Banca Popolare di Milano's rights issue and the problem of listed cooperative banks in Italy

Last August 25th^th The Board of Directors of Banca Popolare di Milano (BPM), an Italian listed cooperative bank, has resolved to conduct the rights issue approved by BPM’s shareholders at the general meeting held in June. Maximum amount of the deal: 1.2 billion Euros, versus a current market capitalisation of 682 million (closing at 29 September^thOn 27 September^th, the Board of Directors resolved to reduce the issuance to 800 million Euros. In any case, BPM's share capital will be more than doubled in the next couple of months.

BPM’s recapitalisation will increase the Tier 1 ratio to 8.7% (but according to Mr Andrew Sentance, a former external member of the Monetary Policy Committee at the Bank of England, a corresponding reduction in assets classified as non-performing would raise the ratio to 13.9%, which is much higher than that of all its immediate competitors*) and will enable the bank to negotiate better loan terms (which, in the first six months of 2011, were a major factor in the 39% fall in net profit).

Many considerations might be made about the real needs of such a huge deal for BPM’s shareholders, but what is relevant here is how such a huge deal has been approved by shareholders and, consequently, the implication of the cooperative nature of the bank.

Italian cooperative listed banks follow specific regulations, particularly concerning corporate governance. Shareholders are divided into “members” (those who purchase newly issued shares and request member status according to the Board's procedures and terms) and “non-member” shareholders. Only member shareholders are permitted to vote at General Meetings, provided they have been members for 90 days prior to the Meeting, either in person or via a proxy granted to another member. Any member may act as a proxy holder, but for a limited number of proxies as established by the bank's Articles of Association (at BPM, the current limit is 3 proxies). Finally, each member has only one vote, irrespective of the number of shares held.

What is the outcome of a similar governance structure? The maximum capital increase of 1.2 bln Euros – more than tripling the current market capitalisation – was approved by 3,840 shareholders (10% of whom were under 18 years of age), representing only 2,02% of shares in issue.

At the same meeting held in June 2011, another item on the agenda concerned increasing the number of proxies that any member may represent at meetings, from the current 3 to 5. Approval of the new limit would have meant potentially greater representation of the share capital required to approve even significant matters (such as a capital increase). Surprisingly, the majority (55%) of the 3,840 voting members (including 395 under-age members) rejected the proposal: shareholders controlling 2% of the share capital will continue to control the voting power. In reality, the possibility of increasing the number of proxies from 3 to 5 is not a real issue (it would merely have been a faint signal of improved governance); what is strange is that the majority of the speeches at the Meeting focused on this issue rather than on the 1.2 billion euro capital increase. And the reason given by those who voted against it was: “an increase in proxies (from 3 to 5) would mean shifting the focus from people to capital”. But isn’t this the very essence of a listed company?

Who pays for such abysmal governance? Of course, BPM’s (like any other cooperative bank’s) shareholder-members. Unfortunately, “the people” do not decide the share price; it is mostly driven by large institutional investors. In fact, investors (even those most oriented towards long-term growth) without any decision-making power at a listed company are likely to view that stock as more speculative than others. Looking at the share prices for six banks listed on the Italian FTSE MIB index, as of August 31^st, the three cooperative banks (BPM, Banco Popolare and UBI Banca) performed worse than the other three (Banca MPS, Intesa San Paolo and Unicredit) last year: -61% on average for the three cooperatives (BPM -58%, Banco Popolare -64% and UBI -62%) compared with -49% for the others (Banca MPS -49%, Intesa -47% and Unicredit -51%). Shareholder-members do not want institutional investors to run the bank, but it is the institutions that determine the price of their investment. Moreover, it is unlikely that the €800 million rights issue will be subscribed to by “ordinary people” alone; institutions will be absolutely essential, with two possible outcomes: either the deal will be a great success and retail ownership will be significantly diluted, or, in the event of a high level of unsubscribed shares, the already low share price will continue to plummet at the sole expense of shareholder-members (most of whom are BPM employees).

The dramatic situation appears to be unrecognised by BPM's shareholder-member associations, which largely represent the bank's employees. They are still fighting to maintain the existing governance structure, in order to retain their political power (and to lose money). Fortunately, the Bank of Italy disagrees with the associations (the most influential of which is, perhaps ironically, named ’Friends of BPM“) and has compelled the bank's Board of Directors to drastically review its governance system: the bank's management must become much more independent from the shareholder-members.

On 27 September^th The Board of Directors, under pressure from the Bank of Italy, has finally agreed on the proposal for a new governance structure, which will be put to a vote by shareholders (likely the same 2% that approved the capital increase) at the next extraordinary general meeting, scheduled for 22 October^And (the notice of meeting has not yet been published): a dualistic system, with a Management Board of 5 members and a Supervisory Board of 17, in which 2 members of the Supervisory Board (responsible for appointing the managers) would be elected from a slate of nominees put forward by institutional investors, provided that the minority slate receives votes from at least 100 shareholder-members or 2% of the share capital (that is to say: either 100 votes or almost 100% of voting members).

What changes? Probably nothing, but the possibility for institutional investors to deal with the “Friends of BPM” to have a couple of managers on the Board.

Short-term results: private equity funds began vying to have their representatives appointed to the Board by offering a guarantee on unsubscribed rights during the capital increase (Investindustrial offered to guarantee 10% of the share capital, Sator offered 200 million euros, the same amount offered by Clessidra); thanks to the changes to the governance system – which reduced the management powers of shareholder-members – and thanks to the private equity funds’ campaign, BPM’s share price rose by more than 19% in four days, proving that the price is determined by institutional investors, not by the “Friends of BPM”.

Long-term results: probably none, but the hope that the Bank of Italy, finally understanding that special rules for listed cooperative banks represent a dramatic distortion of market rules, would push for their definitive elimination.