European banks (1): Afternoon mega-merger

The consolidation process that has been reshaping the Italian banking system for the last three years reached a climax on March 21, when four of the five top banks in the country announced their intentions to merge following hectic negotiations.

This is after a winter when the Italian banking sector appeared paralyzed by the exclusive merger talks between Banca di Roma and Banca Commerciale Italiana (BCI).

After three weeks of intense rumours, Unicredito Italiano proposed to BCI (they are respectively the third and the fifth largest bank in Italy) that they should swap their shares.

Just a few hours later, the directors of Sanpaolo-IMI, Italy's largest group, announced a similar operation to merge with Banca di Roma.

The alliance between BCI and Unicredito - to be named Eurobanca - will be Europe's sixth largest bank in terms of total revenues with €10.3 billion ($11.4 billion) and the continent's seventh largest in terms of market capitalization at €39 billion. The exchange ratio would be five shares of BCI to every eight of Unicredito's.

The deal is effectively a takeover of BCI by Unicredito Italiano, whose shareholders will have 63% of the new bank's capital. "That leaves no doubt who will be in charge," says Luca Comi, analyst at Monte dei Paschi Mercato. The merger combines Unicredito's strong position in retail with BCI's corporate finance expertise and international presence.

With 40% of its assets outside Italy, BCI is the most international of Italian banks. It has particularly focused on eastern Europe and South America: it owns the Brazilian bank Sudameris and the Central European Investment Bank in Hungary.

The merger plan is quite ambitious. Eurobanca plans to increase its return on equity from 13% (the average for Unicredito and BCI) to 23% by 2002. To achieve that, the cost-to-income ratio must fall to 46% from 63%. Centralization of asset management, money markets and capital markets, along with information technology and back-office functions are the other main points of the proposal. Staff will be reduced by 3,700.

The merger probably spells the end of 92-year-old Enrico Cuccia's domination of the Italian financial world. Cuccia has been at the helm of Mediobanca, the secretive investment bank, for the last 50 years. Throughout the winter Mediobanca had been trying to merge BCI and Banca di Roma. Mediobanca now fears being taken over itself and needs a big shareholder. BCI, Banca di Roma and Unicredito are its main shareholders each with an 8% stake. An alliance between BCI and Banca di Roma would have refreshed Mediobanca's position in Italian finance. But the merger between Unicredito and BCI may give Alessandro Profumo, Unicredito's chief executive officer, the strength to break the Cuccia spell.

Deutsche Bank, with 4.5% of BCI and 0.75% of Unicredito may welcome the merger. It was Rolf Breuer, Deutsche's chairman, who first postulated the idea at the beginning of February. But Germany's Allianz a core shareholder of Unicredito with the 3%, and Italy's Generali with 4.9 % of BCI could cause a problem. The two companies are fierce competitors in both the German and Italian insurance markets and cohabitation in the same bank is difficult to imagine. It seems that Generali is the new bank's preferred partner. On March 4 Profumo admitted that while the relationship with the German insurance company is excellent, nothing is untouchable.

The BCI integration would be the latest step in an impressive strategy of growth that Credito Italiano, one of the oldest Italian banks, started just after its privatization in 1993. In 1995 it bought Rolo Banca, a rich regional bank which is already showing a return on equity of 21%. The growth continued last year when Credito Italiano merged with three large northern saving banks - Cassa di Risparmio di Verona, Banca CRT di Torino and CassaMarca di Treviso - to create Unicredito Italiano, the third largest banking group in the country.

Now comes the big leap forward with the BCI merger. "It won't be easy," explains Comi. "BCI is a great bank with its own culture and its own story. Its integration will be much more difficult than the previous ones, which involved normal regional saving banks."

But Unicredito's growth plans do not stop at BCI. The group knows it needs to grow abroad to be competitive in Europe and is looking east. "We do not think there are great expansion opportunities in euroland for us," says Roberto Nicastro, Unicredito's strategy director. "On the contrary, central and eastern European countries have less competition and better opportunities. There, the GDP growth ratio is around 5% a year and banks' revenues-growth often exceeds 10%, allowing well-run banks to achieve very satisfactory risk-adjusted returns. We are particularly interested in those countries such as Poland, the Czech Republic and Hungary that have already embraced serious reform or those that are giving encouraging signs such as Slovakia. But Russia is still far behind and at the moment we are not yet interested." Poland is the first target.

Unicredito and its German shareholder Allianz have jointly bid to buy the 55% of Bank Pekao, the second largest banking group in the country, due to be privatized before July. Unicredito faces stiff competition from Citibank but Nicastro is convinced that being an Italian group might bring particular advantages. "First, Poland is bound to join euroland in the next decade and an Italian group knows very well how to cope with the convergence towards the Maastricht criteria," he points out. "Second, Poland is an economy driven by small and medium-size companies exactly the same as Italy. Lastly, Italy is already Poland's second largest trade partner."

Unicredito would be "the only bank in Europe to be among the top three banks in two different large European countries" claims Nicastro. But after Sunday's announcements the competition is going to become increasingly tough for Unicredito just within its own domestic borders. The Sanpaolo-IMI offer to ally with Banca di Roma will create Italy's first bank with countrywide coverage from 2,400 branches.

The merger has geographical synergy, combining IMI, an investment bank, with Sanpaolo, a large retail bank in the north of the country. Banca di Roma is the leading retail bank in the central and southern regions.