Papa, Ghizzoni, and Mustier: UniCredit’s new guard fights to revive its empire
After a few difficult years, culminating in the resignation of its long-serving chief executive, Italy’s biggest lender is hoping for a fresh start. But plenty of hurdles need to be overcome if it is ever to reassume its position as one of Europe’s leading banks.
New chief executives usually enjoy a honeymoon period. Federico Ghizzoni has had no such luck. The boss of UniCredit, Italy’s biggest lender, who took over the reins last September, has one of the toughest tasks in European banking: turning around a fallen star.
Less than three years ago UniCredit was the fourth-biggest bank in Europe, with a market capitalization of more than €80 billion. Its growth had been rapid and seemingly inexorable; a bank transformed in 10 years through a series of acquisitions from a domestic player with total assets of about €170 billion to a pan-European financial institution with a €1 trillion balance sheet and a presence in 22 countries. Its long-serving chief executive, Alessandro Profumo, was feted as one of the continent’s best dealmakers.
Then came the financial crisis. Although the bank was partly burnt by its investments in structured credit, what really brought it down to earth was its ambition. The purchase of Germany’s HVB in 2005 led to a protracted integration process and that of domestic rival Capitalia two years later has yet to prove its worth and saddled the bank with bad debts as the financial crisis took hold. To make matters worse, its core growth markets in central and eastern Europe were badly affected by the first rounds of the credit crunch. The bank was left dangerously undercapitalized.
The economic environment has since improved in both emerging and western Europe but the scars of that acquisition-led strategy are still being felt at the bank.
Although the bank’s geographical reach remains, much else has changed. Profumo has gone, having fallen out with his shareholders over capital-raising plans. The Italian lender’s market capitalization, meanwhile, has collapsed to €31.7 billion, meaning it is no longer ranked within even the top-10 biggest banks in Europe. Or put another way, its market cap now is just €10 billion more than the amount UniCredit paid for Capitalia in 2007 – an acquisition that gave the group a combined value of nearly €100 billion at the time. Growth driven by daring acquisitions has made way for a period of reflection and consolidation.
It is against this backdrop that Ghizzoni is trying to resurrect the bank’s reputation. It will not be easy, not least because as a UniCredit veteran and one of Profumo’s former chief lieutenants he is intrinsically linked to all the key decisions of the past. In that sense he is Gordon Brown to Profumo’s Tony Blair.
When Brown succeeded Blair as UK prime minister he was determined to strike his own path and distance himself from the previous administration’s most unpopular decisions. Yet as one of the leading members of the Blair government he could never escape his previous role. Ghizzoni will hope for a more successful tenure at the top than Brown managed.
The market remains to be convinced. UniCredit’s share price has fallen since Ghizzoni’s appointment on September 30 as investors wait to see what plans the bank has to improve its profitability (although the stock is outperforming the Stoxx 600 index of bank shares year to date). Last year UniCredit announced a net profit of €1.32 billion, down 22% from 2009.
After UniCredit’s fourth-quarter results were announced in March the analyst community was split about the bank’s potential. Paola Sabbione, research analyst at Deutsche Bank, wrote that the quarter’s operating trends were encouraging and recommended investors buy the shares.
In a more in-depth report the previous month, Sabbione had described UniCredit as "the phoenix [that] could realistically rise... due to macro-support, especially for Germany and central and eastern Europe, and a renewed commitment from senior management to the definition and achievement of a solid business plan".
Conversely, Paola Biraschi, analyst at RBS, wrote after the latest results that while they were "healthier than expected... balance sheet trends were weaker." Biraschi has a hold recommendation.
Marcello Zanardo, analyst at Alliance Bernstein, wrote: "Fourth-quarter results after many quarters finally triggered a positive reaction, driven mainly by better than expected revenues." Yet he also warned on asset quality in Italy and thin capital ratios. Zanardo has an underperform stance on the stock.
Ghizzoni, a quiet, mild-mannered person, knows he has to produce results. "In broad terms our biggest priority, after three years of declining results, is to turn around profitability," he says. "We want to bring back the group to a level of profitability in line with our best peers."
The strategy to do so is less about a radical overhaul than getting the most out of the bank’s existing growth businesses, especially central and eastern Europe and corporate and investment banking, while turning around its struggling Italian operation.
