Financials Credit Analyst

Hank Calenti, CFA

CreditContinuum

Credit

Executive Summary: European bank AT1 significantly outperformed Asia as each EU benchmark Basel III bond tightened during the week. Concurrently, increased risk appetite resulted in performance across the credit continuum in Asia bank bonds. A steepening US Treasury yield curve and risk-on market sentiment drove bank credit spreads tighter, globally. Please see our <a href="https://www.smartkarma.com/insights/bank-macro-manifest-risk-rally-gathers-steam-as-bad-news-more-stimulus" target="_blank" data-smartkarma-citation="insights:47886" rel="noopener">Bank Macro Manifest: Risk Rally Gathers Steam as Bad News = More Stimulus</a> for more details.Europe’s AT1 performance further compressed option adjusted spreads between European AT1 and Asia financial institutions to 50bps inside 2019 levels. This begs the question of how much more spread compression is possible.Globally, <a href="https://www.smartkarma.com/entities/unicredit-spa" target="_blank" data-smartkarma-citation="entities:21234:1" rel="noopener">UniCredit's (UCG IM)</a> 8% coupon 2024 callable note led AT1 and broader bank bond performance, tightening 102bps over the week. This outperformance coincided with positive risk asset sentiment following the announcement that former ECB President Mario Draghi was asked to form Italy’s next government. Investors may wish to consider what additional catalyst could drive spreads tighter. UniCredit is expected to report earnings on Thursday, 11 February.In Asia, Nanyang Commercial Bank led AT1 bond performance by tightening another 54bps on the week. Relative to <a href="https://www.smartkarma.com/entities/bank-of-east-asia-ltd" target="_blank" data-smartkarma-citation="entities:341:1" rel="noopener">Bank of East Asia's (23 HK)</a> 5 5/8% coupon 2022 callable note, the Nanyang outperformance is beginning to look overdone. Please see <a href="https://www.smartkarma.com/insights/bank-credit-compass-credit-tourist-may-vacate-if-real-fundamentals-do-not-catch-up" target="_blank" rel="noopener">Bank Credit Compass: Credit Tourist May Vacate if Real Fundamentals Do Not Catch-Up</a> for more details.<a href="https://www.smartkarma.com/entities/state-bank-of-india" target="_blank" rel="noopener">State Bank of India's (SBIIN)</a> prediction of double-digit returns following results that were better than expectations, drove its shares to a 40% gain during the week. SBIIN’s credit was already there, in our view, but other India-headquartered bank credits may benefit.Meanwhile, in the broader Emerging Market (EM) Senior Unsecured HY area, Turkish bank bonds continued to catch-up with their higher rated EM peers with several notes tightening by +60bps over the week. Given the positive developments in Turkey over the last few weeks and the global risk-on environment, several of these banks continue to trade wide relative to most other EM banks.Market Outlook: Investors remain susceptible to management’s prophecies. Asset quality indicators may greatly underestimate the level of troubled debt due to continued forbearance, restructuring efforts and early-stage aging. This is driving provisioning costs lower than would be expected in a more normal operating environment. The value of these reports is significantly diminished for credit investors. Financial repression creates a market, which in its nature, is always a one-sided bet with the Fed / ECB/ BOJ. There is limited price discovery.  As such, credit value should remain driven by larger market forces.

