mgt

2010

New mgt

2011
2011

% sold

Seller

Buyer

Name @ date

Today

IRI

market

CI

Foundations involved

Unicredit

Credito Italiano

55%

COMIT
IMI
San Paolo 1

51% IRI
7% Treasury
23% CSP

market
block trade
market

COMIT
IMI
IBST

ISP
ISP
ISP

CSP

BNL
Ambroveneto & Cariplo
San Paolo & IMI
Unicredito & Credito Italiano
UCI & CRTS
MPS
Mediocredito Centrale
BIN & COMIT
UCI & CariTro
MPS & BAM

62%

market

BNL
Banca Intesa (BIN)
Sanpaolo IMI (SPI)
Unicredito Italiano (UCI)
UCI

BNP
ISP
ISP
UCG
UCG
MPS
Unicredit
ISP
UCG
MPS

Cariplo, CRPa
CSP
CRT, CRV, CM
CRT, CRV, CM, CRTS
MPS
BDR
Cariplo
CRT, CRV, CM, CRTS, CRTRO
MPS

Banca di Roma (BdR)

UCG

CRR, BDS

SPI

ISP

CSP

SPI
UCI
Capitalia (CAP)

ISP
UCG
UCG

CSP, CRPR, CRB, CRVe, CRUP, CRGo
CRT, CRV, CM, CRTS, CRTRO, CRMonte
CRR, BDS,CRRE

UniCredit (UCG)
Intesa Sanpaolo (ISP)
ISP
UCG
MPS
UCG
UCG
MPS
UCG
UCG
MPS
UCG
MPS
UCG

UCG
ISP
ISP
UCG
MPS
UCG
UCG
MPS
UCG
UCG
MPS
UCG
MPS
UCG

CRT, CRV, CM, CRTS, CRTRO, CRMonte
CSP, CRPR, CRB, CRVe, CRUP, CRGo, CARIPLO
CSP, CRPR, CRB, CRVe, CRUP, CRGo, CARIPLO, CRF
CRT, CRV, CM, CRTS, CRTRO, CRMonte, CRR, BDS, CRRE
MPS, CRBIVC
MPS, CRBIVC
MPS, CRBIVC
MPS, CRBIVC

ISP

UCG

UCG


UCG

UCG

UCG


RI: €5bn

ISP

ISP

ISP

CSP, CRPR, CRB, CRVe, CRUP, CRGo, CARIPLO, CRF

RI: €2.1bn

MPS

MPS

MPS

Management/ Shareholders

MPS, CRBIVC

CR Roma

27%
100%

Treasury

CRTS
Fondazione MPS
Treasury
CariTro Foundations
BAM
Mediocredito
Centrale & Savings
Banco di Napoli
Cardine Foundations
Cassamarca
BIPOP-Carire

CRBIVC

Santander

market
Banca di Roma

Banco di Roma
BIN
UCI

Libyan authorities buy a stake

Libya and Abu Dhabi buy stakes

Piccini: Italy country head
GM: Morelli for Micheli /
Chairman mgt board: Beltratti for Salza
CEO: Ghizzoni for Profumo

* CSP= Compagnia di Sanpaolo, BDR= Banco di Roma, CRB= Cassa di Risparmio di Bologna, CRV= Cassa di Risparmio di Verona, CRVe= Cassa di Risparmio di Venezia,
CRUP= Cassa di Risparmio di Udine e Perdenone, CRGo= Cassa di Risparmio di Gorizia, CRPa= CaRiParma, CRF=Ente Carifirenze, CM=Cassamarca, CRTS= Cassa di Risparmio di Trieste, CRTRO= Cassa di Risparmio di Trento e
Rovereto, CRMonte=Carimonte, BDS= Banco di Sicilia, CRBIVC= Cassa di Risparmio Biella e Vercelli, IBST=Istituto Bancario Sanpaolo di Torino

05 February 2014 ◆ 15


Ciampi law to fill the ambiguity of the Foundations’ role
The third legislative intervention in the process of definition of the Foundations‟ legal framework
became necessary to fill the normative gap of the Amato law. As per MP on.le Cambursano: “it
became evident that we were missing adequate instruments when, identified the no profit goal as
the sole raion d‟etre... the Italian legislative context could not provide adequate support”. The
Ciampi law defined Foundations as: legal entities of private nature, with full statutory and
managerial autonomy, only pursuing goals of social utility, temporarily supervised by the Finance
Ministry. This ended the dispute on the public nature of Foundations which was assigned in the
constituting law of 1990. In presenting to the Banking Association (ABI) in 1996, the then Finance
Minister, Ciampi said the Amato law separated banks from Foundations “but not completely
dethatching two souls which has been cohabitating in a single institute”. He continued saying the
Foundations-banks system required a second reform, the one on the “disposal from Foundations of
bank shares, so to allow to both entities to become permanently autonomous, both free to pursue,
according to their nature, their, very different, goals”. As Senator Debenedetti put it, Ciampi
acknowledged that “the Amato law, solving one problem, shed light on others: firstly the one of
ownership”.
Two years of Parliamentary gestation
On 12 February 1997 the then Finance Minister, Ciampi, presented a decree to reform the law
regulating Foundations. The lower House started the debate in March of the next year, approving a
draft on the 18th with 271 votes in favour, 212 against. On 12 May 1998 the bill then went to the
Senate, which approved it with significant changes on 11 November 1998 with 148 votes in favour,
11 against and 5 abstained. The Lower House then approved the new bill from the Senate a few
days later, converting into law on 23 December.
Government proposal: investment principles, regulatory authority
The governmental decree proposed that Foundations followed the principles of: 1) efficiency in the
management of funds, 2) capital preservation, 3) generation of adequate returns through portfolio
diversification. The decree also confirmed the institution of a regulatory authority with the power
to verify the management of assets, the adequate profitability and the conformity with statutory
goals. Also, the authority would authorise operations of concentration and transformation, could
commission the managing bodies and even dissolve the entities in case of irregularities in the
management.
From a harsh contrast in the Lower House...
The Lower House hosted a tough debate on the bill. There was wide agreement on the private
nature of Foundations and on the progressive disposal of bank shares. The contrast between
majority and opposition was more related to practicalities such as what would happen during and
post the sale process, how long it should take to carry this out, who if any would regulate and
supervise these entities and whether the management of assets should be regulated and controlled,
assigned to third parties or let in the full domain of the management of Foundations.
The majority, composed of the centre-left parties, proposed the institution of a regulatory
authority fixing parameters of adequacy of investment return and the monitoring of the principles
of preservation and prudent management of capital. Also, they proposed the disposal of bank stakes
over four years.
Regarding the regulatory authority, MP on.le Agostini said: “one of the powers of the authority is to
define the parameters linking the capital to the returns of the Foundation to devote defined
resources to the pursuit of statutory goals... as capital preservation is the fundamental scope of a
Foundation”.

