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Rumour Mill Alive and Kicking

13 January 2017 by Gary Kirk

It was an interesting start to trading in the European bank capital market yesterday morning, as the rumour mill went into overdrive, with brokers’ headlines claiming that Unicredito was about to breach its Maximum Distribution Allowance (MDA) and as a consequence, the coupon on its AT1, due to be paid in March, would be withheld. Our initial reaction was disbelief; Unicredito is Italy’s second largest borrower and has been keeping investors completely up-to-date on plans to strengthen the balance sheet capital, by an aggregate EUR13bn.

On reading the press release from Unicredito it was apparent that nothing had changed, and the explanatory report was being misconstrued, possibly to generate market volatility for the broker community(?). At the end of last year, Unicredito management announced that they planned to raise EUR13bn, including Italy’s largest ever share issue together with 14,000 job cuts, in order to strengthen the balance sheet and eliminate EUR17.7bn of bad loans. Importantly, a number of large investment banks, including Morgan Stanley, UBS, JPM and BOA signed a pre-underwriting agreement for the issue that is due to launch in Q1-2017.

The explanatory note was merely being factual in laying out the strategic plan for the long term health of the bank. The key part of this 5-part plan is of course the capital increase and here bank management stated that the ECB have cleared the share issue to qualify as CET1 and there are no formal restrictions to carry out the transaction in Q1-2017. They also stated that the improvement in the asset quality will entail additional loan loss provisions of EUR8.1bn, to be booked in Q4-2016; which should be viewed favourably by debt investors as the management are seriously tackling the balance sheet clean-up. The part of the note that led to the rumours mentions that, should the capital increase (and/or asset reductions) not be realised or the benefits derived were less than anticipated, this could have temporary negative impacts on the capacity of Unicredito to comply with the constraints of the ‘regulator’ to pay out coupons on its AT1. This to us seems obvious and there is nothing new in this – the management are merely being factual and pointing out the potential risks.

The bank also released a press note stating that 99.6% of shareholders are in favour for the share increase (up to EUR13bn) to be carried out by 30-June-2017. The estimated impact of a successful issue would increase the CET1 ratio (currently 10.7%) by 345bps, which would align Unicredito alongside many of the leading European systemic banks.

The AT1 bond in question (UCGIM 8%) initially declined 3 points on the rumour (90.5 bid-side), before recovering to close the day around 92.00.

We are not involved in the UCGIM 8%, but observing it from a distance, it illustrates how cautious the market is, which is probably not a surprise given where yields are – the phrase “priced to perfection” is now frequently applied to both fixed income and equity markets.  In this case, we saw investors reacting fast to rumours, maybe without checking the factual basis of the story.  It seems to support our view that company specific volatility is likely to increase in 2017, which will create opportunities for those nimble enough to take advantage.

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