Executive Summary: European bank AT1 significantly outperformed Asia as each EU benchmark Basel III bond tightened during the week. Concurrently, increased risk appetite resulted in performance across the credit continuum in Asia bank bonds. A steepening US Treasury yield curve and risk-on market sentiment drove bank credit spreads tighter, globally. Please see our Bank Macro Manifest: Risk Rally Gathers Steam as Bad News = More Stimulus for more details.Europe’s AT1 performance further compressed option adjusted spreads between European AT1 and Asia financial institutions to 50bps inside 2019 levels. This begs the question of how much more spread compression is possible.Globally, UniCredit's (UCG IM) 8% coupon 2024 callable note led AT1 and broader bank bond performance, tightening 102bps over the week. This outperformance coincided with positive risk asset sentiment following the announcement that former ECB President Mario Draghi was asked to form Italy’s next government. Investors may wish to consider what additional catalyst could drive spreads tighter. UniCredit is expected to report earnings on Thursday, 11 February.In Asia, Nanyang Commercial Bank led AT1 bond performance by tightening another 54bps on the week. Relative to Bank of East Asia's (23 HK) 5 5/8% coupon 2022 callable note, the Nanyang outperformance is beginning to look overdone. Please see Bank Credit Compass: Credit Tourist May Vacate if Real Fundamentals Do Not Catch-Up for more details.State Bank of India's (SBIIN) prediction of double-digit returns following results that were better than expectations, drove its shares to a 40% gain during the week. SBIIN’s credit was already there, in our view, but other India-headquartered bank credits may benefit.Meanwhile, in the broader Emerging Market (EM) Senior Unsecured HY area, Turkish bank bonds continued to catch-up with their higher rated EM peers with several notes tightening by +60bps over the week. Given the positive developments in Turkey over the last few weeks and the global risk-on environment, several of these banks continue to trade wide relative to most other EM banks.Market Outlook: Investors remain susceptible to management’s prophecies. Asset quality indicators may greatly underestimate the level of troubled debt due to continued forbearance, restructuring efforts and early-stage aging. This is driving provisioning costs lower than would be expected in a more normal operating environment. The value of these reports is significantly diminished for credit investors. Financial repression creates a market, which in its nature, is always a one-sided bet with the Fed / ECB/ BOJ. There is limited price discovery.  As such, credit value should remain driven by larger market forces.

Bank Credit Weekly: AT1 Outperformance in Risk-On Environment

Financials & FinTech research, Galliano’s Financials Research

Victor Galliano

Financials & FinTech research

Financials & FinTech, EM & Developed Markets

Galliano’s Financials Research

Galliano's Financials Research provides fundamental research in Emerging Markets financials, including FinTech, as well as financials in select Developed Markets.

The investment style applied is generally value oriented, although Growth At Reasonable Price (GARP) strategies can also be used where appropriate. 

Our investment research approach aim is often contrarian, looking to capitalise on overly sceptical or optimistic consensus views. In terms of valuation techniques, the focus is on PBV ratio to ROE, PE multiples and dividend yield, as well as the application of PEG ratios and, where appropriate, Sum of the Parts (SOTP) valuations.

Equity Bottom-Up

<ul>
<li>
<a href="https://www.smartkarma.com/entities/unicredit-spa" target="_blank" data-smartkarma-citation="entities:21234:1" rel="noopener">UniCredit SpA (UCG IM)</a>  is to appoint Andrea Orcel as its next CEO, according to reports in the financial press</li>
<li>Orcel will need to walk the tightrope of defending Unicredit’s shareholder value and the political hot potato of the potential Banca Monte dei Paschi absorption</li>
<li>We believe that Orcel as CEO will act as an effective check to Unicredit chairman-designate Padoan, the most influential and vocal proponent of the BMPS deal</li>
<li>In the event of a Unicredit-BMPS union, we would expect Orcel to drive for a capital neutral deal, with a relatively clean BMPS balance sheet</li>
<li>Despite Unicredit shares having rallied by over 6% in the last two days on the Orcel announcement, we still see Unicredit as a very attractive value play among Italian and European banks</li>
<li>Risks to our view include a Unicredit-BMPS union that implies the absorption of a high level of BMPS NPLs and a less than neutral impact on Unicredit’s capital position</li>
</ul>



UniCredit SpA (UCG IM)  is to appoint Andrea Orcel as its next CEO, according to reports in the financial press
Orcel will need to walk the tightrope of defending Unicredit’s shareholder value and the political hot potato of the potential Banca Monte dei Paschi absorption
We believe that Orcel as CEO will act as an effective check to Unicredit chairman-designate Padoan, the most influential and vocal proponent of the BMPS deal
In the event of a Unicredit-BMPS union, we would expect Orcel to drive for a capital neutral deal, with a relatively clean BMPS balance sheet
Despite Unicredit shares having rallied by over 6% in the last two days on the Orcel announcement, we still see Unicredit as a very attractive value play among Italian and European banks
Risks to our view include a Unicredit-BMPS union that implies the absorption of a high level of BMPS NPLs and a less than neutral impact on Unicredit’s capital position


Unicredit (UCG IM) – Orcel’s Balancing Act

Thematic (Sector/Industry)

