Is the Italian banking future based on UniCredit?

BACKGROUND OF ITALY’S FINANCIAL SYSTEM

It is public renowned that Italian banks have significantly higher percentage of NPLs (non-performing loan is a loan that is in default or close to being in default) in comparison to other banks in Europe. The fact of having this high rate of bad credits has led some banks to the brink of default, beginning last year with four small banks – Banca Popolare dell’Etruria, Banca delle Marche, Cassa di Risparmio di Chieti and Cassa di Risparmio di Ferrara – these were later rescued from bankruptcy by the Bail-In decree issued by the Italian government with the use of a Bad Bank that would collect bad credits and sell them.

Following the same trend, Monte dei Paschi di Siena as well suffered from several issues. The oldest surviving bank in the world and the third largest Italian commercial and retail bank by total assets was forced to make a raising capital of €5 billion in order to restructure its internal banking system. Nevertheless, the Italian institution failed to raise capital on a market transaction and is now to be recapitalized by the Italian State.

As the following picture clearly shows, we can see the overall Italian NPL trend across some years which are taken into consideration in the analysis; as a percentage of gross loans, Italy’s non-performing loans have been quite high from 2007 to 2016, with only a slight reduction that occurred last year. This trend is somewhat negatively impressive since the country is well above other Mediterranean nations such as Spain and Portugal, whose banking systems are far from being completely healthy too.

figure 1: Data from Thomson Reuters Datastream, retrieved from <Financial Times>

If many local banks, such as those mentioned so far, are currently facing troubles is dealing with their debts, UniCredit SpA is not following the same trend, because on the first side the bank has an high percentage of NPLs but on the other side UniCredit is trying to recover them. Indeed, in a period in which financial losses are continuing to increase and the number of banks near the default are increasing, UniCredit, the biggest Italian bank for assets, has recently announced a plan to raise its capital for €13 billion. If successful, this would be the biggest capital increase in the Italian stock exchange history as well as one of the largest at European level.

Figure 2: Data from Banca d’Italia, retrieved from <Financial Times>

Similarly to the NPL trend, also Italian banks’ debts constantly grew in almost the same period of time. Indeed, as Figure 2 displays, debt shifted from a relatively low rate in 2008 – with an estimated value of about €20 billion that year – to a very high value – more than €80 billion – in 2016.

TRANSACTION DETAILS

UniCredit started to raise its capital on February 6^th, making available €13 billion of new shares on the market which are offered first to existing shareholders. UniCredit’s shares were “unpacked” in two parts: the UniCredit stock, which is now traded at €12.43, and the trade for right that started at €13.052 for right. While releasing new shares, the bank also offered to investors 13 new ones for each five held. Shares are offered at the price of €8.09 until March 10^th, with a 38% discount on the theoretical ex-rights price (TERP), that is the price of the shares with the right issue attached. This €13 billion raise will almost double the current capitalization, which currently amounts to €16.5 billion.

TRANSACTION RATIONALE

This capital increase in UniCredit’s capital is part of its strategic plan called “Transform 2019” which was presented at the Capital Markets Day in London on December 13^th, 2016. This plan has been set on five well-defined strategic pillars:

• To strengthen and to optimize capital, as well as to align capital ratios with the best in class G-SIFIs;

• To improve the asset quality;

• To transform the operating model, to increase customers focus, whilst simplifying and streamlining products and services to reduce the cost in serving customers;

• To maximize commercial bank value, to capitalize on Retail client relationship potential and the “go to” bank status for Corporate clients in Western Europe, but also to further strengthen the leadership position in Central and Eastern Europe, as well as to enhance cross selling across business lines and countries;

• To adopt a lean but strong steering Group Corporate Center, consistent Group-wide KPIs to drive performance, ensure accountability, leaner support functions and transparent cost allocation.

Figure 3: Data from “Transform 2019” UniCredit strategic plan

UniCredit along with With “Transform 2019”, the Italian financial institution has set targets to strengthen and optimize its capital, as the one concerning its intention to reach in 2019 more than 12,5% Fully Loaded CET1 ratio (The Tier 1 capital ratio is the ratio of a bank’s core equity capital to its total risk-weighted assets). Jean-Pierre Mustier, Chief Executive Officer at UniCredit Spa, has crisscrossed the world in the past two months seeking to cajole investors into buying €13 billion in new shares.