05 February 2014 ◆ 16

On the disposal process of bank stakes, MP on.le Agostini, sponsor of the proposal for the majority
group proposes that Foundations dispose of bank stakes within four years and that, at regime, they
dedicate their entire activity to the pursuit of the social good.
Very much opposed to this view, the conservative minority argued for a liberal solution, letting
Foundations free to manage their assets independently and without the supervision of any
authority. MP on.le Pace, in stating his opposition to the bill of the majority said: “there is the
attempt to attribute the power to fix the return on investments to the regulatory authority... the
higher the return, the higher normally will have to be the risk borne. The authoritarian
determination... of the investment return implies the acceptance of a degree of risk and this risk
is borne by Foundations, there is no aspect of the law which mentions what would happen in the
case of doing so and obliging Foundations to externalise the management of their investments,
depriving them from the possibility to manage it directly, these investments would go to
(colloquially speaking) „snafuz‟ (from Dictionary.com: „a badly confused or ridiculously muddled
situation‟)”.
On 18 March 1998, the Lower House approved a draft bill consisting essentially of:


Exclusive pursuit of social good – the bill approved indicated Foundations would
exclusively pursue goals of public good.



Indications on investments - the bill approved indicated the principles of efficiency,
capital preservation and portfolio diversification to grant an adequate profitability of the
invested capital and the conferral of asset management to authorised agents to grant
adequate transparency also to stake disposals.



Restriction of instrumental activities – the bill approved indicated Foundations could
control companies instrumental to fulfil statutory goals, exclusively in sectors like
scientific research, education, art, healthcare.



Regulatory authority - the bill approved indicated Foundations would be subject to a
regulatory authority which would verify the adherence to the law, the healthy and prudent
management, the profitability of the investment portfolio and the effective keeping of
statutory goals. This would have the power to remove administrative organs or even
dissolve a Foundation in case of grave irregularities, after having consulted with the
Foundation.



Fiscal treatment of bank stake disposals – the bill approved indicated that the privileged
fiscal regime on the disposal of bank shares would lapse after four years if Foundations still
held control on the bank.

...to a wide agreement on a compromise in the Senate
When the discussion of the matter went to the Senate, the harsh debate has been overcome, with
relevant amendments to the bill approved in the Lower House. In particular, the agreement
included:


The introduction of the local development among the scopes of Foundations;



A definition of return, net of operating costs and taxes, provisions to mandatory reserves;



The establishment of control as per the art. 2359 of the Civil Code of law;



The possibility for Foundations to buy stakes in the Bank of Italy;



The incompatibility for individuals to be part of Foundations‟ and banks‟ boards at once.

In essence the approved deal diluted the powers of the regulatory authority and the indications on
the investment activity.
The agreement is reflected in the final vote: 148 votes in favour, 11 against and only 4 abstained.

05 February 2014 ◆ 17

Senator Debenedetti the main oppose to the compromise...
The opposition to the final bill came from Senator Debenedetti, notwithstanding his belonging to
the majority party. He was seeing the reform as a failed opportunity to provide the impulse to
diversify the shareholder base of banks, removing the strong links with Foundations. He had a very
clear idea of what to do: “it is now necessary that Foundations/associations overcome the identity
crisis, rediscovering a precise social or cultural vocation. Foundations/associations, clearly
belonging to the private sphere of law, will be able to construct the pendant of joint stock
companies: the latter pursuing profit maximisation, the former regulated as not for profit
entitites... Loyal to their origins, Foundations/associations will only invest their wealth with the
objective to generate returns to fund their institutional, not for profit and to allow lasting
interventions in the pursuit of their statutory goals. They will predominantly invest in a diversified
portfolio of financial assets. They will be allowed to maintain stakes in banks and companies, but
with no control. As guarantee, the management of financial resources of Foundations/associations
will happen through a professional manager and Foundations‟ management will be responsible for
how they have invested and how they have utilised the returns”. He also proposed a revision of the
concept of control related to the voting behaviour at AGMs as opposed to the number of shares
held, as per the art. 2359 of the Civil Code of law.
On Foundations-banks relationship, he added: “converting the stakes of Foundations/associations in
marketable securities, having separated the control from the ownership, having reoriented their
activity on the prudent portfolio diversification and on the spending of returns which derive from
it, will fall the main reason of the link with political power”.
On the link with politicians, he highlighted the importance of the ownership structure of
Foundations: “There is no doubt that a Foundation is a company: a company which does not
distribute profits but which can pursue, and this is the difference, surpluses. Also, they do not
receive contributions from private individuals, they originate from a separation, certainly not
from private donations provided by a universe of agents, so that the Foundation is an organisation
conceived for the wellbeing of the beneficiary of services which the Foundation offers and so it
does not have to report to its contributors... the fact that administrators are largely appointed by
politicians introduces for Foundations a particular category of agents which establish transactions
with Foundations: politicians... Foundations do not belong to anyone as nobody has the right on
their profits but they are controlled by administrators who are subject to their appointment by
politicians”.
He then linked the implication of the political influence on Foundations for financial markets: “it is
then necessary to pose this question: what is the propensity to risk of Foundations‟ administrators?
Low with respect to financial risk and low with respect to political risk... in conclusion, the
absence of contributors and the power of appointment from politicians are non- trivial on the
utility function of Foundations‟ administrators. If we introduce in financial markets operators who
formulate their demand not through a risk-return equation, we distance the market from a
condition of efficiency”.
He therefore proposed Foundations should sell the bank stakes, diversify their investment portfolios
to reap more stable returns to fund their grants and to remove the link with politicians. A
regulatory authority should monitor that investments are coherent with capital preservation and
diversification and they could remove administrators or even dissolve Foundations in case of
improper behaviour.
...together with a few more
Going through the Senate‟s documents, we also found a few individual proposals alternative to the
agreement between majority and minority.
Senator Sella di Monteluce proposed either the introduction of a fiscal incentive to dispose of bank
stakes or the transfer of voting rights on bank shares to the Finance Ministry if, after four years,