<ul>
<li>The investor rotation into value focusing in on EM and DM banks; our key picks are <a href="https://www.smartkarma.com/entities/credicorp-ltd" target="_blank" data-smartkarma-citation="entities:25963:1" rel="noopener">Credicorp Ltd (BAP US)</a>, <a href="https://www.smartkarma.com/entities/turkiye-garanti-bankasi-as" target="_blank" data-smartkarma-citation="entities:25026:1" rel="noopener">Turkiye Garanti Bankasi As (GARAN TI)</a>, <a href="https://www.smartkarma.com/entities/commercial-international-bank" target="_blank" data-smartkarma-citation="entities:27625:1" rel="noopener">Commercial International Bank (COMI EY)</a> in EM banks, and <a href="https://www.smartkarma.com/entities/unicredit-spa" target="_blank" data-smartkarma-citation="entities:21234:1" rel="noopener">UniCredit SpA (UCG IM)</a>, <a href="https://www.smartkarma.com/entities/caixabank-sa" target="_blank" data-smartkarma-citation="entities:21255:1" rel="noopener">CaixaBank SA (CABK SM)</a>, and <a href="https://www.smartkarma.com/entities/bper-banca-s-p-a" target="_blank" data-smartkarma-citation="entities:21165:1" rel="noopener">BPER Banca S.p.A (BPE IM)</a> in Southern Europe banks</li>
<li>Exchanges and Big Data, the convergence; <a href="https://www.smartkarma.com/entities/intercontinental-exchange-inc" target="_blank" data-smartkarma-citation="entities:10221:1" rel="noopener">Intercontinental Exchange (ICE US)</a> is strong on recurring revenues, and both ICE and <a href="https://www.smartkarma.com/entities/s-p-global-inc" target="_blank" data-smartkarma-citation="entities:9735:1" rel="noopener">S&amp;P Global Inc. (SPGI US)</a> should deliver shareholder value creation from transformative M&amp;A</li>
<li>Potential for premium growth and returns in digital payments; we like <a href="https://www.smartkarma.com/entities/nexi-spa" target="_blank" data-smartkarma-citation="entities:28921:1" rel="noopener">Nexi SpA (NEXI IM)</a>, where we see clear benefits from its M&amp;A, and we see <a href="https://www.smartkarma.com/entities/paypal-holdings-inc" target="_blank" data-smartkarma-citation="entities:4747:1" rel="noopener">Paypal Holdings (PYPL US)</a> as a core holding</li>
<li>Digital wealth managers focus on the mass affluent; <a href="https://www.smartkarma.com/entities/finecobank-banca-fineco-spa" target="_blank" data-smartkarma-citation="entities:21188:1" rel="noopener">Finecobank Banca Fineco (FBK IM)</a> stands out in Europe, <a href="https://www.smartkarma.com/entities/xp-inc" target="_blank" data-smartkarma-citation="entities:28619:1" rel="noopener">XP Inc (XP US)</a> is the leader in Brazil but looks over-valued and exposed to increased competition, in our view</li>
<li>Risks to our positive views on our themes includes slower than expected growth in digital payments, transactions and increased regulation on big data; a slower than expected global GDP recovery also could adversely impact bank fundamentals</li>
</ul>


The investor rotation into value focusing in on EM and DM banks; our key picks are Credicorp Ltd (BAP US), Turkiye Garanti Bankasi As (GARAN TI), Commercial International Bank (COMI EY) in EM banks, and UniCredit SpA (UCG IM), CaixaBank SA (CABK SM), and BPER Banca S.p.A (BPE IM) in Southern Europe banks
Exchanges and Big Data, the convergence; Intercontinental Exchange (ICE US) is strong on recurring revenues, and both ICE and S&amp;P Global Inc. (SPGI US) should deliver shareholder value creation from transformative M&amp;A
Potential for premium growth and returns in digital payments; we like Nexi SpA (NEXI IM), where we see clear benefits from its M&amp;A, and we see Paypal Holdings (PYPL US) as a core holding
Digital wealth managers focus on the mass affluent; Finecobank Banca Fineco (FBK IM) stands out in Europe, XP Inc (XP US) is the leader in Brazil but looks over-valued and exposed to increased competition, in our view
Risks to our positive views on our themes includes slower than expected growth in digital payments, transactions and increased regulation on big data; a slower than expected global GDP recovery also could adversely impact bank fundamentals