"One of the first questions we asked after I became chief executive was what we want to be," says Ghizzoni. "Did we want to change completely our DNA? We decided that our core business would continue to be commercial banking and we want to be a large European bank. But we had to understand why we had some difficulties and take some measures."
A big criticism of Profumo’s empire was that it was less than the sum of its parts – that UniCredit became a large federation of businesses rather than a unified banking group. It has yet to show, for instance, that it is more than an acquisition machine – that it can become a big bank on a standalone basis from which clients can profit.
"The full value of the franchise is there," says Paolo Fiorentino, chief operating officer. "We have gone through different phases – M&A, post-M&A integration, then the global financial crisis – but now it’s the right time to execute our strategy and to share with our customers the full benefits of this large franchise."
Ghizzoni denies that the pace at which UniCredit grew and the size it reached was a problem. "The bank didn’t grow too fast," he says, pointing out that the opportunity to buy a business such as HVB, which included the much-desired central and eastern Europe assets held by its subsidiary, Bank Austria Creditanstalt, was too good to ignore.
One advantage of its presence in so many markets is a diverse funding base. With more than 9,600 branches, UniCredit has solid retail support that has enabled the bank to avoid taking drastic measures. The lender has not needed to access European Central Bank funding for more than two years. "The funding is very solid and relatively cheap thanks to our European diversification," says Roberto Nicastro, general manager.
UniCredit’s loans to direct funding ratio - which includes deposits as well as securities bought by the bank’s customers - is 95.3%. The rest is funded through the wholesale markets. Unlike other pure Italian lenders, UniCredit can use its German, Austrian and Polish, and where possible, east European businesses to benefit from better pricing conditions on its debt, and so avoid paying for Italian sovereign risk.
Still, Ghizzoni acknowledges that the growth by acquisition strategy meant that the firm became more rigid – decisions took too long to take and there were too many silos with insufficient accountability. He says post-merger synergies, which the group had planned, were delayed by the global financial crisis.
One of his first acts as chief executive was to change the governance of the group so that each country head has become directly responsible for profit and loss. The aim is to cut costs, drive revenues and better meet customers’ needs.
"It has been done mostly to stay close to the customer. You cannot be a service company unless you improve your quality of service," says Ghizzoni.
It’s a sentiment shared by Jean-Pierre Mustier, the charismatic former boss of Société Générale’s investment bank, who has just joined UniCredit to head its corporate and investment banking business. Explaining his plans for the division, he says: "We need to improve our revenues relative to risk-weighted assets and that can only be done through better cross-selling of products and better delivery of service."
Ghizzoni understands, however, that it is actions not words that will determine whether his leadership proves a success. "I’ve just come back from meetings in the US and UK. The market is very curious about us. One investor told us we are the best turnaround story in Europe. Another said we have potential. This is not yet reflected in the share price but it’s up to us to translate that potential. It’s a pivotal moment."
Libya and capital
The issue that might yet stall Ghizzoni’s plans is the same one that eventually led to Profumo’s downfall – capital.
In less than a year between the first quarter of 2009 and January 2010, with the share price in free fall, Profumo was twice forced to ask UniCredit’s shareholders for extra cash, having previously insisted that the bank was well capitalized. At the same time he negotiated with the Libyan Investment Authority to take a 2.6% stake in the bank. This came on top of the Libyan central bank holding of almost 5%, making Muammar Gaddafi’s regime the single-biggest shareholder in the bank.
The Libyan investment proved the last straw, prompting a backlash from Italian regulators, politicians and shareholders, many of whom were already fed up with Profumo’s perceived haughtiness. He resigned last September after 15 years in charge.
The Libyan government’s involvement in UniCredit has continued to prove controversial, especially with Gaddafi now the west’s enemy number one following the eruption of rebellion in the north African country. The bank has managed to sideline any difficult questions about the holding by freezing the shares in line with UN and EU policy. Dividends are paid into an escrow account while the Libyans’ voting rights have been blocked. However, former central bank governor Farhat Bengdara is still allowed to sit on the board as vice-chairman as part of a three-year mandate that ends in 2012. Bengdara is not on the UN/EU blacklist so does not have to resign.
Ghizzoni says management has "no regrets" about the Libyans’ involvement. "It’s very easy to look back," he says. "Until the civil war began Libya was accepted by the international community as a good investor."
