Monday, October 6, 2008

Why UniCredit is a victim of its own success

by Sudip Roy

UniCredit is one of the world’s biggest financial groups but concerns over its capital base have made it vulnerable to panic-stricken investors.

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The challeges facing Unicredit

HVB acquisition

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UniCredit's CEE network

Full Profumo interview

In normal times, if a bank had a core tier 1 capital ratio of 5.7% and total regulatory capital of more than 10% it would draw comment from analysts but it would hardly set the alarm bells ringing. Especially as that bank had made a net profit of €2.9 billion for the first half of the year. These, though, are far from normal times, as UniCredit is finding out to its cost.

Over a three-day period during the last week of September, and following government rescues of several banks across Europe, the Italian firm’s share price fell 24%, at one point trading at its lowest level since December 1997. Concerns mounted that UniCredit would fail to meet its 2008 targets, in particular its core tier 1 ratio goal of 6.2%, and would need a capital injection. The tide turned only after the Italian regulator banned short selling of financial and insurance stocks on October 1.

Such was the severity of the crisis engulfing UniCredit that its chief executive, Alessandro Profumo, went on national television later in the day to deny that he was resigning because of the plunging share price and to emphasize the bank’s financial strength. An earlier internal document that was leaked to the media made the same point, stating that the bank’s solvency levels were secure and that its short-term funding for the year was 10 times the level required by regulators.

Although UniCredit has never been immune to the credit crunch, despite its well-diversified strategy and emphasis on retail banking – it has already made net credit write-downs of €800 million this year and its markets and investment banking group has suffered losses because of its exposure to toxic assets – the speed at which it has become embroiled in the financial crisis is astonishing.

UniCredit has grown over the past decade through a series of acquisitions. In the past three years alone it has spent $61 billion on Germany’s HVB, local rival Capitalia and other outfits in emerging Europe that have transformed it into one of the world’s biggest financial institutions. Some of those deals, most notably in Kazakhstan and Ukraine, have come at a hefty price. The bank’s capital had become strained. To put this into context, Unicredit’s market cap on October 2 was just €38 billion.

The benefits from its acquisition of Capitalia, arguably Italy’s weakest bank, will take a few years to be fully realized. That effort will be made harder by a downturn in Italy that is already hitting the asset quality of UniCredit’s local retail business. Provisions for loan losses will probably have to increase. Its exposure to Germany, through HVB, is also causing concern.

That said, its strategy for the next three years of aggressive organic growth in central and eastern Europe, economic conditions notwithstanding, and retrenchment in western Europe, is sensible and most analysts still back the bank’s business model over the long term. As the architect of that model, Profumo deserves the opportunity to see UniCredit through this difficult and surreal time and prove whether he can deliver growth organically as well as through acquisition. His moves to raise capital – through the sale of real-estate assets, a convertible bond and paying dividends through shares – should give him sufficient breathing space.

If, however, UniCredit was to capitulate to the financial crisis, it would become by far its biggest bank victim and, with operations in 23 countries including some outside the EU, the most complicated for regulators to tackle. For that reason alone, let’s hope sanity returns to the markets soon.

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Why UniCredit is a victim of its own success

UniCredit is one of the world’s biggest financial groups but concerns over its capital base have made it vulnerable to panic-stricken investors.

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