FinTech & Financial Investment Themes 2021

<ul>
<li>In our Southern Europe bank screens, we look for attractive valuations, core capital strength and constructive signals on credit quality</li>
<li>In Italy, we are positive on <a href="https://www.smartkarma.com/entities/unicredit-spa" target="_blank" data-smartkarma-citation="entities:21234:1" rel="noopener">UniCredit SpA (UCG IM)</a> , which is attractive on valuations, credit quality and capital as well as <a href="https://www.smartkarma.com/entities/bper-banca-s-p-a" target="_blank" data-smartkarma-citation="entities:21165:1" rel="noopener">BPER Banca S.p.A (BPE IM)</a> on valuations and NPL coverage</li>
<li>In Spain, <a href="https://www.smartkarma.com/entities/banco-bilbao-vizcaya-argentari" target="_blank" data-smartkarma-citation="entities:21251:1" rel="noopener">Banco Bilbao Vizcaya Argentari (BBVA SM)</a> screens well on valuation, NPL coverage and the capital ratio will get a boost post US Bancshares disposal; we are also positive on the Caixabank-Bankia merger</li>
<li>
<a href="https://www.smartkarma.com/entities/banco-comercial-portugues-sa" target="_blank" data-smartkarma-citation="entities:21358:1" rel="noopener">Banco Comercial Portugues Sa (BCP PL)</a> is one to watch in Portugal, while we believe that the Greek banks still have a way to go on balance sheet de-risking</li>
<li>Risks to our positive views on the recommended Italian and Spanish banks include a reversal of investor sentiment into a more “risk off” mode, including investors shunning value shares</li>
</ul>


In our Southern Europe bank screens, we look for attractive valuations, core capital strength and constructive signals on credit quality
In Italy, we are positive on UniCredit SpA (UCG IM) , which is attractive on valuations, credit quality and capital as well as BPER Banca S.p.A (BPE IM) on valuations and NPL coverage
In Spain, Banco Bilbao Vizcaya Argentari (BBVA SM) screens well on valuation, NPL coverage and the capital ratio will get a boost post US Bancshares disposal; we are also positive on the Caixabank-Bankia merger

Banco Comercial Portugues Sa (BCP PL) is one to watch in Portugal, while we believe that the Greek banks still have a way to go on balance sheet de-risking
Risks to our positive views on the recommended Italian and Spanish banks include a reversal of investor sentiment into a more “risk off” mode, including investors shunning value shares


Southern Europe Bank Screens; Picks for 2021

<ul>
<li>The elephant in the Italian bank M&amp;A room is government controlled <a href="https://www.smartkarma.com/entities/banca-monte-dei-paschi-di-siena" target="_blank" data-smartkarma-citation="entities:21162:1" rel="noopener">Banca Monte dei Paschi di Siena (BMPS IM)</a>, which needs to find a merger partner in 2021; will that be <a href="https://www.smartkarma.com/entities/unicredit-spa" target="_blank" data-smartkarma-citation="entities:21234:1" rel="noopener">UniCredit SpA (UCG IM)</a>, post-Mustier, and who could be its new CEO?</li>
<li>We believe that, in the event of a Unicredit acquisition of BMPS, it would require meaningful “government sponsorship”; in effect, for BMPS, pre-deal, to dispose of the bulk of its NPLs – which is underway – and for a capital infusion that renders the deal to be capital neutral for Unicredit</li>
<li>The other big M&amp;A unknowns relate to the listed mid-cap banks especially <a href="https://www.smartkarma.com/entities/banco-bpm-spa" target="_blank" data-smartkarma-citation="entities:28121:1" rel="noopener">Banco BPM SpA (BAMI IM)</a> and <a href="https://www.smartkarma.com/entities/bper-banca-s-p-a" target="_blank" data-smartkarma-citation="entities:21165:1" rel="noopener">BPER Banca S.p.A (BPE IM)</a>; these banks need to cut costs and branch networks, which can be more readily incorporated into a merger restructuring plan</li>
<li>We believe that the risk of a BMPS acquisition is largely priced into Unicredit shares, and we expect its wide PBV discount to premium valued <a href="https://www.smartkarma.com/entities/intesa-sanpaolo-spa" target="_blank" data-smartkarma-citation="entities:21200:1" rel="noopener">Intesa Sanpaolo (ISP IM)</a> to narrow;  our recommendation is to go long Unicredit, short Intesa</li>
<li>We think <a href="https://www.smartkarma.com/entities/credit-agricole-sa" target="_blank" data-smartkarma-citation="entities:21373:1" rel="noopener">Credit Agricole Sa (ACA FP)</a> is unlikely to sweeten the <a href="https://www.smartkarma.com/entities/credito-valtellinese-spa" target="_blank" data-smartkarma-citation="entities:21175:1" rel="noopener">Credito Valtellinese Sc (CVAL IM)</a> cash offer of €10.50 per share, and with CreVal shares trading at a 7% offer premium, there could be downside risk</li>
<li>We remain negative on Banco BPM shares, as, in the wake of the CredAg offer for CreVal, we believe that BPM’s options are limited, and that it may be the potential “back-stop” merger candidate with BMPS, in the event of no deal with Unicredit; the alternative could be a BPM-BPER merger, and we turn constructive on BPER, after its protracted underperformance</li>
<li>Risks to our view include Unicredit acquiring BMPS on worse than expected terms, with Intesa on the other hand delivering better than expected synergies and savings from the UBI integration; other risks also include a bidder emerging for BPM, as well as no merger or bid for BPER</li>
</ul>