05 February 2014 ◆ 18

these would not have sold the shares. Voting rights would be returned once the disposal would be
completed.
Senator Miglio proposed the partial utilisation of proceeds from the sale of banks‟ stakes into the
reduction of the Italian public debt and summarised his worries about the new law as follows:
“What will Foundations do with the colossal wealth they will administer with the disposals of bank
shares? Foundations are about to become a formidable power centre...the only certain fact is that
it will be about discretional decisions, made by party emissaries, not subject to any effective
democratic, direct or indirect control, a power as strong as irresponsible... the most formidable
instrument of influence-peddling and manipulation of consensus which has partitocracy has ever
has is being introduced”.
Lega Nord Padania and Rifondazione Comunista parties opposed the compromise. Senator Co‟
declared: “Foundations will be more and more destined to forget their goals of social welfare to
transform in power centres inside the banking sector”.
Today’s debate has not changed much
It has been an extremely formative experience to retrace the topics and the evolution of the
Parliamentary debate of the Ciampi law which is behind today‟s legal framework. We notice that
much of the Parliament‟s attention went to issues such as portfolio diversification, divestment of
banks shares, portfolio diversification, monitoring of capital preservation and adequacy of
investment returns, political interference, outsourcing of portfolio management, conflict between
investment goals and grant-making focus shows how:
1)

The Parliament had already identified the crucial factors/risks 15 years ago;

2)

Today‟s debate has not changed dramatically, implying the current framework did not
solve all the criticalities which had been identified.

05 February 2014 ◆ 19

Pressure (to reform) is all around
The IMF, the Bank of Italy and the Government have affirmed their support to a reform of
Foundations involving: 1) portfolio diversification; 2) leverage cap; 3) stricter governance. This
suggests that Foundations should: a) reduce their stakes in banks and diversify their investment
portfolios; b) reduce the risk of interference into the bank or from politicians. This shows the
level of the debate has raised from national to the international scene, increasing the pressure
on Italy to reform ahead of the implementation of the Common European Regulator.

IMF recommending a reform of Foundations...
The IMF 2013 Article IV Consultation published by the IMF last September included a chapter titled
„Reforming the corporate governance of Italian banks‟. This includes an analysis of the current
system of Foundations and provides recommendations of reform to foster corporate governance.
Lights and shadows of the Foundations’ system
The IMF analysis of the Italian banking system composes of the following points:


Concentrated ownership of Italian banks – Italian banks‟ ownership structure is
concentrated with the largest shareholder controlling on average 45% of the capital or 18%
when weighted by market capitalisation. This can facilitate decision making but in Italy
there are „minority shareholders that exercise control beyond their ownership through
legal devices such as joint lists, coalitions with other shareholders (formalized or not),
voting rights ceilings and cross-holdings. These shareholders are also often linked to nonprofit foundations, whose governance differs from a standard corporation‟.



Foundations propelled Italian banks forward... – Foundations supported two consolidation
waives, giving rise to three large banking groups. They also supported the recapitalisation
of banks in the crisis, providing 20% of the capital needs since 2008.



...but they have also dragged their feet – Foundations have dropped their bank ownership
to 40% in 2012 but they are still major shareholders in four of the top 10 banking groups.
Despite the indication of the law to lose control of banks, Foundations appoint the
majority of board members in the two largest banks.



Governance challenges – „Local politicians dominate the boards of several foundations‟.
„Foundations do not follow basic corporate governance practices. For example, the
appointment of governing bodies is often non-transparent and foundations do not follow
uniform accounting and disclosure rules. In addition, there has been little oversight of the
foundations, despite the law‟. „Despite provisions in law 461/98 that require
diversification of obligations, some large foundations still have portfolios heavily
concentrated in their ―original bank, with stakes varying from 30 to 90 percent. Some
foundations have also made use of bank credit (mortgages, credit lines) to fund
miscellaneous expenditures, such as capital increases, real estate acquisitions or
restructuring. Others have invested in risky derivative products‟.