What is the reason of this  €13 billion transaction? In 2004 the bank was one of the most efficient financial institutions in all Europe, reaping prosperity and high profits. However, a negative factor that the bank has been forced to deal with in the last years has been its NPLs, which reached a high percentage, that is about €84.4 billion. Moreover, the bank is currently afflicted by financial losses, as it has recently reported in an official statement claiming that it reached a bigger than-expected €13,44 billion loss in Q4 2016.

Figure 4: Data from Mediobanca, retrieved from <Financial Times>

This capital increase would help UniCredit to eliminate these problems and therefore to restore the bank operating efficiency. The bank has announced that it wants to use most of the money – about €8.1 billion of the total €13 billion – to absorb losses on loans that it is selling to investors at a discount. Unlike Monte dei Paschi di Siena, UniCredit is seeking  funding for a cleanup, not for its immediate survival. The bank also plans to dismiss an additional 6,500 jobs, bringing the total to 14,000 employees, as well as to cut costs by €1.7 billion a year. Furthermore, along with cutting costs, Mr Mustier’s strategy is to sell assets, including €18 billion of bad loans in a deal with Pimco and Fortress, US funds focused on managing distressed assets. UniCredit has a target of €4.7 billion of net profit in 2019, more than triple that of 2015 under Federico Ghizzoni, the former Chief Executive Officer.

MARKETS REACTION

Since their release on February 6^th, it is important to pay attention to the movement of shares and rights, whose offering is interesting not only for big shareholders, but also for thousands of small investors. They are all faced with the dilemma of whether or not taking up the offer.

UniCredit‘s shares held up relatively well after the bank launched its rights issue, but closed down at 6.9 % at €12.21 on February 6^th. The price of the rights to buy into the cash call – Europe’s largest one since 2010 – reached 18.85 % lower, with traders saying they were moving in sync with the shares and there was no sign of speculative arbitrage. However, on February 6^th losses were amplified by the spread between 10-year Italian and German government bonds hitting 200 basis points, its highest since mid-October 2014. Now UniCredit‘s top shareholder is U.S. investment firm Capital Research and Management Company with 6.7 %, followed by Abu Dhabi’s sovereign wealth fund Aabar and asset manager BlackRock (N:BLK) with a stake of about 5 percent each.

Figure 5: data from Bloomberg, retrieved from <Bloomberg>

Shareholders have three options to choose from

•  The first possibility is to exercise the option right paying an amount equal to the price of the new shares seeking the increase of the value of UniCredit’s stock.
• The second possibility is: to not take part in the option rights, and therefore they are obliged to sell their shares until today (February 17). In regard of this, Traders have claimed that shareholders who do not want to “follow” their rights tend to sell them in the first days of the process, and therefore, since they do not behave correctly, their rights face a dilution of more than 70 percent.
• The third possibility is a mix of the first two because an investor can sell part of its option rights and use the money obtained to buy new shares.

CONCLUSION

In conclusion, Italy has €200 billion of NPLs, the worst kind of defaulted loan, on Italian banks’ books. As this situation negatively affects the whole banking system, it requires strict measures with the purpose of lessening its impact on local market. First and foremost, it must be solved because all the banks cannot have all this percentage of loans that are in default or close to being in default, if this situation will continue to remain some banks will reach the default like Lehman Brothers in 2008 . Second, since the ECB (European Central Bank) continues to impose higher percentage of CET1 ratio.

Hence, we have, from one side, Monte dei Paschi di Siena which was obliged by the ECB to make a capital increase of €8,8 billion and failed making it, while, on the other side, we have UniCredit involved in a capital increase of €13 billion that is not requested by regulators in Italy or the European Central Bank.

Not all the Italian banks can now afford such a high capital increase, like UniCredit had, but most of those institutions need to make serious strategic plans to put into action some important intervention to restore their financial health alongside with a harmless government’s operation, as far as possible.