TheFirstQuarter of 2017 markeda turning point in both capital and credit in European financials. As the reflation trade has picked up steam, European banks have maintained lower valuations than US banks (0.7x vs. 1.2x book), driven by a lack of confidence in capital and an inadequate clearing mechanism for legacy non-performing loans (NPLs). The ECB recently noted there were still € 921 billion of NPLs at significant EU financial institutions. However, its guidance on NPLs, released with NPL in ratios March, >3x offered the level a firm of US but and pragmatic Japanese pproach banks to accelerate NPL resolutions and Q1 2017 was the second biggest quarter for announced capital issuance in over five years. While at home the opportunity in financials is linked closely to rising rates, banks in Europe offer a different hook: tangible progress on balance sheet clarity.
Third Point recently made an investment in UniCredit SpA (MIL:UCG), which raised €13 billion in fresh capital in March, the largest rights issue in European financials since 2009. UniCredit is the second largest listed bank in Italy and has a significant presence in Germany and Austria. We invested in their last rights issue in early 2012, similarly taking advantage of significant volatility during the rights period to establish our position.
We view UniCredit’s current recapitalization as a definitive clean -up. UniCredit has raised almost two times the capital that was the “consensus” view in mid-2016 and is raising another €6+ billion from selling its stake in Bank Pekao and Pioneer Asset Management. This combination of almost €20 billion of fresh capital puts the bank at ~12.6% pro forma CET1. UniCredit also cleaned up almost half the NPLs in its Non -Core Bank and took significant upfront charges related to its restructuring plan, which will see headcount reduced by 14% and branches reduced by 25%, all by 2019.
We were drawn to UniCredit by its low valuation and the rights issue. We believe in the medium-term story because of its new CEO, Jean Pierre Mustier. Mustier had an over 20 year career at SocGen, where he contributed to building its leading equity derivatives and asset management businesses. He then ran UniCredit’s Corporate and Investment Bank from 2011 – 2015, where it was consistently one of the financial industry’s most efficient businesses on a cost/income basis (<45%). While UniCredit shares have appreciated since the rights issue, we still see significant upside for UniCredit with shares trading at just 0.65x tangible book, <9.0x our 2018E EPS estimate and <7.5x our 2019E estimate. These forecasts exclude additional potential upside from rising interest rates or better asset quality, despite the significant progress on NPL resolutions and property transactions we have seen in recent quarters.
From Daniel Loeb (Trades, Portfolio)'s first quarter 2017 Third Point shareholder letter.