The elephant in the Italian bank M&amp;A room is government controlled Banca Monte dei Paschi di Siena (BMPS IM), which needs to find a merger partner in 2021; will that be UniCredit SpA (UCG IM), post-Mustier, and who could be its new CEO?
We believe that, in the event of a Unicredit acquisition of BMPS, it would require meaningful “government sponsorship”; in effect, for BMPS, pre-deal, to dispose of the bulk of its NPLs – which is underway – and for a capital infusion that renders the deal to be capital neutral for Unicredit
The other big M&amp;A unknowns relate to the listed mid-cap banks especially Banco BPM SpA (BAMI IM) and BPER Banca S.p.A (BPE IM); these banks need to cut costs and branch networks, which can be more readily incorporated into a merger restructuring plan
We believe that the risk of a BMPS acquisition is largely priced into Unicredit shares, and we expect its wide PBV discount to premium valued Intesa Sanpaolo (ISP IM) to narrow;  our recommendation is to go long Unicredit, short Intesa
We think Credit Agricole Sa (ACA FP) is unlikely to sweeten the Credito Valtellinese Sc (CVAL IM) cash offer of €10.50 per share, and with CreVal shares trading at a 7% offer premium, there could be downside risk
We remain negative on Banco BPM shares, as, in the wake of the CredAg offer for CreVal, we believe that BPM’s options are limited, and that it may be the potential “back-stop” merger candidate with BMPS, in the event of no deal with Unicredit; the alternative could be a BPM-BPER merger, and we turn constructive on BPER, after its protracted underperformance
Risks to our view include Unicredit acquiring BMPS on worse than expected terms, with Intesa on the other hand delivering better than expected synergies and savings from the UBI integration; other risks also include a bidder emerging for BPM, as well as no merger or bid for BPER


Italian Banks M&A Scenarios: The Italian Job in 2021

Italy

UniCredit S.p.A. attracts deposits and offers commercial banking services. The Bank offers consumer credit, mortgages, life insurance, business loan, investment banking, asset management, and other services. UniCredit operates worldwide.

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UniCredit SpA (UCG IM)

Bank Credit Weekly: AT1 Outperformance in Risk-On Environment

European bank AT1 significantly outperformed Asia as each EU Basel III AT1 note tightened. Concurrently, increased risk appetite drove performance...

Hank Calenti, CFA

Unicredit (UCG IM) – Orcel’s Balancing Act

Andrea Orcel's soon-to-be-confirmed CEO appointment affords UCG shareholders some protection in the BMPS acquisition scenario; we expect a focus on...

Victor Galliano

FinTech & Financial Investment Themes 2021

Our key 2021 investment themes and ideas in EM and S Europe banks, exchanges and data providers, digital payments companies and digital wealth...

Victor Galliano

Southern Europe Bank Screens; Picks for 2021

As 2021 Southern Europe bank picks, Unicredit, BPER and BBVA, Caixaban-Bankia stand out in terms of valuation, capital strength and credit quality

Victor Galliano

Italian Banks M&A Scenarios: The Italian Job in 2021

Italian banks M&A is gathering and we take a largely contrarian stance on stocks; pairs trade long Unicredit, short Intesa; positive on BPER,...

Victor Galliano

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