It is difficult to say what will happen to the stake, he adds. "Nobody can buy or sell these shares at the moment. If there is a new government in Libya that is internationally accepted, it will decide what to do with the shares. If it sells I don’t think it will be sold in one block."
The uncertainty surrounding the Libyan stake serves to emphasize the delicate nature of UniCredit’s capital base. The bank has a core tier 1 ratio of 8.58%, which seems healthy enough. Indeed, UniCredit already meets the Basle III requirements eight years ahead of schedule, for even if its core tier 1 was diluted thanks to the new rules it would still be 7.3%, above the minimum threshold of 7%.
UniCredit, however, lags behind other leading European banks, such as Credit Suisse, HSBC and Barclays, which all have ratios above 10% under current rules. "Compared with other major European banks, capital remains on the lower end," says Alliance Bernstein’s Zanardo.
Other Italian banks are increasing their capital levels ahead of Europe’s stress tests. Intesa Sanpaolo, the country’s second-biggest lender, recently closed a €5 billion rights issue, even though it, like UniCredit, already claims to be Basle III compliant. The deal took Intesa’s ratio to 10%, setting a new standard for commercial Italian banks.
Regional banks such as Banco Popolare and UBI Banca have also increased their capital while Italy’s third-biggest lender, Banca Monte dei Paschi di Siena, has announced plans to raise as much as €2.5 billion later this year. The country’s banks have come under pressure from the government to shore up their capital in an effort to ensure that they do not become vulnerable to any possible sovereign debt crisis in Italy.
Ghizzoni insists, however, that UniCredit will not follow the other lenders with a cash call. He denies that UniCredit will be pushed into a transaction eventually by the market or investment banks pitching for business.
"You cannot be driven only by the pressure of the markets or the pressure of the investment banks," he says. "We have to look at our own position."
Ghizzoni forecasts that by January 1 2013, UniCredit’s core tier 1 ratio will be 8.45%, if Basle III rules are applied – the figure boosted by an expected 115 basis point increase, according to analysts’ consensus, from retained earnings.
Ghizzoni believes also that it makes little sense to ask shareholders to stump up more money while there’s still so much uncertainty about what the regulatory changes will be. One of the key issues facing UniCredit is whether it will be classified as a systemically important financial institution (Sifi) – one of the big banks that might be required to hold additional capital buffers.
"We need to have greater clarity about the new regulations, including Sifis," says Ghizzoni. "Then we’ll also have the results of the stress tests. So I’d like to have more information about these two important events. In addition, we are working on our new strategic plan that should be presented to the financial community by the end of the year. So I think once we get clarity on the new regulations and after we’ve finished our plan we will be able to better assess the overall situation."
He adds: "Our aim is to increase our core tier 1 ratio. We want to do it, but not necessarily through a capital raise. You can also generate capital organically and by working on management actions."
One option open to UniCredit would be to dispose of non-core assets. The bank is, for instance, trying to sell its asset management arm, Pioneer, either outright or through the disposal of a large stake. However, it will only do so if the price is right. If not the business will be reorganized and relaunched. Analysts at Deutsche Bank reckon the sale of a 33% stake could generate a 20bp uptick in the bank’s core tier 1 ratio. Other peripheral businesses, particularly in eastern Europe, could also be up for sale.
Another avenue it could explore, according to analysts, would be to list some subsidiaries, as Santander is doing. Although the bank has given no indication that it is planning to issue shares in some of its subsidiaries, such a move would help the capital levels across the group. While some of UniCredit’s divisions are overcapitalized – HVB has a 15.3% core tier 1 ratio while at the Polish subsidiary, Pekao, the figure is 17.9% – others are at the opposite end of the scale. For the Italian business it is 1.7%. IPOs would adjust these imbalances and would increase capital in the holding company, says Deutsche’s Sabbione, as would higher dividend payout ratios in HVB, Bank Austria Creditanstalt and Pekao.
The conundrum facing UniCredit, like many other lenders, is that its cost of capital, about 10%, far exceeds its return on equity, at 2.7%. "It’s a very important point," says Ghizzoni. "It’s fashionable to go to the market to raise capital but do you know what the question will be one year from now? How to remunerate this capital? We cannot forget that capital has to be remunerated."
