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The Globe and Mail

UniCredit's rights issue is a wager on Europe

A Unicredit bank in Rome, Nov. 14, 2011.


European bank investors are being asked to dig deep yet again. After months of prevarication, UniCredit has taken the plunge and is asking its shareholders for €7.5-billion ($10.4-billion), equivalent to about half its current market capitalization. For investors who have hung on this long, the offering amounts to a wager that Italy – and the euro zone – can avoid disaster. But UniCredit's balance-sheet shrinkage could ultimately prove self-defeating.

Newish chief executive Federico Ghizzoni is preparing the bank for a more austere environment. He is assuming little economic growth in UniCredit's main markets of Italy, Germany and Austria. Only its operations in Central and Eastern Europe offer any prospect of expansion. He's also taken an €8.7-billion goodwill hit on prior acquisitions, possibly clearing the way for future disposals.

The rights issue will lift UniCredit's core Tier 1 capital ratio to 9 per cent under new Basel III rules by next year – more than regulators are demanding. At the same time, Mr. Ghizzoni aims to slash about €1.5-billion of annual costs by 2015, and is putting risk-weighted assets worth €48-billion – 11 per cent of the total – into runoff. Investors who buy into the vision are being promised a bank that will earn a 12-per-cent return on tangible equity by 2015.

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For shareholders who have watched their UniCredit shares halve in value this year alone, the rights issue probably makes sense. If Italy's new technocratic government avoids economic disaster, government bond yields should fall and the funding squeeze on banks should ease. But if Italy goes the way of Greece, there is little its banks will be able to do to avoid the disaster. Besides, it's a reasonable assumption that the syndicate underwriting the rights issue – led by Bank of America Merrill Lynch and Mediobanca – have negotiated clauses to protect them from being left on the hook if the worst happens.

The problem is that UniCredit's plan is far from unique. Other banks are taking a similar approach to deleveraging. Given the importance of bank funding to Europe's economy, this does not bode well for economic growth. UniCredit may be asking shareholders to ignore an economic scenario that its own actions could make more likely.

Peter Thal Larsen

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