LONDON (Reuters Breakingviews) - UniCredit's revamp is a key moment in Italy's bank crisis. A cost cull, bad debt purge and mega-cash call mean the country's biggest bank should soon be less of a worry. With Rome facing a volatile 2017, it's just as well.
All Italian banks are hampered by low rates and high bad debts, but UniCredit's lowball 10.8 percent core Tier 1 capital ratio and Banca Monte dei Paschi's ongoing fragility are the two biggest concerns. Add in the political uncertainty following the domestic referendum and getting investors to support a 13-billion-euro rights issue - nearly the same size as UniCredit's markets value - is a big ask.
Recently-installed CEO Jean-Pierre Mustier had already delivered the bad news: the sale of stakes in profitable businesses like Pekao. But the overall 20 billion euros of capital raised will enable provisions of 77 percent on bad loans - compared to around 60 percent now - and over 40 percent on those deemed unlikely to pay. UniCredit will have a comfortable common equity Tier 1 ratio of 12.5 percent. A combination of lower loan losses and cutting costs by 1.7 billion euros, with over half coming via cutting branches and staff, should bring UniCredit's return on tangible equity to around 9 percent by 2019, from 5 percent last year.
Given that's at best in line with UniCredit's cost of capital, this isn't exactly amazing. The German business remains a drag, albeit one that would be costly to sell, and which provides a hedge if markets panic over Italy's debt. But from a valuation perspective, there's scope for upside from UniCredit's current 0.5 times tangible book value: adjust for the fresh capital, and fair value is over 80 percent, according to Breakingviews calculations.
Italian banking now has two pillars - UniCredit and Intesa Sanpaolo - but two concerns. One is that raising smaller banks to the same level of provisioning could cost 9 billion euros, according to Mediobanca research. The other is that rights issue investors will know UniCredit's assumed annual GDP growth of less than 1 percent in 2017 could be too optimistic if the populist 5-Star wins Italian elections, and the country quits the euro zone.
Still, Mustier's plan is robust enough, and healthier bigger lenders could mean more options for smaller ones. Assuming Europe can muddle through, UniCredit shouldn't have to.
On Twitter twitter.com/Unmack1