Clearly, though, the imbalance between UniCredit’s cost of capital and the return on it is not sustainable. "Our plan is to have a return on tangible equity higher than the cost of our capital by the end of 2012 and by the end of 2014 our return on equity to be higher than the cost of capital, which as of December 2010 is just above 10%," he says.
If the cost of capital remains high over the next two to three years, these would seem ambitious targets, although conversely the charge could be much lower by 2014. Either way senior managers are confident. "It’s not a huge leap," says Mustier. "It is possible to have a return on equity above the cost of capital without changing the risk profile. Just take transaction banking. That business doesn’t use much capital. We can grow revenues relative to risk-weighted assets. In addition, within the corporate and investment bank we will look to cross-sell products more, such as structured finance, trade finance, derivative hedges, to increase returns."
He adds: "The return on equity for banks in general on a mid-cycle basis should be between 12% and 14%."
Achieving this goal will depend largely on resurrecting the Italy unit, making the central and eastern Europe business more effective and squeezing more out of the corporate and investment banking division.
Luck will be needed too. Although the macroeconomic environment in the countries that UniCredit operates in has mostly improved over the past year, the recovery remains fragile. Nowhere more so than Italy, which has the highest debt-to-GDP ratio in the eurozone, at 119%.
If Italy gets dragged down and joins Greece, Ireland and Portugal in the eurozone gutter, UniCredit’s plans for renewal will be crushed. For the time being Italy is just about safe, with a budget deficit below target and faster-than-expected growth in 2010, albeit with output inching up by just a meagre 1.3%. That figure, moreover, was below the 1.7% rate at which the eurozone as a whole grew. The country’s fate is still very much in the balance.
Turning around the Italian business is management’s biggest priority this year and crucial to any success. It’s obvious why. Although the bank does not disclose detailed profit-and-loss numbers for the Italian business, local media report that it made a €50 million loss in 2010 and aims to achieve a net profit of €600 million this year.
The media also mention a pre-impairment profit of €4.12 billion reported by the division, which is expected to grow to €4.59 billion in 2011, assuming no cost growth.
"The net loss reported by the Italian business must imply that this saw fiscal year 2010 write-downs, loan-loss charges and other impairments absorbing the vast majority of pre-impairment profits," says a February note on the bank by RBS.
It adds: "These results are not surprising, in our view, and show the point we have been making since our initiation on the stock: the Italian business has low profitability primarily due to the high cost of credit."
The note concludes: "We continue to believe that the low profitability of UniCredit is attributable to the weak asset quality of the Italian business. Although this will improve cyclically, we estimate the bank to generate a return on tangible common equity of 10% in fiscal year 2013 (up from 5% in fiscal year 2010), below the cost of capital, making the stock a relatively less-preferred investment in a pan-European context."
The market is very curious about us. One investor told us we are the best turnaround story in Europe
Deutsche Bank’s Sabbione is more upbeat. While she acknowledges that asset quality improvement in Italy will be slow, she believes that the revamp of the business can be achieved if UniCredit follows through with its stated strategy.
That strategy is three-pronged, with an improvement in the cost of credit the most important. "The cost of risk for Italy in 2010 was 150 basis points," says Nicastro. "The goal is to halve it and we are going to do it after a management reshuffle and through strengthening our soft collection capability. We are already seeing an improvement."
He blames the financial crisis, rather than the acquisition of Capitalia itself, arguably Italy’s weakest bank at the time, for the worsening situation. "The Capitalia acquisition followed immediately afterwards by the crisis did not allow us to promptly reduce exposures to certain corporate customers where both UniCredit and Capitalia were active prior to the merger – this meant our cost of risk worsened, leaving it higher than our peers’."
He adds, however, that just managing loan collections better, especially to troubled small and medium-sized enterprises, and sharply reducing loan-loss provisions, will help the cost of risk fall back to peer levels even if the economy is weak. "This will have an impact on the P&L. And if the economy improves there will be additional benefits."
One of the things that Nicastro is trying to improve is loan-response times. He has a chart in his office that is updated monthly showing how well, or badly, the bank is hitting its targets between its loan agreements, delivery and repayments. The chart covers different districts within Italy and across retail and corporate banking. It’s a sign of the emphasis that senior management is putting on getting the small details right to generate more business.