Implications for banks of Foundations’ ownership – The concentrated, risky investments
mentioned in the above point „increased the riskiness of their portfolio and raised
pressure on banks to generate dividends to support the weak financial position of the
shareholder foundation. The IMF‟s FSAP stress test found that „banks influenced by
foundations are particularly vulnerable to slow growth or adverse macroeconomic
conditions. In the adverse scenario [...] the CET1 and Tier 1 capital shortfalls of this
category of banks would be respectively, €3.2 and €5.4 billion (0.2 and 0.3 percent of
GDP), accounting for 40–50 percent of the shortfall of all Italian banks in the test. Banks

05 February 2014 ◆ 20

that have the highest proportion of foundation ownership display higher NPL ratios, lower
NPL provision coverage and lower capital ratios. This is confirmed by a BoI study that
indicates that bank performance has been negatively correlated to the proportion of
foundation ownership‟.
The report suggests the implementation of the following reforms for Foundations:
1.

the introduction of strict divestment procedures for Foundations.

2.

the diversification of investment portfolios and the requirement of minimum reserves
invested in safe assets to provide a buffer.

3.

the introduction of a leverage cap to prevent levered acquisitions of risky assets.

4.

the introduction of „term limits for foundation board members and of a cooling off period
between a political office and the appointment to a foundation – a provision currently left
to the „Code of Ethics‟‟.

5.

„the implementation of strict oversight with prompt corrective actions‟.

...the government and BOI are on a similar page...
F. Saccomanni calling for unpleasant changes in the Foundation-Bank link in 2012...
In a speech to Foundations in June 2012, Fabrizio Saccomanni, then General Manager of the Bank of
Italy, provided the following recipe for the banking sector and for Foundations:


Foundations should diversify their investment portfolios;



Banks would need to cut costs to weather the storm of the crisis abandoning the federal
organisational model;



Banks should constrain remuneration and dividends to strengthen capital.

These measures would entail:


The dilution of Foundations‟ control over banks;



The absorption of the local banks pertaining to the larger groups into the parent company,
implying the removal of local brands, board seats and presence;



The structural fall of dividend yield for an investment in bank equity.

All the three above implications should have sounded unpleasant for Foundations whose presence in
the capital of banks aims at maintaining the attention of the company on the needs of local
households and SMEs and whose grant making activity requires cash generative investments.
...and for a reform of the Foundations’ law in 2013
In 2013, Saccomanni became Finance Minister in the Letta government. Over the year, a number of
Foundation-controlled banks went into problematic situations and a few scandals involving
Foundations broke out. The Italian press has reported his agreement with the Bank of Italy to
propose a reform of the law ruling Foundations based on four pillars:
1.

Abolish the control of banks by Foundations;

2.

Ensure effective portfolio diversification of investments through a cap of 30% of the total
portfolio in a single investment;

3.

Forbid the underwriting of rights issues with leverage;

4.

Forbid to invest in derivatives and hedge funds.

There has been little recent update on this, but if confirmed, it would pursue the recommendations
provided by the IMF last September.

05 February 2014 ◆ 21

...in agreement with the Bank of Italy
In October 2013, Ignazio Visco, governor of the Bank of Italy, provided the following indications
when talking about Foundations: „Banking Foundations should have diversified their portfolios to
reduce their dependence on the results of their reference bank. Some have not done so, they will
have to adapt, taking market conditions into account‟.
This confirms the Bank of Italy‟s expectation that Foundations without diversified investment would
be potentially suffering from a financial standpoint as fixing the problem could imply the
recognition of financial losses or of material dilution in the equity stake in the reference bank.

...and Draghi’s suasion were the prelude to today’s state
Mounting pressure for Foundations to put banks and the country before their interest...
Former BOI governor Mario Draghi exercised his moral suasion on the banks‟ as well as on
Foundations‟ management. Table 1 reports extracts from the Governor‟s speeches at the World
Saving Day, an annual event organised by ACRI, Italy‟ association of banking Foundations. The
beginning of the crisis marks the beginning of a recurring explicit reference made by the Governor
on the role Foundations should have in the banks. The Governor‟s requests and expectations from
the banks progressively escalated over the years:


2007 – No mention in the speech of Foundations and of their role in the banks.



2008 – The Governor‟s call is for a generic wish of having Foundations accompanying banks
on the journey of growth, providing them with firm roots. There is not explicit reference
to capital increases.



2009 - The Governor‟s request is explicitly to: support the upcoming capital increases,
refrain from interfering with management and take a long view on the return on their
investments. The tone has changed markedly on the previous year and is a call to arms, in
our view, with little gratification in exchange.



2010 – The Governor‟s intervention sets low expectations on the perspective of the
Foundations‟ investments in the banks; they are called to sacrifice and to suffer together
with „their‟ banks. Moreover, Foundations are asked to revise their governance on top of
putting further capital at the banks‟ disposal „without flinching‟. The Governor does not
envisage a good ROI but effectively warns that the alternative is the nationalisation of the
banks, recalling the poor luck of the country with state-owned banks.



2011 – The Governor anticipates that the EBA test will hit Italian banks on their sovereign
bond exposure and warns about further rights issues coming up. He once again exerts his
pressure on Foundations to keep on underwriting the inevitable capital increases.

...and to take a more painful role than what institutional investors are asked to do
The above confirm the mounting pressure the former Governor of the Bank of Italy put on
Foundation‟s management regarding the responsibility as strategic shareholders in Italian banks. His
messages implied Foundations must put the health of the banks, of the banking sector, and the
country‟s economy before their interest (ROI, diversification, etc). This principle, applied to
today‟s situation could imply the risk of dilution of Foundations‟ stakes into the potential coming
rights issues from minor banks and their investment repositioning outside of the banking sector, in
our view.

05 February 2014 ◆ 22

Table 1 – Extracts on Foundations from Governor Draghi’s speeches at the World Savings Day
Date

Role

Rec c omendation

Oct-07 no mention

no mention

Oct-08 Large shareholders but with diversified portfolios

"As shareholders in banks, the Foundations are called upon to show dynamism and
foresight in performing their role. They have the chance to accompany I taly‟s
banks on their journey of growth, providing them, as before, with firm roots in
the variegated local realities of the country."

