UniCredit Bombshell Shouldn’t Be the Last One: Jonathan Weil
Everyone in the world who pays any attention to the financial markets seems to know that the balance sheets of European banks are a joke. All you have to do is compare the stock prices of these companies with the book values on their balance sheets to see that.
On average the shares of the 32 companies in the Euro Stoxx Banks Index trade for about 44 percent of book value, or common shareholder equity, according to data compiled by Bloomberg. Put another way, a typical large euro-area bank would have us believe its net assets are worth more than twice what the stock market says the bank is worth. The problem is the companies’ numbers can’t be trusted, and it’s been this way for years.
So imagine the surprise this week when UniCredit SpA (UCG), one of Italy’s largest lenders, had the fortitude to acknowledge that its asset values were in need of an 11-figure chopping. The truly unexpected part wasn’t that the bank experienced a loss of 10.6 billion euros ($14.3 billion) during the third quarter, but that its management chose to recognize these losses’ existence.
No other company in the index has reported anywhere near that much red ink for the third quarter. Most showed quarterly profits. The next-biggest net loss, at Belgium’s KBC Groep NV (KBC), was 1.6 billion euros.
Yet even after its recent confession, UniCredit’s shares still trade for just 28 percent of book value. On its balance sheet the company showed shareholder equity of 52.3 billion euros as of Sept. 30. At 75 cents a share, meanwhile, the company’s stock-market value is a mere 14.5 billion euros.
It’s easy to see why the discount is so big. About 12 billion euros, or 23 percent, of UniCredit’s equity consisted of deferred-tax assets. Basically, this number represents the money UniCredit believes it will save on taxes in the future, assuming it will be profitable. Trouble is, in a crisis, those assets are pretty much useless.
On top of that, UniCredit’s balance sheet still showed 11.5 billion euros of the intangible asset known as goodwill, even after the bank wrote this down by 8.7 billion euros last quarter. Goodwill isn’t a salable asset. It’s the ledger entry a company records when it pays a premium price to buy another. The asset exists only on paper. (For what it’s worth, European banks are allowed to count deferred-tax assets as part of their regulatory capital, unlike goodwill.)
Add up the goodwill and deferred taxes, and that’s 23.5 billion euros of junk assets right there, which is more than the company’s market capitalization.
Hence, the problem: The numbers don’t make sense, at least not in the real world. And this is from a bank that would seem to be a beacon of candor by European standards, considering that no one else reported such huge third-quarter losses at a time when Europe is on the verge of disaster.
The French lender Credit Agricole SA, for instance, showed 19 billion euros of goodwill as of Sept. 30. That’s 7.4 billion euros more than its current market cap. Dexia SA (DEXB), the French- Belgian lender, took a government bailout in October, only three months after passing European regulators’ stress tests. Lack of faith in big banks’ numbers isn’t strictly a European problem, either. In the U.S., Bank of America Corp. shows $70.8 billion of goodwill, about $11 billion more than its market cap.
There’s no secret about the banks’ predicament. Were they to get aggressive about taking losses and raising fresh equity, investors might worry they’re in grave danger. If they don’t get aggressive enough, the markets will conclude their numbers aren’t credible, in which case they may blow up anyway.
UniCredit seems to be staking out some sort of middle ground, only the markets are saying it’s not enough. This week the company said it plans to raise as much as 7.5 billion euros of capital by selling stock. That’s a drop in the bucket for a bank showing 950 billion euros of assets.
Sure, we can all hope the banks muddle through long enough for Europe’s leaders to come up with a solution to the region’s debt crisis somehow, as unlikely an outcome as that seems. Yet the longer this game of delay-and-pray goes on, the worse the problems will get.
UniCredit can’t possibly be the only lender in Europe that has incurred such huge losses. And the markets are telling us its losses are probably even bigger than what the company has disclosed. Maybe next year will be when the banking industry’s real bombshells drop.
(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)
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