The other two ways the bank hopes to boost the Italy business are, first, by enhancing revenues and, second, by cutting costs further. The former should be partly the natural consequence of interest rate increases although, of course, tighter ECB monetary policy might have a negative impact on asset quality. Greater discipline in underwriting capabilities to drive fee-based income will also be needed. The bank has appointed a new country chief risk officer with enhanced powers for this very reason.
As for costs, analysts expect savings of €190 million from its One4C programme, an initiative devised by Profumo to make the bank’s structure more efficient, especially in Italy. The bank hopes also that the One4C programme will enable it to better cross-sell corporate, retail and private banking products and services to customers.
Another important strategy is greater investment in online banking, which would allow further savings by supporting the downsizing of the network without compromising revenues. UniCredit is worse than the average in terms of cost per branch, for example, although it is better than rivals on a cost per employee metric.
Whether all of this will be enough to make the Italian business consistently profitable remains to be seen. Improvements should be possible irrespective of the state of the economy but the extent to which it is turned around will be determined by the country’s growth prospects. With Italy accounting for 40% of the group’s risk-weighted assets and two-thirds – €44 billion – of its gross impaired loans, domestic market recovery is vital to UniCredit.
The importance of the macroeconomic environment to the group’s fortunes is illustrated well in central and eastern Europe. The crisis proved that the region was no one-way bet, with UniCredit’s operations in the former Soviet Union, in particular, hitting difficulties. In 2009 and 2010 provisions on loan losses in Kazakhstan, Ukraine and Russia were 18%, 10% and 9% of their loan books respectively, according to Deutsche Bank.
The Kazakh business, bought in 2007 at the top of the cycle, accounted for goodwill impairment of €359 million last year. One consolation is that Kazakhstan accounts for just 0.6% of the group’s total loan book.
Now the region is on the up again, with growth forecast at 4.2% for this year. But the recovery varies country to country, with Hungary, Kazakhstan and Ukraine lagging behind Poland and Turkey.
Last year the bank’s central and eastern Europe division made a pre-tax profit of just over €1 billion, up 16.7% on the previous year. About 70% of the bank’s business in the region is done in five countries – Poland, Turkey, Russia, the Czech Republic and Croatia. The improving economic outlook in these countries largely supported the performance.
Still, trouble spots remain. In the fourth quarter the bank increased provisions in the Baltic republics and Romania compared with the previous three months, according to Alliance Bernstein’s Zanardo. It made similar adjustments in Turkey and Slovakia too despite their better economic outlook. Other countries saw a fall in provisions but according to Zanardo, "their weight on total provisions is marginal".
He adds: "This, also in addition to revenue weakness in Croatia, generated significant pre-tax profit fall quarter versus quarter in the main top central and eastern Europe subsidiaries, excluding Russia – up 52%."
Gianni Franco Papa, who was appointed head of the CEE division in December, after nearly three years as general manager of the Ukraine subsidiary, says that despite the region’s ups and downs the investment rationale remains persuasive. "What’s important is that the business model still holds. We are still seeing there is economic convergence to western economies and a financial penetration gap exists. These remain the drivers of the region," he says.
He adds: "Clearly, however, liquidity is not as abundant as before. We have to address this and reshape the strategy to focus more on areas of sustainable growth."
Overall the group is committed to investing in the region – there are plans to open 1,000 branches over the next five years – but the allocation of capital will be more selective.
"There will be three main clusters that will form our strategic plan for the next few years," says Papa.
The first will be the main engines of UniCredit’s growth in the region – Poland, Turkey, Russia and Romania. In both Turkey and Romania, for example, the bank plans to open 300 branches over the next five years.
I swore I would never work in a bank again, but what made me change my mind is that UniCredit is unique in Europe
The second group includes the Czech Republic, Hungary, Slovenia, Serbia, Slovakia, Croatia and Bulgaria – countries where the bank is a market leader but where it can generate further economies of scale, for example in technology.
The final cluster includes the riskiest countries – the Baltic republics, Ukraine and Kazakhstan. The strategy for these markets will depend on the group’s risk appetite and also their economic value. Ukraine, for example, reminds Ghizzoni of Poland of 10 years ago. The potential is clear; the question is whether the political wherewithal will allow Ukraine to realize it fully.