Oct-09 - "The Foundations have been an anchor for I talian banks.

Foundations need "to continue to accompany the strengthening of capital and

They have accompanied them through the worst storms of the

reserves and to persevere in the role of shareholders who are present but do not

financial crisis, strengthening their capital and reserves; they are

interfere with management, which has been the basis of their success in recent

supporting them now in the weak recovery that is projected. Many

years. The Bank of I taly hopes that the Foundations will continue to demonstrate

have accepted sacrifices in the short term, thus contributing to the the same farsightedness that kept them tied to their traditional strategic values
soundness of the system, the ability of banks to supply credit to the

at the height of the crisis, and that they will be able to take the long view and

economy, and the enhancement of their own investment in the long

contribute to the development of a sound banking system ready to face the

term."

challenges of international competition."

- Foundations have gone beyond the function of institutional
investors and maintained a long-term view.
- "Following the important mergers of two years ago, the I talian
banking system needs stability to meet the management and
strategic challenges that exiting the crisis will pose."
Oct-10 "The I talian experience of banking foundations is positive [...] for

"Just as the future promises to be challenging for banks, it will be challenging for

the role they have played as stable, solid shareholders in banks; a

their largest shareholders as well. The foundations will have to act on three key

role filled in other countries by institutional investors, which are

fronts: their own governance, the recapitalization of banks and self-discipline in

rare in I taly. During the crisis, the foundations‟ long-term view of

their relationship with banks‟ managements. For the action of banks‟ control

banks‟ prospects and their roots in the territory – factors driving

bodies to be adequate, it is necessary that the

development at local, regional and national level – were crucial. When boards of their main shareholders, which help to elect them, be equally adequate.
other shareholders, such as investment funds, until the eve of the

For the reasons described earlier, they will be asked to make a significant effort

crisis so vociferous in demanding efficiency gains and changes of

to strengthen banks‟ capital, an effort to be faced without flinching. The

management, vanished, often for good, it was the foundations that

foundations must continue to take a long view; they must understand that they

subscribed for the repeated capital increases that made it possible

cannot sacrifice the prospects of their banks and the economies they serve to

to weather the storm unscathed."

the desire for immediate monetary returns, which, besides, are now harder to
obtain. The I talian experience of public banks is vivid in our memory. Certain
relationships between local economic groups, public banks and politics ultimately
proved disastrous for the banks and deleterious for civic mores; in more than one
case, local development was hindered rather than helped. With great, conscious

Oct-11 "At European level, the largest banks are expected to equip

"We are fully confident that, as in the past, the banking foundations will shoulder

themselves with adequate buffers of high-quality capital by the

their share of responsibility. I f necessary, adequate backstops will be identified

middle of next year. The amount is determined for each bank taking

and put into operation in a timely manner."

its exposure to sovereign risk into account. The request for
temporarily higher capital ratios is necessary in order to address
investors‟ current worries, with benefits for banks‟ funding on the
wholesale markets. Our banks are up to this new challenge."

Source: Mediobanca Securities, Bank of Italy

05 February 2014 ◆ 23


CoCo: transit to portfolio diversification
The CoCo market is developing as regulatory frameworks for banks are stabilising and investors
are hungry for yield. The removal of the fiscal asymmetry in Italy should open the market for
Italian banks too. We see CoCos as the tool to bridge Foundations to portfolio diversification
from their current concentration into bank equity stakes. In fact, swapping Foundations’ equity
stakes into CoCos would: 1) boost the cash flow generation and the visibility of the investment
yield for Foundations; 2) solve the governance anomaly of the current Bank-Foundations model;
3) while having a neutral impact to banks’ regulatory capital ratios. Foundations would not
abandon banks in a difficult moment, but could plan the future portfolio diversification over
time and with higher investment yield visibility.

Matching bank capital needs with investors yield hunger...
The contingent capital (CoCo) market is developing
The issue of the new form of bail-inable Tier 1 and Tier 2 CoCos has gathered pace since the last
summer, as banks have tested the Basel III compliant Additional Tier 1 (AT1) capital market and
also boosted Basel III compliant Tier 2 capital. This has been driven by local leverage rules (UK and
Switzerland) and in some cases, consideration of the proposed EU bank bail-in rules. Table 2 lists all
CoCo issuance to date. We have taken note of $11bn issuance of AT1 in 2013. The most recent issue
is CS $2.25bn CoCo.
And significant further issuance is expected
The volume of issuance is likely to increase quite markedly this year. A recent presentation by
HSBC‟s Treasurer said the bank would issue US$15bn to US$20bn of AT1 capital in the years to come
and CoCo bonds are now part of the capital landscape. In addition, Deutsche Bank has stated that it
will issue €5bn of AT1 by 2015. The large Swiss banks, which have already been very active this year
in issuing AT1 and Tier 2 CoCos, will also be more active in 2014 as they seek to get to their 2019
leverage target of 4.2% early.
The Italian fiscal anomaly has been removed
We do not find Italian names among the issuers of CoCos thus far. This is because until December,
CoCos did not benefit from tax deductibility of interest. This has now been amended and we expect
banks will consider this as an alternative instrument to a rights issue to boost capital ratios without
diluting share count.
Attractive risk/reward for yield seekers
This new asset class of CoCos has a clearly defined risk profile, providing exposure to bank debt
while embedding equity tail risk. The market is set to become much more liquid, in our view. In
addition, the regulators are moving Core tier 1 ratios up to levels above the individual bank‟s Basel
III minimums with the use of Pillar 2 and counter-cyclical buffers. This suggests that breaching the
triggers of between 5% and 7% will take another major market hiatus. This makes these bail-in
bonds attractive for those seeking yield and offer an attractive risk/reward profile for investors
looking for credit risk exposure.
The instrument for levered banks with depressed profitability and valuation
For the fifth consecutive year we are living in an environment of record low interest rates coupled
with more and more demanding regulatory hurdles. For banks with depressed profitability and
valuation, this can represent an important value trap as meeting the regulatory demands via rights
issue at deep discount to BV can imply a large drag to valuation. CoCos can provide a bridge for
banks running on cyclically low profitability to meet regulatory constraints today without diluting
share count. These instruments effectively allow levered banks to build up capital over time.

