After months of intense talks, on March 23, Banca Popolare di Milano (PMI:IM) and Banco Popolare (BP:IM) agreed to merge and to form the third largest bank in Italy by assets (€170bn). The deal comes after a tacit approval by the ECB and is probably only the first step of an anticipated bigger consolidation process.

Industry overview

Almost 10 years after the last big mergers engaged by Italian banks, which gave rise to Intesa Sanpaolo and Unicredit in 2007, a new banking consolidation wave is likely to have started in Italy. The industry suffers from low margins, weak corporate governance, high costs and fragmentation. As a recent study from AT Kearney shows, if with respect to revenues per employee Italian banks are in line with European peers (€219,000 versus €220,000), the picture is very different when it comes to revenues per customer and number of branches. In fact, revenues per customer equal only €32 (pre-tax), vis-à-vis the average €46 of southern Europe and €133 of continental Europe, while branches per 100,000 inhabitants are 59.6 in Italy compared to 38 in France and 15.4 in Germany. These data highlight the presence of an overly extensive network of small branches, characterised by a lower number of employee per branch than the European average.  Given the country’s overbanked financial structure, the severe recession left the banks with a massive stock of non-performing-loans (€360bn), equal to one fifth of GDP. In an attempt to boost reform, in January 2015 the government passed a decree (approved in March by the Italian parliament) requiring the 10 biggest Popolari banks with assets above €8bn to abandon the ancestral “one head one vote” structure and to turn into joint stock companies. Moreover, last February a new common holding company was set up to unify the smaller co-operative banks.

Popolari banks, which account for €750bn of tangible assets overall, range from national lenders to small local lenders, with a major presence in Northern regions.

BPM

Banca Popolare di Mlano, founded in 1865, has 1.4 million clients and 654 branches in Italy’s richest regions, with a strong presence in Lombardy, Piedmont and Lazio. It focuses on commercial banking and it operates in small-cap investment banking and private banking through its subsidiary Banca Akros. Between 2011 and 2015, BPM has undertaken a significant turnaround, achieving in 2015 a €289m net income and reducing provisions for bad loans to €342m. Furthermore, in 2015 outstanding loans and deposits increased respectively by 6.6% and 2.1%, while CET 1 Phase in ratio stands at 11.53%. As for non-performing-loans, they represent 16.3% of total credit towards clients, while coverage ratio stands at 39.6%.

Banco Popolare

Banco Popolare was formed in 2007 from the merger of Banca Popolare di Verona e Novara and Banca Popolare Italiana. With 1,813 branches, Banco Popolare is present in 19 Italian regions out of 20, and it has a significant market share in areas rich of SMEs like Lombardy and Veneto. Banco Popolare operates in:

• Retail and corporate banking
• Consumer credit through Agos Ducato
• Bancassurance through JV Avipop and Popolare Vita
• Wealth management/investment banking with its franchise Banca Aletti.

BP has €120bn of assets and a CET 1 Phase in ratio of 13.2%. In 2015, provisions for bad loans decreased substantially from €3.5bn to €803m and coverage ratio for non-performing-loans declined slightly to 43.7%. Total non-performing-loans are proportionally much more substantial than in BPM and amount to €20.6bn, i.e. 24.2% of total credit. This implies that BP has one of the worst loan portfolios among the country’s biggest banks. Only MPS, the scandals-troubled Tuscan lender, has a higher ratio of NPLs on total credit (34%).

Drivers

The anticipated merger creates Italy’s third-biggest bank behind Intesa Sanpaolo and Unicredit, with around €170bn of assets, 2,500 branches (which give the new entity more than 8% market share on a national basis), more than 25,000 staff and in excess of 4 million of clients. The synergy potential from economies of scale and cost reductions is vast, estimated around €365m a year (fully phased from 2018), of which €290m in cost-synergies, and is considered by many important investors of paramount necessity to improve the current low margin of the industry. Taking into account of taxation and an integration cost of 150% of the synergies, the present value of the synergies totals €1.9bn.

The two banks show an interesting complementarity in their retail branch networks: whereas Banco Popolare is particularly strong in Piedmont, Lombardy and Veneto, Banca Popolare di Milano’s network is mainly concentrated in the metropolitan area of Milan and in Rome. The new entity will have its geographical focus in Northern-Italy, and in particular it will have the largest branch network in Lombardy, the richest region of the country, with 15% market share, and a strong presence in Veneto (12% market share) and Piedmont (9% market share).

As part of the deal Banco Popolare, the weakest of the two in terms of asset quality, will undertake a capital increase of €1bn in order to satisfy one of the conditions set by the ECB to approve the deal. Thanks to this cash call, the combined group will have a CET 1 ratio around 13.6%, a level sufficient to exceed Intesa Sanpaolo, widely considered the most solid large Italian bank.

 

One of the crucial considerations behind this deal has certainly been the not-so-hidden desire to preserve the status-quo of cooperative banks even after the dismantlement of its legal foundations. In particular, the ‘one-head, one-vote’ rule, together with ownership restrictions and limits on proxy voting, has distorted governance for decades and it has allowed minority shareholders to block any unwanted change. Although the necessary legal changes have been discussed for many years, it has always been fiercely opposed by local banking unions and politicians, until those norms were unexpectedly repealed by a decree in January 2015. The looming scenario of big foreign banks sweeping up shares of Popolari banks and then dismantling their structure based on localism and lax governance unleashed an uprising of local lobbies and unions. A constitutional challenge of the law, requests for temporary suspension, the recruitment of local business leaders to construct a friendly and stable shareholder base have all been deployed to resist to the looming effects of the reform.

Consequently, in the merger negotiation between Banco Popolare and Banca Popolare di Milano, the need to preserve occupation and localism have played an important role. In fact, the merged bank will be headquartered both in Milan and in Verona, its chief executive will be BPM’s current CEO, Giuseppe Castagna, while Banco Popolare’s Carlo Fratta Pasini will be serving as chairman. The deal also contains a plan to spin off most of the BPM’s branches in Lombardy into an entity that will remain separate from the main group for three years – a move intended to protect the network of BPM by postponing any redundancy, as requested by union shareholders, and initially opposed by the ECB. On the other hand, the initial request to keep a temporary ownership restriction to 5% has been dropped.

Structure

Thanks to the capital increase, Banco Popolare’s shareholders will receive 54% of the combined bank while BPM investors will take the remaining 46% in a stock-for-stock “merger of equals”.

The two banks still need to present a business plan in the next days, and the deal is also subject to the approval of both lenders’ shareholders, with a EGM vote due to take place by November.

This deal has been anticipated for months, but negotiation between the two banks has been slowed by ECB demands for stronger capital and asset quality, whereas both the banks were initially reluctant to raise more equity. Finally, Banco Popolare had to consent to undertaking a capital increase worth €1bn, which is expected to be completed by the end of October.

For this cash call, which could include the issuing of financial instruments convertible into shares, a pre-underwriting agreement has already been signed by Mediobanca and Bank of America Merrill Lynch, the advisers of Banco Popolare for the whole transaction. Banco Popolare is advised also by Colombo & Associati, while Banca Popolare di Milano is advised by Citi and Lazard. Gatti Pavesi Bianchi (Banco Popolare) and Lombardi Molinari Segni and Studio Marchetti (BPM) are the legal advisors of the transaction.

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To contact the authors:

Giulio Giacomo Coperti         giulio.coperti@studbocconi.it

Emanuele Sessa                  emanuele.sessa@studbocconi.it