Despite calls from analysts to rationalize its presence in the region to generate more revenues out of the core countries and free up capital, Papa says that the bank is not considering any asset disposals, not even of Kazakhstan – unless it receives an offer too good to refuse, which, in any case, it hasn’t.
"As far as UniCredit is concerned we’re here to stay," he says. "Having said that, we are reassessing our strategy and have to see if in certain countries we want to be more like a boutique, which in itself would free up capital."
Ghizzoni stresses that a review of the model in some countries will not undermine the bank’s credentials in the region – the strategy remains the same. "We want to continue to be the number one bank in central and eastern Europe and invest further in key markets."
Papa adds: "After a couple of hard years of restructuring the business, we’re back to growth."
The other area that needs to perform consistently strongly is the bank’s corporate and investment banking business. Last year the unit’s profit before tax was €2.7 billion, up 30.3% on 2009, and another business largely supported by macroeconomic recovery in Germany and emerging Europe.
The appointment of Mustier to lead the corporate and investment bank is interesting. He began his career in 1987 as a stock options trader at Société Générale, turning the French bank into the leading equity derivatives house in the world. By 2003 he was heading SG’s corporate and investment bank and established himself as a star investment banker.
His career took a nosedive, however, in the wake of the Jérôme Kerviel trading fraud, overseeing a €4.9 billion trading loss in 2008. He left SG in August 2009 amid a probe into insider trading. Although the French market watchdog eventually cleared Mustier of all legal charges, it imposed an administrative fine. Mustier denies any wrongdoing and is appealing against the decision.
For a while it looked as if he had left banking behind for good but the lure of UniCredit was too strong. "I swore I would never work in a bank again but what made me change my mind is that UniCredit is unique in Europe," he says.
"One of the bank’s strengths is its cultures and I stress the plural," he adds. "It’s an Italian bank in Italy, a German bank in Germany and so on. You are confronted with many different cultures and the ability to mix them makes it exciting. UniCredit is different from other European banks. We have a presence in 22 countries and in more than five of them we are either first, second or third, which means we are strongly locally rooted. We combine in a unique way local presence with global product factories that gives us a competitive advantage."
The peripatetic Mustier – he will be based in Milan, London and Munich – has the opportunity to rebuild his reputation as much as UniCredit’s. His appointment has certainly intrigued analysts, who wonder whether Mustier will try to differentiate UniCredit through a specialist product as he did at SG.
The Frenchman, however, says that is not his intention. "We don’t want to develop a product that is standalone," he says. "We want to deliver the proper derivative hedge to companies but the client side is more important than the product side."
Instead he wants to build on the bank’s balance-sheet strength and deliver more products and better-quality services to clients. "The bank is one of the most important lenders in Europe and the largest lender in central Europe," says Mustier. "Our focus is on both loans and fee-driven businesses. We have about €200 billion of loans to customers. It’s a very good platform from which to develop capital markets and structured finance businesses."
Mustier declines to be drawn into specific goals such as a top-five ranking in European debt capital markets, saying that the results will take care of themselves if the approach is right. Cross-selling to clients is a crucial aspect to his strategy for growing revenues.
"We have to make sure that we develop true banking services to our clients, such as loans and transaction banking. That is our first goal," he says. "That way we create dynamic banking relationships. After that we can offer capital markets and structured finance products. From transaction banking to M&A advisory, we should not neglect any segment of the business."
He adds: "It’s not rocket science. It’s a traditional approach to banking."
That’s not to say that there won’t be any risks; after all taking risk is the lifeblood of any banking activity. But Mustier stresses that the business will be kept simple. "If I don’t understand something the client won’t either. It will be a no-nonsense approach."
Like the rest of the management team, Mustier talks well about the possibilities. But he and they will be judged on results.
"If the market sees customer-driven profits, costs coming down and the cost of risk declining, it will start to look at our projections with more confidence," says Fiorentino.
Ghizzoni simply says: "We need to be more disciplined, more self-confident and have better execution. In the current scenario, the vision is less important than the execution."
When Profumo took a ragbag of nine Italian banks in 1998 and merged them, few would have believed that the new institution would become one of the dominant forces in European banking. For 10 years UniCredit lived the dream. That dream then turned sour.
UniCredit has to prove itself all over again.