05 February 2014 ◆ 24


Table 2 – AT1 CoCo issuance monitor
Issue Date

Bank

Type Currency Amount (m) Amount (US$m)

09/11/2011

Rabobank

AT1

09/05/2013

BBVA

04/09/2013

Credit Suisse

06/09/2013

Last Price

CT1 Trigger

Coupon

Maturity

Description

Options

110.705

8.0%

8.400%

Perpetual

Capital Type Coco Tier 1

Call Option 6-YR

USD

2,000

2,000

AT1

USD

1,500

1,500

107.5

5.125%

9.000%

Perpetual

Capital Type Coco Tier 1

AT1

CHF

290

322

104.402

5.125%

6.000%

Perpetual

Subordinated Hybrid Tier 1

Société Générale

AT1

USD

1,250

1,250

108.125

5.125%

8.250%

Perpetual

10/10/2013

Banco Popular

AT1

EUR

500

683

112.014

5.125%

11.500%

20/11/2013

Barclays

AT1

USD

2,000

2,000

104.5

7.0%

8.250%

10/12/2013

Barclays

AT1

EUR

1,000

1,366

104.326

7.0%

11/12/2013

Credit Suisse

AT1

USD

2,250

2,250

106.625

5.125%

Total

AT1

11,371

Fitch S&P
BBB

NR

Call Option 5-YR

BB-

NR

Call Option 5-YR

BB+

NR


Call Option 5-YR

BB

BB+

Perpetual


Call Option 5-YR

NR

NR

Perpetual

Basel III Tier 1 Cocos

Call Option 5-YR

BB+

B+

8.000%

Perpetual


Call Option 5-YR

BB+

B+

7.500%

Perpetual


Call Option 5-YR

BB+

BB-

8.328%

Perpetual

Source: Mediobanca Securities

05 February 2014 ◆ 25


...fitting the new Foundations-banks needs
Portfolio diversification remains the final objective...
In Re-Foundation, 28 May 2012, we concluded that the lack of portfolio diversification of
Foundations, excessively concentrated on holding equity stakes in the banks of reference, could put
their financial sustainability in jeopardy. As solution to the problem, we proposed to implement
investment portfolio diversification to provide the stable, superior returns to allow Foundations to
plan their long-term grant making activities with more comfort instead of having to cutting them.
...but a transitory period may be needed...
Given the low net cashflow generation of current investment, implementing portfolio diversification
would entail actively selling bank shares to buy other securities. We understand the reluctance of
doing so while these companies are still in the midst of a serious crisis, both in the hope of
extracting more value in the future, and with the sense of responsibility of not abandoning the ship
while it is navigating in difficult waters. We therefore look for a transitory phase which could
provide Foundations with their primary need of yield, without depriving banks of their support.
...which could be embodied by a dedicated CoCo for equity swap...
We believe a swap of Foundations stakes into banks into a CoCo could satisfy the governance reform
needs of the Foundation-banks liaison while:
1.
2.
3.

giving Foundations the time to transition towards portfolio diversification
allowing Foundations to enjoying higher and more stable and visible yield
supporting banks out of the current regulatory and macroeconomic woods.

...immediately ticking the governance and yield stabilisation needs
The CoCo/Buyback operation would not solve all issues at once (diversification, higher yield,
income stability/predictability), but it would provide an immediate solution to:
a)

the governance issues;

b)

the lack of investment yield and visibility Foundations have been suffering from for several
years.

Would minority shareholders rights be stepped over?
We would not see a problem of shareholders rights to the Foundations stakes‟ swaps into CoCos.
The next chapter shows how the operation would be beneficial to minority shareholders but anyhow
we have seen similar operations which have been dedicated to single shareholders (POP and SAB
recent rights issues). Even with Foundations there is a precedent. The emergency rights issue of
UCG in 2010 through the issuance of €3bn CASHES was subscribed by Foundations and by the Libyan
investor. In hindsight this has been a very favourable operation for minority shareholders.

05 February 2014 ◆ 26

Buyback neutral to capital ratios
We simulate the implication of a conversion of Foundations’ equity stakes into CoCos at par for
UCG and ISP. This operation, neutral to capital ratios, results in 14-30% EPS upgrade as the
increased interest expenses of the CoCos are more than compensated by the amount of share
buyback due to the current below-BV valuation of both banks. As a result, RoTE expands 2-5
p.p. and yield by 1 p.p.. This would imply a win-win-win scenario for: Foundations (certainty of
yield), banks (governance, profitability), minority shareholders (profitability, yield), while it is
neutral to the government’s too big to fail risk. We calculate CoCos would generate a 3% annual
investment yield premium vs the current ATM covered call alternative, securing a higher
visibility and sustainability of the Foundations’ grant making activity. Had Foundations held
CoCos instead of bank equity over the last 12 years, they would have cashed in €22bn extra
profits after costs and grants (over 50% boost to the current total capital), implying they could
have made 140% more grants over the same period. At the same time, we see the post
Buyback/CoCo operation leaving ISP and UCG with TE/TA well above retail peers, hence at no
compromise to the risk profile of the banks.
8.3% coupon for UCG and ISP
Our analysis of the AT1 CoCo issuance outstanding implies that for the rating of UCG and ISP, a
coupon of 8.3% should suffice to satisfy the market‟s demand (see Table 2).
28% of ISP and 11% of UCG at stake
Table 3 summarises the stake of ordinary shares owned by Foundations in ISP and UCG. We identify
25 Foundations hold shares in ISP for 28% cumulative stake and 11 in UCG for 11% ordinary shares.
Table 3 – summary of Foundations stakes (% of ordinary shares) in ISP and UCG
ISP
Compagnia di San Paolo
Fondazione Cariplo
Fondazione C.R. Padova e Rovigo
Ente C.R. Firenze
Fondazione C.R. in Bologna
Fondazione Cariparma
Fondazione C.R. di Udine e Pordenone
Fondazione di Venezia
Fondazione CR di Ascoli Piceno
Fondazione C.R.di Gorizia
Fondazione C.R.di Pistoia e Pescia
Fondazione C.R. di Forlì
Fondazione CR Della Spezia
Fondazione CR Pisa
Fondazione CR Cuneo
Fondazione CR Carpi
Fondazione C.R. Lucca
Fondazione CR Livorno
Fondazione VarroneC.R. Rieti
Fondazione C.R. Carrara
Fondazione Banca Nazionale delle Comunicazioni
Fondazione CR Città di Castello
Fondazione CR Bolzano
Fondazione CR Terni e Narni
Fondazione CR Fano
Fondazione Cassa di Risparmio di Verona, Vicenza e Belluno
Carimonte Holding Spa
Fondazione Cassa di Risparmio di Torino

