UniCredit: Progress story gets global buy-in

Supported by the fruits of its Transform 2019 plan and pan-European message, UniCredit has recently underlined its broad market access in a series of TLAC-driven trades, attracting over $20bn of orders to $10bn of deals in Q1 alone. Mirko Bianchi, co-chief financial officer, UniCredit, explained the group’s strategy to Neil Day for Bank+Insurance Hybrid Capital, in association with Crédit Agricole CIB.

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Neil Day, BIHC: You were very active in the bank capital space in the first quarter, following the senior non-preferred private placements beforehand. What are the reasons for this significant issuance activity following your earlier hiatus from the capital markets space in 2018?

Mirko Bianchi, UniCredit: We actually had quite a strong start in 2018, issuing our inaugural euro senior non-preferred in January 2018, and it was afterwards that we were absent from the market for a variety of reasons until we restarted our issuance programmes in November.

One reason was the market volatility driven by the Italian elections, which began in March 2018. Another important factor was the upcoming US sanctions. It became clear that we needed to do more work with the US authorities and we wanted to know exactly where we would end up before coming to the market again — that’s very much in line with our approach to transparency. And then in August 2018 we had the Turkish situation, where we took a large impairment.

By November 2018 everything was clearer and we were able to tell the market what the various impacts could be, and that’s when we jumpstarted issuance for UniCredit.

Early this year the market had recovered quite substantially, so we began taking advantage of this positive environment to achieve a significant portion of our TLAC funding plan. Another reason for being so active was that we were also anticipating further potential market volatility due to the European elections in May this year, and therefore looked to identify market windows away from those.

Day, BIHC: What is the rationale for the Additional Tier 1 and Tier 2 transactions in terms of the UniCredit capital and MREL and TLAC planning? What is your funding plan for this year and how far you are in terms of achievement 2019 year-to-date?

Bianchi, UniCredit: There are two factors behind the AT1 and the Tier 2 transactions. The first is we wanted to be in compliance with the TLAC regulation. We are a G-SIFI bank — the only one based in Italy — and because of that we are required to have a 19.6 percent TLAC ratio, of which at least 17.1 percent has to be fulfilled with subordinated instruments including senior non-preferred. The second reason is to ensure that we maintained our AT1 and Tier 2 1.5 percent and 2 percent buckets in full in order to optimise our capital stack. Of course, from a forecasting perspective, we also need to take into account the regulatory amortisation profile of our capital instruments, and the risk weighted asset growth that we are planning for 2019.

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Our 2019 TLAC funding plan called for EUR9bn of issuance, including EUR6.5bn in subordinated instruments. Year-to-date we have done a EUR1bn AT1 transaction, then EUR2.1bn of Tier 2, and EUR2.6bn in senior non-preferred, so in the first quarter we issued 90 percent of the TLAC subordinated instruments that we had planned for the year. What’s left for the rest of the year is a mere EUR2.5bn of senior preferred, as well as EUR600m of senior non-preferred that will be executed if necessary — this will, of course, depend on the RWA development of the group.

Day, BIHC: How satisfied are you with the results — the pricing and distribution, for example — of your various issuances this year?

Bianchi, UniCredit: We are actually extremely satisfied with what has been achieved so far — and also with the senior non-preferred we did in November of last year. We have issued almost $10bn equivalent of subordinated instruments and collected more than $20bn of orders in total, which gives you an idea of the power and investor appetite for our credit. Demand came from a range of institutional investors across the globe, with both US and European accounts coming in for very significant amounts. We are particularly pleased with the demand from US investors, who once again demonstrated that we have a very broad investor base and very strong market access in different currencies across the capital structure, and also in private placements as well as market instruments.

Take our latest Tier 2, for example: the $1.25bn 15 non-call 10 transaction was the first callable Yankee Tier 2 for quite some time — back in December 2018 ING had to pull a similar deal. Again, this shows our issuance strengths and how much investors believe in our story and our credit profile.

Day, BIHC: You paid limited new issue premiums on the euro AT1 and Tier 2 issuance, while paying some elevated levels in US dollars — how important a consideration is this?

Bianchi, UniCredit: First of all, we are a pan-European bank, so our home market is euro-based. But since setting up our global MTN programme in 2017, we have done a lot of work in the US market, a lot of investor meetings and roadshows to open up this new market for us. And normally when you do inaugural trades you pay concessions. However, when swapped back into euros the dollar spreads for subordinated products still look very competitive thanks to the different shape of US rates versus euros.

When we did the very first senior non-preferred deal in January 2018, the market was also still opening up, so we paid a little bit of a concession at that point. But then when we did our Tier 2 transaction and we paid zero new issue concession, this shows you how quickly our profile has developed in the US market, which is a testament to our strategy there.

Day, BIHC: As you said, you’ve done 90% of the subordinated plan for this year — you have been hitting the market quite heavily. That contrasts with 2017, for example, when you had done only around one-third by July. Issuers always have to balance spreading out issuance with optimising funding costs, but some might say this year it’s been very much about market access for UniCredit, with less on focus issuance costs — how would you respond to that?

