Moody’s Market Implied Ratings group has an interesting – and bearish – note out on UniCredit, highlighting concerns about the bank’s exposure to Central and Eastern Europe.
The note, written by analyst Lisa Hintz, suggests UniCredit’s CDS-implied rating of A1 is “an overly optimistic signal of the bank’s level of credit risk”. From the report:
UniCredit largely avoided the proprietary trading and structured product problems suffered by the other large European banks. However, the financial problems arising from the economic downturn, such as imbalances, could cause deterioration in UniCredit’s loan portfolio, and we do not believe this is reflected in the trading levels of its credit default swaps.
UniCredit’s CDS-implied rating is A1, down three notches from a recent high of Aa1 and one notch below its senior unsecured rating of Aa3 (Figure 1). We still see this as an overly optimistic signal of the bank’s level of credit risk, in that it doesn’t capture UniCredit’s comparatively thin level of capitalization and heavy exposure to Central and Eastern Europe. This exposure came after a rapid expansion which has left the bank with an unseasoned loan portfolio.
Moody’s stresses that the implied ratings group is separate and distinct from the ratings unit of the company – which, in FT Alphaville’s opinion, makes MIR that much more interesting.
As David Munves, managing director of credit strategy, put it to Bloomberg last year, MIR “a product that is basically publicising where the market disagrees with Moody’s”.
MIR’s assessment of UniCredit jibes with this contrarian persona. Moody’s rates UniCredit at Aa3 with a stable outlook; MIR thinks the CDS and bond-implied rating of A1 is a tad starry-eyed. (Which implies, of course, that MIR’s analyst believes the Moody’s rating is even more unreasonable optimistic…)
Why? Poland, mainly, per the charts below (and FT Alphaville’s repeated warnings):
Loans to Central and Eastern European clients made up 13% of UniCredit’s assets at the end of 2007. These made up an even greater portion of its revenue—21% in the third quarter.
Until the recession hit, these countries were undergoing rapid economic growth, but were dependent on capital inflows, and in most cases, exports. Both have dried up, leaving these countries, their citizens, and their companies with a much reduced ability to service their loans. Moreover, much of the bank lending, either through trade finance or unmatched currency lending, requires liquid foreign exchange markets. As East European currencies have fallen out of fashion, the cost of hedging these exposures has risen. This risk either has to be borne by the borrower or the bank—in either case the costs and risks are larger than foreseen at the time of underwriting.
As for Poland in particular, MIR notes Moody’s negative credit outlook on the Polish banking system and the “expectation of increasing pressure on wholesale funding and foreign exchange hedging facilities”, adding:
Poland has been heavily dependent on transfer payments from nationals working elsewhere in Europe. With rising unemployment, many are losing their jobs.
On Friday, Poland’s CDS was trading around 243, which according to MIR suggested an implied rating of Baa1, compared with Moody’s sovereign rating of A2.
The report also notes that the bond market led the CDS market in discounting the risks associated with UniCredit’s unseasoned loan portfolio:
UniCredit’s refinancing of its 5-year debt announced January 7 was priced to yield 288 bp over German bunds, representing a bond-implied rating of A1, a gap of -1 to Moody’s rating. This is three notches from the +2 CDS-implied rating gap at the time of pricing.
(In MIR speak, a gap of -1 means one notch below Moody’s rating; +2 means two notches above).
And in case you missed their point:
The markets have since narrowed, but we think the market may still be underestimating the risk in both cases.
Hear that UniCredit? MIR is watching you.
Related links:
UniCredit chief scrutinised as bank struggles – FT
UniCredit boosts capital with sales – FT
“Welcome to the first truly European bank” – Lex
State bailout looms for Italian banks – FT