For decades, the Institute for Religious Works embarrassed the Vatican with a legion of alleged sins––rampant money-laundering, thwarting Italian authorities by concealing the identity of its depositors, and an arrogance that might be best expressed by the phrase, “God’s bankers do their own thing. The rest of the banking world can do theirs.” Even bank offices in a medieval prison tower commissioned by Pope Sixtus V deepened the dark legend.
But since early 2013, the IOR, informally called the Vatican Bank, has modernized its operations and rescued its reputation. Today, the IOR is tightly regulated by the Vatican’s SEC, the Department of Financial Intelligence. It regularly exchanges tax and other information on its depositors with the Italian government. It publishes richly detailed annual reports, which are audited by Deloitte.
Now, IOR’s president, Jean-Baptiste de Franssu, wants to transform the bank’s business model. Appointed last July, de Franssu is the IOR’s second professional leader, and the former European chief of Invesco, the $800 billion-plus mutual fund colossus based in Atlanta.
For de Franssu, the IOR of the future should progress from chiefly handling deposits to his specialty, managing money. As a fund manager, he says, the IOR would deliver a bigger, more reliable stream of income to his boss, Pope Francis. It’s a daring idea. The IOR’s problems with making good money, and making it consistently, suggest that asset management may very well be the righteous path.
The IOR published its 2014 annual report on May 25, and the numbers illustrate its challenge. The Vatican Bank’s income is crucial to the Catholic Church’s financial health. Its profits go directly to support the budget of the Holy See, the branch that comprises the congregations, councils, and media organs that spread the Pope’s message to the world’s 1.2 billion Catholics. This year, the Bank will contribute $62 million to the Holy See, accounting for one-quarter of its $235 million budget.
Most years, the Holy See operates on the edge, running small surpluses or, more frequently, large deficits. When funds from the Bank and investments dwindled, past Pontiffs have been forced to use donations intended for charity, including the “Peter’s Pence” collected on a Sunday in the spring from parishioners around the world, to cover operating expenses. Pope Francis doesn’t want that to happen again. He’s effectively ordering the IOR to ensure that its cash flows are both big and reliable.
Today, the IOR’s model fails to consistently meet that standard. Its biggest regular source of revenue is the “spread income” between what it pays depositors and the interest it receives on the securities that back those deposits, mainly short-term government and corporate bonds. The IOR does not make loans. Traditionally, it has handled accounts for Vatican employees and religious orders and, served religious orders transferring funds to missionaries in remote parts of the globe to fund schools and construct churches.
Because interest rates are so low, the IOR’s spread income is modest, and shrinking. Last year, it totaled $57 million, down from $60 million in 2013. The IOR did manage to post earnings of $77 million for 2014, but that was only because it generated a huge windfall when declining rates boosted the value of its bond portfolio. In 2013, rising rates delivered the opposite effect: they saddled the IOR with a steep loss on those fixed-income holdings. That lowered its profits to just $3.2 million. So it was obligated to raid its capital to pay a $62 million dividend to the Pope.
Here’s the rub: If the value of the IOR’s bonds had remained flat in 2014, it would have earned just $37 million, far below the dividend of over $60 million and rising that it effectively promises the Holy See.
De Franssu wants to smooth those peaks and valleys. In his annual letter, he endorsed a strategy “that will allow the IOR to sustain and grow its annual contribution to the Holy See,” adding that the key lever is expanding the institution’s asset management franchise.
In reality, managing portfolios for clients is already a big business for the IOR. Since 2008, deposits have shrunk from $3.6 billion to $2.4 billion, while assets under management and custody for clients have expanded by 40%, to $3.8 billion. The IOR invests most of those funds for religious orders, a category that includes the Franciscans, Jesuits, and Carmelite Sisters. A smaller portion comes from dioceses around the globe and the offices of the Holy See. The IOR is clearly following its customers, who want to park funds in relatively high-paying portfolios as opposed to IOR bank accounts that pay 0.4%.
Despite its sizable scale and rapid growth, asset management doesn’t make much money. The IOR manages those portfolios exclusively in-house, remarkably deploying a staff of no more than 15. None of the portfolios is outsourced, and the IOR staff appears to pick the securities. As stated in the annual report, “Investment decisions are taken by the IOR on the basis of a portfolio management agreement signed by customers.”
Those agreements have produced less than stellar results. For 2014, asset management and custody services—essentially holding, but not choosing, securities for customers—generated $16.6 million in revenue. That’s around 0.4% of the $3.8 billion in customer assets, a fee that’s typical for a large index fund, but far below the figure of well over 1% for most actively managed portfolios.
It’s uncertain if de Franssu plans to raise those modest fees. Even if they do rise a bit, he’ll have to attract many additional billions in funds to give the IOR steady income of well over $60 million, year after year. De Franssu clearly perceives that religious orders and dioceses have many billions sitting in local banks or parked with asset managers. The view is that they’d like nothing more than to hand those funds over to a super-competent manager with the Vatican’s imprimatur.
Outside the IOR, the Vatican views asset management as a big potential moneymaker. Last July, Pope Francis appointed the tough-talking Cardinal George Pell of Sydney, Australia, as head of the newly created Secretariat of the Economy, a supremely powerful organization overseeing all of the Vatican’s financial branches, including the IOR. At his first press conference, Pell announced his plans to form Vatican Asset Management, or VAM, a centralized investment office that would manage all of the Vatican’s capital, and hopefully, billions of euros, pesos, and dollars flowing in from dioceses and religious orders. The idea was for the IOR, under professional asset manager de Franssu, to incubate VAM, then decide if the organization should remain part of the IOR or become independent.
As it turned out, Pell is getting stiff resistance to the VAM concept from the Vatican’s traditional money managers. They mainly work for an organization called APSA, which oversees the Vatican’s investment portfolio of less than $1 billion and has been entrenched for decades. So far, the VAM idea hasn’t advanced. So the leading pioneers in asset management are de Franssu and the IOR. He’s showing that a once tradition-bound, formerly scandal-plagued institution can learn a new trade. You can be sure that Pope Francis, who covets cash for charity, not for bureaucracy, is granting that strategy his special benediction.