UCG

9.71%
4.95%
4.51%
3.32%
2.02%
0.71%
0.50%
0.45%
0.35%
0.31%
0.31%
0.26%
0.25%
0.07%
0.07%
0.06%
0.05%
0.04%
0.04%
0.02%
0.02%
0.01%
0.00%
0.00%
0.00%
3.53%
3.00%
2.51%

05 February 2014 ◆ 27

Cont
Fondazione Cassa di Risparmio di Modena
Fondazione Manodori
Fondazione Cassa di Risparmio di Perugia
Fondazione Cassa di Risparmio di Trieste
Fondazione Banco di Sicilia
Fondazione del Monte di Bologna e Ravenna
Fondazione Cassa di Risparmio di Pisa
Fondazione Cassa di Risparmio di Lucca

ISP

UCG
0.65%
0.48%
0.36%
0.34%
0.12%
0.03%
0.02%
0.01%


An unprecedented buyback...
In Table 4 we simulate the conversion of Foundations‟ stakes in ISP and UCG into CoCos as the
combination of:
1.

The buyback of the equity stakes owned by Foundations

2.

And the issuance of CoCos matching the capital bought back

This implies 28% equity buyback at ISP and 9% at UCG, corresponding to €14bn and €5.8bn
simultaneous buyback/CoCo issuance, respectively.
Table 4 – ISP and UCG CoCo for equity swap
ISP
Current Foundations holding
BV 2013e
Core capital 2013e
Buyback/Coco
Buyback/CoCo
Coupon
New NII
Post-tax impact
...as % of 2015e adj. profits
Old share count
New share count
EPS impact
Old 2015e adj. profits
New 2015e adj. profits
Old 2015e EPS
New 2015e EPS
EPS change %
TE vs RoTE impact
Goodwill+intangibles
TE post CoCo
TEPS post CoCo
2015e RoTE post CoCo
2015e RoTE pre CoCo
Yield impact
2015e payout ratio
Old 2015e DPS ord.
New 2015e DPS ord.
DPS change %
Old div. yield
New div. yield

UCG

28%
49,289
32,102

9%
62,588
21,516

13,820
8.33%
-1,151
-737
-18%
16,434
11,826

6,885
8.33%
-573
-367
-10%
5,789
5,153

4,034
3,297
0.25
0.28
14%

3,857
3,490
0.52
0.68
30%

14,822
20,647
1.75
16%
11%

15,971
39,732
7.71
9%
7%

44%
0.10
0.12
23%
5.2%
6.4%

40%
0.23
0.27
19%
3.9%
4.6%


05 February 2014 ◆ 28

...costing 10-18% of 2015e adj. profits, but boosting EPS by 14-30%
We foresee an extra interest income cost of €1.1bn at ISP and €0.5bn at UCG by applying a coupon
of 8.3%, taking 2015e profits to €3.3bn at ISP (from €4.0bn) and to €3.5bn at UCG (from €3.9bn). At
the same time, share count should fall to 12bn at ISP (from 16.4bn)and 5.1bn at UCG (from 5.8bn).
The result should be an EPS upgrade of 14% at ISP and 30% at UCG, reflecting the buyback at more
discounted price at UCG (0.7x 2014e TE) vs ISP (0.9x 2014e TE) and implying a more than
proportionate cancellation of shares compared to the absolute loss in profits.
RoTE up 2-5 p.p. ...
We calculate that the buyback would imply new TEPS of €1.8 at ISP and €7.8 at UCG. Consequently,
2015e adj. RoTE should go to 16% and 9% at ISP and UCG from 11% and 7%, respectively, reflecting
the beneficial gearing effect to returns.
...and yield up c.1 p.p.
We simulate what dividend yield would do, were ISP and UCG to keep the payout ratio stable. We
calculate that DPS could rise by c.20%, for c.1 p.p. higher yield in the 5-6% region.

A deal ticking all the boxes
Despite the magnitude, we believe that the operation would be a positive evolution for all
stakeholders involved:


Foundations would gain higher and more visible cash investment yield;



Banks would confirm their capital ratios while gaining EPS upgrades, dividend yield and
governance;



Minority shareholders would gain EPS and DPS upgrades and better governance;



The regulator and the government would not compromise on the too big to fail risk of the
bank, while accommodating the suggestions of the IMF.

