Finance

Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

Jean Pierre Mustier has a mandate to change UniCredit SpA and is wasting none of it.

Five months after taking the reins of the Italian lender, the CEO unveiled a mammoth capital raising and a new business plan on Tuesday. The hope is that this covers the cost of UniCredit's past mistakes. It doesn't yet provide a sustainable business model for the future.

Step one is a 13 billion-euro ($13.8 billion) rights offering. That will pay for 12.2 billion euros of charges in the fourth quarter, including 8.1 billion euros of new provisions against bad loans. Some 18 billion euros of bad loans are to be sold through a securitization. The result? The common equity Tier 1 ratio, a measure of financial strength, will rise to 12.5 percent in 2019 from a measly 10.8 percent today. That satisfies the demands both of regulators and stock market investors.

Capital Cushion
UniCredit's common equity Tier 1 capital ratio is well below the average of its European peers
Source: Bloomberg Intelligence

It would be tempting fate to suggest that any clean-up in Italian banking is decisive. But the sums being raised here are high relative to what some observers think UniCredit needs. Analysts at Exane last month argued a fundraising of more than 7 billion euros would be excessive. By raising so much money Mustier has made life a little harder for rival Banca Monte dei Paschi di Siena SpA. Does the Siennese lender now need more than people think? And will it be able to find it?

It's in Mustier's interests to raise as much equity as possible while he enjoys his honeymoon. Any capital increase risks failing if investors think it might not be enough and another might be needed later. Suppose UniCredit sells new stock at a 40 percent discount to its prevailing share price of 2.58 euros on Tuesday morning, or 1.55 euros. That would require it to sell 8.4 billion new shares to raise its target -- more than its current 6.2 billion share count. Investors who don't subscribe will be diluted more than 50 percent.

Can Mustier deliver investors a decent return on the expanded capital base? His plan is vague: he wants to transform the operating model, cut costs, increase focus and cross sell. Investors have heard this all before. The vision is for a pan-European bank which is nevertheless "simple". Good luck with that.

Mustier has set some targets. Costs are expected to fall to 52 percent of income and net income will be 4.7 billion euros in 2019 (more than double the 1.8 billion euros analysts expect the bank to report for this year.)

Miserable Returns
UniCredit's return on tangible equity trails peers
Source: Bloomberg Intelligence

It should add up to a return on tangible equity of 9 percent. That's twice what the bank is forecast to make this year. It's nevertheless below UniCredit's estimated cost of equity, likely to be about 12 percent even after the balance sheet clean-up.

No one would have believed Mustier had he said UniCredit could make its cost of equity in three years. But investors need to believe UniCredit can really get to that point and isn't structurally condemned to inadequate returns. There's no commitment on when that will be.

So why did the shares rise as much as 9 percent on Tuesday?  It's most likely a reflection of shareholders' already low expectations. Analysts had been estimating net income for 2019 would be between 3.2 billion euros and 4.5 billion euros, according to data compiled by Bloomberg.

Sliding Stock
UniCredit stock is down by two-thirds since mid-2014
Source: Bloomberg

Investors who have suffered as the shares have fallen by two-thirds since mid 2014 won't want to cash out now and miss a potential recovery. But Mustier has only bought himself time.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Chris Hughes in London at chughes89@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net