Bianchi, UniCredit: We are definitely very focused on issuance costs — we are of course very NII-driven. But at the same time, we are a G-SIFI, and TLAC is coming in by the second quarter, and we want to run a bank that is very safe, not only from a liquidity perspective but also from a capital perspective. We therefore wanted to make sure that firstly, the market sees that we are compliant with TLAC ratios in advance — and we already were at the end of 2018 — and also, that we build a managerial buffer on top to make sure that we run a very safe ship that allows the group to navigate future potential volatility.

The difference between 2017 and 2019 is that we live in a period of quite high uncertainty, and if you want to manage a balance sheet on a conservative basis you need to make sure that you approach the market at the right time, without putting yourself into a difficult situation that can have negative repercussions. That’s our approach to the market and why we have done what we have done.

Day, BIHC: Would you hope that — particularly for the rest of this year — now you have done so much, you can be a bit more relaxed and able to focus even more on the cost side?

Bianchi, UniCredit: For sure. Also, part of our tactics in approaching the market in the first quarter was to use the primary market to manage down our secondary levels, and if you look the spread development of all our instruments, that has been achieved and is a big success for us.

Day, BIHC: Unlike some peers, you seem to be targeting a well spread redemption profile in terms of maturities and call dates on capital instruments. Is this a factor in the choice of the June 2026 date as first call date for the new AT1 issue?

Bianchi, UniCredit: Definitely. We have a very experienced funding team and we carefully plan the redemption profile, in terms of the calls and maturities of our capital instruments, to make sure that we avoid as much as possible any cliff effects. That’s important and the choice of June 2026 as the first call date fits completely into this policy of keeping a very smooth profile on AT1 calls.

Refinancing risk in general is important, and that’s one of the reasons why we also use both the euro and dollar investor bases. If you look at our issuance pattern, it is to try to do a euro, then a dollar, a euro, a dollar, etc, so we don’t put too much pressure on either investor base. That goes hand in hand with making sure that we tactically position our call dates and our refinancing profile. We have always done this and it’s a very important way of making sure that we manage our future issuance in a safe way.

Day, BIHC: The first non-call of an AT1 has prompted a lot of discussions about various aspects of AT1 structures and issuance. One is the call schedule, whether it coincides with the resets or every interest payment date after the first call. On your most recent AT1, you stuck with what you’d done beforehand. Is it a topic investors have raised with you?

Bianchi, UniCredit: We decided to keep our traditional call schedule for the recent AT1 to be aligned with all the other outstanding AT1s — that’s the first reason. Also, the recent AT1 non-call decision has been very well absorbed by the market and the market read it as an idiosyncratic event. We did not face any specific questions on call dates.

Day, BIHC: I imagine your AT1 call policy may nevertheless be something AT1 investors ask about in general. What can you say about your policy?

Bianchi, UniCredit: We did not actually have any specific questions on our call policy. This is probably because the first call date of any of our new-style AT1 is still two and a half years away, in September 2021. We cannot say anything more on our call policy. What I can say is that also regulators are very focused on this, and we got perhaps more questions on it from regulators than investors.

Day, BIHC: You have been acting to enhance the group’s risk profile. How are these efforts coming along and are you seeing any positive outcomes yet?

Bianchi, UniCredit: This is the last year of our Transform 2019 plan and we are going to announce the new plan on 3 December. Under the Transform 2019 plan we have made impressive progress in improving several KPIs in asset quality, costs reduction and the group’s risk profile. We took very decisive action and massively reduced our NPE stock, which is down EUR38.6bn since Q3 2016, more than 50 percent, and net NPLs are down even more on a relative basis — we have done an incredible EUR27bn of NPE disposals in the period. At the same time, we have increased our NPE coverage by more than eight percentage points — that is very important, especially for future provisioning — and UniCredit had the second highest NPE coverage of all Eurozone banks in the latest EBA transparency exercise and the highest in Italy. So from a provisioning perspective, we are extremely well positioned. We have meanwhile strengthened our underwriting processes to contain as much as we can the creation of NPLs — it’s not enough simply to reduce NPLs; you have to work on underwriting policies in parallel. We are expected-loss driven and for new business we have an expected loss of 34bp, below the expected loss of the NPE stock, which is 38bp.

Our pro-active and decisive de-risking actions benefit all our stakeholders, and we are well ahead of regulatory expectations and requirements. We have always stressed that our programme is self-led and not being done for the sake of the regulators — it is above what they would expect of us. We are doing it because we believe we need to have a risk profile that is in line with European and global SIFIs, and that’s why we have such demanding targets for ourselves.

In Q3 2018 we also announced that we will be reducing our BTP spread sensitivity by 35 percent and we are doing that to remove the volatility sensitivity of our capital.

And then to further enhance our group risk profile, we will also ensure that all group legal entities become self-funded by progressively reducing intragroup exposures without, of course, reducing funding synergies. One example is what we are doing with Yapı Kredi, where we are reducing our intragroup funding by 50 percent over the next 24 months, and we are basically applying the same approach to all other legal entities.