Banks: levering up, without compromising on the risk profile
The Buyback/CoCo operation implies a significant gearing up of ISP and UCG balance sheets. shows
the comparison of the CASA, CA Group, Natixis, BPCE Group, and ISP and UCG leverage (TE/TA) and
regulatory capital ratios (T1) before and after the Buyback/CoCo operation. We selected the two
French peers as benchmark given their peculiar position on regulatory capital which bases on the
implied guarantee from the mother companies (CA Group for CASA and BPCE Group for Natixis) in
case of capital need. In fact, the French regulator validated the fairly geared business models of
the listed entities (CASA and Natixis) – 1.4% and 2.8% tangible equity/tangible assets ratio (TE/TA),
respectively – given the solid capital base of their controlling shareholders who would stand behind
their subsidiaries in case of trouble. We note that the post Buyback/CoCo ISP and UCG would still
land at leverage and regulatory capital ratios well above the ones of CASA (1.4%) and Natixis (2.8%)
and in line with the one of the safer delisted retail groups, CA Group (3.2%) and BPCE Group (4.3%).
This implies to us that the operation should be acceptable from a regulatory standpoint.

05 February 2014 ◆ 29

Chart 12 – TE/TA vs T1 ratio comparison
6%

TE/TA (lhs)

14%

T1 ratio (rhs)

12%

5%

10%

4%

8%
3%

6%
2%

4%

1%

2%

0%

0%
CASA

CA
Group

KN

BPCE ISP CoCo
Group

ISP

UCG
CoCo

UCG


Foundations: annual investment yield 3% above the ATM call, accretive from year 2
Swapping an equity stake for a CoCo in essence implies swapping the opportunity of cashing in the
volatile premium on the sale of a call option on the stake for the certainty of cashing in the high
CoCo coupon. Chart 13 shows the annual yield from selling at the money (ATM) calls on ISP and UCG
vs the yield of the CoCo we simulated. Only in the first year the current conditions would provide
the seller of the ATM call a return above the one of the CoCo. From year 2 onwards, the CoCo
would generate excess returns vs the covered call sale. Over a 10 year period, we calculate an 3%
annual premium in favour of the CoCo, implying a structurally higher sustainability of cash flow.
Clearly this scenario does not keep into account the potential equity upside on share price that the
stake would provide vs the CoCo, likewise, it does not account for the potential downside the
equity exposure could give.
Chart 13 – ATM call vs CoCo annual yield
12%
ISP

UCG

CoCo

annual yield

10%
8%
6%

4%
2%
0%
1

2

3

4

5
year

6

7

8

9

10

Source: Mediobanca Securities, Bloomberg

Simulation: CoCos core profits above reported ones in the last 12 years...
Chart 14 shows the evolution of Foundations‟ core profits and grants approved in the 2001-12
period, contrasted with the simulation of what hypothetical core profits would have been had
investments delivered a return in line with the CoCo coupon, maintaining costs and tax rate in line
with reported results. We calculate that:

05 February 2014 ◆ 30




Core profits with CoCos would have always largely exceeded grants approved;



Core profits with CoCos would have always exceeded reported core profits.

The above imply that:
1.

Foundations generated €16.2bn cumulative core profits over the period 2001-12 vis-à-vis
€15.5bn grants, implying no net reserves have been built over a twelve year period;

2.

the hypothetical financial sustainability of Foundations would have been superior to the
actual one as Foundations would have accumulated a buffer of capital vis-à-vis the same
grants made.

Chart 14 – Core profits (CoCo and reported) vs grants approved
Eur m
4,000

Core profits

Grants approved (€ m)

Core profit CoCo

3,500

3,000
2,500

2,000
1,500
1,000
500
-

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012


...for €22bn extra profits or 140% more grants
Chart 15 shows the core profits – grants approved under the reported and the CoCo scenario for the
2001-12 period. We calculate CoCos-like returns would have generated €22bn extra profits,
implying:
1.

A potential boost to the aggregate Foundations‟ capital of over 50%;

2.

A 140% boost to the cumulative 2001-12 approved grant pool of €15.5bn.

Chart 15 – Core profits – grants approved (reported vs CoCo simulation)
2,500
2,000

1,500
1,000
500

CoCo

-500

Status quo
-1,000
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

05 February 2014 ◆ 31

Appendix
Mediobanca Performance Indicator
When making investments, Foundations keep into consideration three factors: 1) capital
preservation (risk); 2) cash flow generation (yield) to finance annual grants and cover the
structure‟s expenses; 3) pure investment return (capital appreciation). To grasp a synthetic
indicator of investment performance we created the MB performance indicator similar to a total
return calculation but creating a level playing field on performance calculation which adjusts for
the asymmetric generosity in grant making. We defined it as:

Where the return in any given year is the ratio between: a) the sum of the net cash flows generated
by investments (dividends, interest and trading results minus the costs of the Foundation) and the
capital appreciation of investments, and b) the sum of the market value at the end of the previous
year plus the grants made in the previous year. This way we keep into consideration:


Yield maximisers, traders and diversified portfolios: core revenues incorporate all
aspects of the different investment types, so that we avoid favouring one model over the
other (e.g., internal investment office vs externally managed diversified portfolio /
concentrated portfolio of stakes vs diversified portfolio / yield maximising portfolio vs
capital appreciation investments).



Efficiency: we deduct core costs (employee salaries, BoD remuneration, consulting
expenses, G&A, amortisation) to capture the benefit of lean and efficient structures vs
more cost-intensive ones (e.g., an internal investment office could have higher costs and
higher revenues as these could exclude investment fees which would instead be
consolidated as negative revenues for investments in externally managed funds).



Asymmetric grant generosity: we add back to the denominator the grants made in the
previous year to create a level playing field between Foundations more generous on their
grant making policy and those which adopt more conservative concessions of grants.

05 February 2014 ◆ 32

Italian banking-foundations-2014-02-05-1

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