Just over two weeks after the rescue of Credit Suisse, immediate fears about the health and the stability of the European banking sector have somewhat dissipated. But with many uncertainties remaining, concerns from investors — in both bank stocks and bonds — have not. And while this uncertainty is largely warranted, investors should take a closer look at UniCredit’s distributions plans as a health gauge for the resilience of major European banks amid the banking turmoil.
On March 28, the Italian lender said that its €3.343bn maximum share buyback programme for 2022 remained unchanged, despite the market jitters already evident by the time of the programme's confirmation. Moreover, together with dividends, UniCredit will distribute up to €5.25bn of its funds to investors.
The Italian national champion is affording a large number, especially given the the market’s high levels of scrutiny on banks’ deposit withdrawals, exposures to various sectors and concerns about higher funding costs.
On April 4, French outfit BNP Paribas highlighted the wider credit spreads that banks pay now compared to before the collapse of Silicon Valley Bank. The spread on the €1bn deal from the bank, that re-opened the unsecured primary market to eurozone banks after nearly a month-long hiatus, was almost 60bp higher than in mid-February, when it last sold a non-preferred debt. Though the earlier trade was two years shorter, the maturity extension was, arguably, not worth as much as 60bp.
Equity markets are also a far from ideal source of funding for banks currently. While much smaller and a regional lender, German-based Oldenburgische Landesbank was forced to postpone its plan for an initial public offering, originally scheduled for May, due to lower valuations.
Central approval
By March 28, just days after the postponed German IPO, the Italian lender announced that its distribution plan had secured the European Central Bank’s approval, even as its share price sat almost 10% lower than it was at the beginning of the month
The bank said that it had "exhibited significant strength in its capital levels and best-in-class organic capital generation," based on financial information provided by the company, which "combined with the robustness of the liquidity position", ensured that "the business can weather stress scenarios from a position of strength".
The ECB’s seal of approval adds weight to UniCredit’s business model, which generated 40% more in distributions last year when compared to 2021, powered by a 13% increase in net revenue year-on-year.
When that announcement was first made, UniCredit's board was yet to approve the distribution. While it was surely aware of the wider concerns aimed at the banking sector and investors’ worries that were abundantly evident at the time, the distribution plan was approved at the meeting on March 31. UniCredit launched the buyback on April 3.
Between March 28 and the end of trading on April 4, UniCredit’s share price rose by nearly 5%, leaving it 30% higher than at the start of the year and 85% up over the last 12 months, explaining some of the confidence that equity investors have placed onto the Italian bank.
Price action revelations
But bond investors have had their own concerns about UniCrediit, as has been exemplified in the trading levels of its most junior debt capital. For some, the call on UniCredit’s €1.25bn 6.625% additional tier one (AT1) bond, due for an early redemption in June, has been contentious, especially after Credit Suisse’s AT1s were completely wiped out two weeks ago.
UniCredit’s AT1 bond was trading at a cash price of around 97 at the start of the year. It ticked up to just under par on March 1 to then plummet to 90 on March 20 just after the rescue of CS and the full write down of its AT1s. As of April 4, the AT1's price has moved back to 98.6, in another sign of strength.
In tandem with the recovery of its AT1, its credit default swaps too have tightened. The five year cost of protection against UniCredit defaulting on its senior debt settled down at 107bp on April 4. This was still 15bp higher than at the beginning of March, but 21bp below the high point on March 20.
While conditions in the banking sector may have somewhat stabilised, they remain fragile and are still far from a full recovery. The return of BNP Paribas — with its five year CDS significantly lower than that of UniCredit, at 67bp — as the first eurozone bank to issue an unsecured bond is a sign of improved market sentiment in the bond market.
UniCredit’s bold plan to part with more than €5bn of its funds, underpinned by the performance of both its equity and debt securities, shows the European banking sector remains largely insulated and resilient. This should give investors a dose of confidence that European banking fundamentals remain strong.