UniCredit Turnaround Is Still Far From Complete

(Bloomberg Gadfly) -- Italian banking has a rare good news story. UniCredit SpA, one of the country's biggest lenders, has overhauled management, raised billions of euros in new capital, and soundly beaten estimates for quarterly earnings -- all in the space of a year.

That's a reflection of CEO Jean-Pierre Mustier's slimming strategy and the improving Italian economy. The work needs to continue if Italy is to purge its financial system of bad loans and deliver a happy ending for UniCredit shareholders.

UniCredit's profit

€945 million

The bank said on Thursday second-quarter profit rose 3 percent to 945 million euros ($1.1 billion), less than six months after reporting a 13.6 billion-euro annual loss. That rebound is thanks to a mix of solid increases in lending, growing fee income, cost cuts and lower loan losses.

The bank's core capital ratio, a sore point with investors in the past, swelled to almost 13 percent. The shares jumped 5 percent, the most since April.

"The engine is working very well," according to Mustier. True enough, but he must take care to keep it humming.

Future progress will involve offloading more non-performing loans, a painful legacy of Italy's double-dip, record-long recession. After several false starts, this is starting to happen in earnest.

UniCredit last month closed a deal to offload 17.7 billion euros of bad loans to Fortress and Pimco, and more sales are likely. Gross non-performing loans fell to 53 billion euros at the end of June from 75.2 billion euros a year earlier.

Protecting and growing revenue in the face of frustratingly low interest rates is another priority if UniCredit is to deliver a 9 percent-plus return on tangible equity in 2019.

Quarterly revenue fell 8 percent. While the European Central Bank's ultra-cheap TLTRO program has limited some of the squeeze on margins, it's temporary, and pumping out more loans could backfire if it means taking on excessive risks. Cost-cuts are keeping pace with the revenue decline, more or less.

One bright spot is UniCredit's ability to generate more fees to buck the broader slowdown in both interest income and trading. Quarterly fee income climbed 7.6 percent. The hope is that a new 10-year partnership with Amundi, which is buying UniCredit's Pioneer asset-management arm, will keep the fees flowing as customers are offered more products. But any stumbles will put more pressure on the cost-cut side to compensate.

Delivering on Mustier's plan will bring obvious benefits: cutting loan losses and reducing non-performing loans should help to narrow the lingering gap between UniCredit's cost of capital and its returns. The implied cost of equity for an average big European bank is about 2 percentage points lower than its return on tangible equity, according to data compiled by Bloomberg. At UniCredit, it's the other way around.

Shareholders clearly see potential. The bank trades at a narrower discount to book value than peers like Barclays Plc, Commerzbank AG and Deutsche Bank AG. But the turnaround will take years. Mustier is right to characterize it as a marathon: the finish line is still some way off.

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

Lionel Laurent is a Bloomberg Gadfly columnist covering finance and markets. He previously worked at Reuters and Forbes.

To contact the author of this story: Lionel Laurent in London at llaurent2@bloomberg.net.

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