Far away from Wall Street too big to fail banks, the Euro Area banking industry has, since negative interest rates were introduced, struggled to achieve consistent profitability, with many arguing about the banking model system too obsolete, the fragmentation with too many banks and very few big powerhouses in euro area banking that could stand up to the more expert U.S. Financials.
All stock market equity desks and especially investors in subordinated bank debt obligations would have a fresh memory of the Deutsche Bank stock price fall out with cascading effects on subordinated debt credit spread and with concerns about the solidity of the balance sheet, given the considerable interlinkages with structured finance products that Deutsche Bank used in its business and that then evolved in serious issues for the ability of the bank and the market in clearing these structured products. So, if anyone would have answered the question at Blue Mountain Capital, ” do you see DB share price, would you buy the CDS”, well then with hindsight taking some precaution would have been the proper choice to make.
So getting back to the future, the question would be “have you see UCG stock performance?”
Concerns about UCG, that could see an increase in the CDS premium, would be of a wide variety, however, there are some important features that could put the Euro Area bank in some choppy waters. The change at the helm of the bank with the outgoing C.E.O. moving to another boutique, being substituted by a former Italy’s Treasury Minister should see investors trying to understand what will be the development of the bank. However, with that, Unicredit seems to be poised to absorb in a merger MPS and all its deteriorated balance sheet, another very difficult chapter in the history of the banking industry in the Euro Area. The deal would bring an undisclosed amount between €3.0 to €6.0 billion Euro to Unicredit, of course, backed by Italy’s Fiscal purse.
The business of structured financial products has never been an easy task to clear for the banks and for credit markets at large, however, UCG seems not to be new in this segment of the market, in fact, the bank has successfully transacted three securitisations of non-performing leases, granted by Unicredit Leasing S.p.A., Fino 1 Securitisation, Prisma SPV, and, Relais SPV, the first all Italian non-performing transaction backed by receivables resulting from leases expected to benefit from the public guarantee for non-performing securitizations, with Class A and Class B Asset Backed Floating rate, given the deflationary interest rate framework in the Euro Area. The acquisition of MPS by UCG would inevitably bring additional ABS derivatives on UCG balance sheet, that would make shareholders uneasy while making the bank very much exposed to credit markets and the solvency of these receivables. Lately, the view from the other side of the Atlantic reminded of the “Euro Area Banks Doom Loop”, in fact withstanding the ECB having expanded Euro Area sovereign debt purchases, Italian banks hold 12% of their assets on the balance sheet, entirely in sovereign debt, that would easily equate to the entire TIER1 equity capital ratio, the minimum requirements for banks to hold, with Unicredit and Intesa San Paolo being the largest banks and largest holders of Italy’s sovereign debt.
Would you consider UCG CDS?
Given the exposure to ABS securitization business and the overall holdings of Italy’s sovereign debt on the balance sheet, any Euro Area credit market hiccup and any sovereign debt volatility, in an adverse credit markets volatility scenario, the bank would eventually require to access the ESM to tap in the Euro Area bank resolution fund.