Finally, we are going to run down the non-core to zero by 2021.

So post-2021 we will have a group with an NPE ratio that is in line with European and global SIFIs, and with an NPE ratio of probably below 4 percent – the core bank is already there.

That’s how we are managing our risk profile. And that probably explains the good acceptance of our funding plan by the market. We say what we will do and aim to overachieve, and so far we have been able to do that.

Day, BIHC: You have already mentioned that last year the Italian elections were a factor in your timing and you’ve mentioned the upcoming elections this year. Is there anything else to add in respect of Italian politics?

Bianchi, UniCredit: No. It is important to recognise that more than 50 percent of our assets and revenues are outside Italy, so we are a very well diversified pan-European bank that has very strong franchises wherever we operate — we always top five wherever we operate, besides Russia. That helps in times of volatility or in times where the economic environment is weaker.

The other important part about being pan-European is that we have market access outside Italy and we make use of that. We have done a couple of Pfandbrief transactions out of Germany and Austria, for example. And going back to the very active first quarter we had, on the same day in January 2019 that we launched the senior non-preferred issue, we launched the Yapı Kredi AT1 and we also launched a German Pfandbrief. Issuing those three transactions on the same day is quite an achievement. On our side, it was again a case of signalling that we have market access via more than one legal entity, and that there is appetite for our paper in a variety of markets — even if we do three transactions in one day.

Day, BIHC: What are the main concerns you have in terms of regulatory headwinds?

Bianchi, UniCredit: We have the highest visibility on regulations since the financial crisis. However, there are some initiatives that are still underway — the Basel IV package now needs to be transposed into European law, while other important elements of the regulatory framework are still being defined at the European level — BRRD2, FRTB and so on.

We incorporated and communicated on these in our future regulatory headwinds slide at our capital markets day in December 2017, in line with our prudent and transparent approach. It covered these issues in a very comprehensive way and I think we were the first and only bank to really publish something like that — it’s important to note that these regulatory headwinds are relevant for the whole banking sector, not just UniCredit. As well as making this information available to the market, we use it as the basis for our capital planning internally, to make sure that we position ourselves vis-à-vis the forthcoming regulatory headwinds. It may be a conservative approach, but it’s important that our representation of our capital ratios always gives a true and fair view of, let’s say, the economic and regulatory reality. And we had neither on the one hand excess capital nor on the other any shortfall in capital — our capital ratios are fully-loaded and fully compliant with all the regulatory requirements. This is also demonstrated in the recent EBA transparency exercise where UniCredit has one of the best capital ratios in the Eurozone and among its Italian peers.

Day, BIHC: What are your expectations in terms of profitability for yourself and the European banking sector? Do you think profitability should be a concern for AT1 investors?

Bianchi, UniCredit: At UniCredit, we are very focused on situations that we can control, so we have a real execution-driven philosophy internally for our Transform 2019 business plan. If you look at the last two years, we have already achieved very tangible results. Our profitability is already close to the targets as the full-year 2018 adjusted group RoTE stands at 8 percent (up 0.8 percentage points versus full-year 2017 adjusted). That incorporated provisions for US sanctions, and we have just closed that issue, removing another risk — we also provisioned more than was necessary, so have a release of capital of around 8bp, which is positive news in this respect, also underlining how we deal with situations on a conservative basis.

If I look at the core bank — so post-2021, once the non-core is no longer included — we already have an adjusted RoTE that is above 10 percent, which shows you the underlying profitability power of the group. And in the fourth quarter of 2018 net profit was the best in a decade. This shows that the restructuring plan is really working and that UniCredit is very well positioned in the European context. We have confirmed our RoTE targets of above 9 percent for the group and above 10% for the group core.

Regarding AT1 investors, they definitely appreciate sustainable profitability and capital base, and that goes back to your question. Our capitalisation is strong: we have a fully-loaded regulatory core Tier 1 ratio of 12.07 percent as of year-end 2018, and we have a target of between 12 percent and 12.5 percent by the end of 2019. This corresponds to a very comfortable MDA buffer of 200bp-250bp. That’s a very important capital target for us and is how we will manage our capital going forwards, which offers very good support for AT1 investors.

Day, BIHC: Possibly related to the profitability question: the new TLTROs were big news — if not surprising. We’re still waiting on the full details, but what do you expect from them?

Bianchi, UniCredit: TLTRO repayments are embedded in our financial planning for 2019, so we did not rely on a potential TLTRO renewal. Alternative funding sources and the related costs are therefore already taken into consideration in our 2019 projections.

Now we have the new TLTRO III that can potentially be used. First of all, we need to understand the economic characteristics of TLTRO III — we don’t yet have that information. What I can say is that I expect it be used tactically. In general we think it will probably be used by banks to manage their net stable funding ratios. I therefore don’t expect it to be heavily used, especially the first tranche, because banks are on a much better footing than when we had TLTRO I and TLTRO II — we were in a very different economic and financial crisis mode at that time — and therefore the take-up will be quite different. But let’s see — I cannot speak for others.