Intesa-UniCredit merger talk betrays shareholder jitters
* Worried banking foundations fear foreign takeover -sources
* Tie-up would face big antitrust hurdles
* Intesa, UniCredit executives deny merger project
MILAN, Nov 20 (Reuters) - Nervous Italian shareholders are toying with the idea of a tie-up between the country's two biggest banks, Intesa Sanpaolo and UniCredit, to fend off the threat of a foreign takeover, sources close to the situation say.
Despite a flurry of denials by executives at both lenders, the sources say discussions about a possible merger were initiated by banking foundations that are core shareholders in the two banks and are worried about their low market value.
Hit by the euro zone crisis because of their vast holdings of Italian government bonds, the two banks have written down billions of euros on goodwill for past acquisitions, announced sweeping job cuts and closed hundreds of branches.
With Italy in the throes of a recession, their profits have suffered as lenders were forced to set aside increasing amounts of cash to cover for rising bad loans.
In the first nine months of this year, provisions for bad debt at Intesa and UniCredit reached a combined 8.4 billion euros. Problematic corporate loans are expected to keep increasing over the next year and rating agency Moody's said on Monday it was keeping Italy's banking sector on negative outlook because of the rapid asset quality deterioration.
The market capitalisation of UniCredit and Intesa has dived by more than 70 percent since 2007. They are now worth 20 billion euros ($25.4 billion) each.
By comparison, Spain's top two banks Santander and BBVA have a value of 57 billion euros and 33 billion euros, respectively.
A source close to a UniCredit shareholder said the bank's CEO, Federico Ghizzoni, had been sounded out about a tie-up, but rejected it. Ghizzoni has dismissed the idea as "folly", while the chairman of Intesa's supervisory board has denied charging a friendly banker with the task of putting out feelers with the UniCredit chief.
The denials followed a report in influential daily Corriere della Sera which spurred a media frenzy over the issue.
Insiders say that while a merger seems unlikely at least in the short term and would in any case face big antitrust hurdles, the cash-strapped foundations are worried about losing their grip on the banks to the benefit of foreign investors.
That is already partly the case at UniCredit, which is regarded as potentially more vulnerable because of its fragmented shareholder structure.
"The foundations are scared," said a source familiar with the thinking of shareholders at both banks.
After a 7.5 billion euro capital increase earlier this year, UniCredit's three biggest single shareholders are Abu Dhabi's investment vehicle Aabar, the Pamplona fund backed by a Russian billionaire and the government of Libya.
Together, those investors hold around 16 percent of the bank, compared with a combined stake of around 12 percent for the foundations - charitable entities with strong ties with local politicians.
HUNGRY FOR CASH
The foundations have also seen their main source of income - dividends from the banks - reduce drastically or dry up altogether as lenders were forced to build additional capital buffers to better withstand the crisis. UniCredit scrapped its dividend last year, while Intesa paid just 0.05 euros a share.
"The foundations are hungry for cash, and I think their reasoning is that a combination of the two banks would make more profits and reward them more," said Roberto Lotici, a fund manager at Ifigest.
UniCredit is Italy's most internationally oriented bank, with operations in 22 countries, and a strong presence in Germany, Austria and eastern Europe.
It has 160,000 employees and around 4,400 branches in Italy, and is considered a gateway to Italy's financial inner circle because it is the top shareholder in investment bank Mediobanca , which in turn is a key investor in Italy's biggest insurer Generali.
Intesa is the country's biggest retail lender with 5,500 branches and makes 80 percent of its revenues in its home country - compared to less than 50 percent for UniCredit.
Both banks have unveiled sweeping job cuts and are shedding hundreds of branches to bolster their sluggish profitability, which has been hurt by rising bad loans and higher funding costs against a backdrop of falling interest rates.
Analysts and investment bankers say a tie-up between the two banks would force one of them to get rid of its Italian branch network in a depressed market to meet antitrust concerns.
"If Intesa and UniCredit came together, they'd have to sell lots of branches which no one wants to buy right now," said a London-based investment banker.
"The only possible synergy would be cost savings, but that would mean sending thousands of people home," he said.
He and other bankers played down the prospect of a foreign lender snapping up a big Italian bank, saying this ran counter to the recent European trend of deleveraging and reducing exposure to weaker euro-zone countries.
But several sources also said that, should the euro zone crisis subside and appetite for assets in the euro zone's third biggest economy pick up, Italian banks would look cheap.
"If elections next spring produce a stable government in Italy, than I think we could see a return of foreign interest," said another investment banker. ($1 = 0.7871 euros) (Additional reporting By Lisa Jucca and Paola Arosio; Editing by Peter Graff)