UniCredit S.p.A. (UCG) Earnings Call Transcript & Summary

Thank you, everybody, for coming along. Stefano Porro, Chief Financial Officer of UniCredit. Everyone's aware how these sessions work. We have 40 minutes. We'll spend about 30 minutes doing some Q&A to begin with and then we'll go straight into audience Q&A. If at any time during our fireside chat, there's something that you really want to ask a question on, please just do throw your hand up into the air and I'll do my best to try and come to you at that point. So first of all, thank you so much for joining us.

Look, the bank at the beginning of the year was clearly in a very strong position. But looking forward, we face a very uncertain macro backdrop. And how do we think about performance of the overall institution going forward both in terms of different regional nuances and also different business line items, businesses which are surprising positively and businesses which are perhaps more challenging than you had initially anticipated?

Chris, so we are entering this phase of uncertainty with some certainties let's say. So a clear strategy and good strategy, strong balance sheet, diversified franchise and especially good commercial momentum because this is what we had in Q1 and this is what is ongoing also today. Now let's start from capital. As a matter of fact, we closed Q1 with 14% so common equity 1 fully loaded taking 70% of the impact from Russia following our extreme loss assessment scenario. In relation to asset quality, we have a healthy asset quality so this will allow us to absorb most or all the potential LLPs coming from the spillover effect following a slowdown that is our base case scenario, but also in case of a recession. Now what is differentiating a slowdown in comparison to a recession? Slowdown looking to our plan is embedding over 2% of GDP reduction in comparison with our base case in the plan that was embedded in our footprint around 4.7% growth in terms of GDP in our countries; and also increasing inflation and for 2022, 4 percentage point more inflation. Recession: so recession, as we communicated last month, for us is fundamentally GDP at 0 2022 and 2023 in our footprint. Now what is necessary to go there is significant further change from a geopolitical standpoint bringing fundamentally to an embargo of oil and gas so fundamentally a full stop and we are not considering this the base case. Also taking into consideration that we are a little bit more than 5 months into the year and as a matter of fact things are going well. There is no sign of deterioration and so taking this into consideration, we cannot consider in this moment the recession as our base case. Now entering a little bit more in details on why we are confident because we have discussed about our confidence and what can be in case a concern. We are confident because we are diversified. So if we are looking our group; we are in many countries, many different product segments. As a matter of fact, if you look also the composition and the exposure and the top line between retail and corporate is really well balanced. And also when you look the composition NII on the top line so net interest income not interest income is also well balanced. And in the top line when you look fees is diversified as well so because they have investment fees, transactional fees and financing fees. And also the model is allowing to have resilience or mitigating action also toward volatility. I'll give you a concrete example. Fees, volatility in the market, we might have tailwinds in relation to the investment fees. But with this type of volatility by our Corporate Solutions division, we can get revenues because we are providing hedging for our corporate clients. And also if you look to our partnership, both in terms of asset management and insurance, the product shelf that we have is such that is allowing us to provide legally consistent and wide product choices to our clients. So this is diversification. So this is one of the very important points. Now let's look to the assumption of our plan so the Unlocked plan. The assumption were conservative. So the top line growth was embedding a conservative assumption on the net interest income and also in relation to fees and was a bad day fundamentally no upside from rates. What we were assuming in Unlocked plan was negative rates in the euro zone until 2024. Now what is currently happening? So let's start from rate so it's a little bit different. So commenting quickly about that. We'd comment about rates, GDP and then inflation. So let's start from rates. With regards to rates, the situation is clearly different in comparison to what we have embedded in the plan. We have communicated in May what can be the impact on our top line on the net interest income assuming 25 basis points deposit facility rate increase by year-end and 25 basis points first half next year, which is the impact around EUR 100 million on our net interest income upside this year and EUR 700 million next year. Then as all of us have been able to see when we are looking to the communication of SCB is likely that the rates rise will be quicker and the magnitude will be different. So if we're assuming to have 50 basis points this year and also 50 basis points next year in the first half, as a matter of fact the upside to our net interest income will be around EUR 200 million this year and will be well above EUR 1 billion next year. So as you can imagine, this can also provide support in case we might have some tailwinds in relation to the volatility that we might expect in the coming future. Now what about GDP? So we are assuming a GDP reduction, which is the effect on GDP. As a matter of fact on GDP, we might have less loans. But as a matter of fact, the effect deriving from rates will more than compensate the potential reduction in the lending. Second point, if we have a lower lending dynamic, as a matter of fact, we will have also less risk weighted assets. So all in all if we are able to have a supporting net interest income but with lower risk-weighted assets, as a matter of fact this is supportive for both the return on tangible equity dynamic and also for the capital generation dynamic. Inflation: inflation, as I was commenting before, is higher. So as a matter of fact is higher, but we have a good track record. So as a matter of fact also in the past in our CE footprint, we have been always able to have a dynamic of the cost below the inflation and we are also front-loaded in Western Europe, some of the action already embedded in the plan. That's why we have also confirmed our targets in relation to cost for 2022 and this is fundamentally the main driver that we are looking at. Then if we're looking to the situation in the different regions because we were commenting also what can happen in a different region. Let's look to Italy. So in relation to Italy if we look during COVID, the amount of savings of households was equal to 7.5% of the GDP. So we think that this can support household to absorb some of the impact that will derive from this situation, I mean will mitigate. And also innovation to corporates, as a matter of further the dynamic of corporate that we have seen so far is good. So as a matter of fact, default rate is low and the dynamic is in line with what we see in 2021. Germany, both private sector and public sector are confirming the financial strength and so we are expecting that, let's say, the measures that will be put in place will help in order to absorb part of the impact that we will have such a situation. Central Eastern Europe: Austria while not expecting to have significant spillover effect assuming no gas deliver stop. In Czech Republic and Hungary, the situation is different in comparison to Austria. But having said that, we are expecting a resilient dynamic of the revenues and overall an asset quality dynamic that will be manageable taking into consideration the actions that have been already taking place. Eastern Europe is the part of the group where the inflation will be higher. Yes, on one hand, they are close to the border. But on the other hand, they have started in advance some specific action like stocking of grains, energy and so on. And so overall, let's say, the starting point of the GDP were also higher and so as a consideration of that, we think that the overall dynamic was in Eastern Europe not only what we have seen so far, but also during the course of the year will remain supportive. Confidence, we are confident in relation to the dynamic that we are seeing on the ground in relation to, let's say, the front line. So the front line is positive, client-centric with the right attitude in keeping the risk discipline as a matter of fact, that's good and the unlocking strategy is proving tried so we think it's working well. Which is the concern? The concern is what we are not controlling as a matter of fact. So what we're not controlling is geopolitical situation. Geopolitical situation and macroeconomic situation that is having and will have an impact from a financial standpoint, but also in the society and this is very important for us. So we will be close to our communities also by an initiative like social lending and so on. And by definition, we will be close to our clients because in such a situation where we are having impact from inflation, impact from the logistic on the logistic chain and so on the market volatility will be there also in order to support well our plans.

You referenced right at the end there the question around geopolitics so I think naturally that sort of takes us on to Russia. So you took 92 basis points in Q1. What would need to happen through Q2 for that number to move materially higher?

Yes, you are right. So we have taken 70% of the capital impact following our external loss assessment. If we would have taken, let's say, the extreme loss assessment scenario as a matter of fact, our capital would have been at 13.6% in terms of fully loaded common equity ratio. So however, above our target of 12.5%, 13%. Whereas the CET so dedicated to that is the strong functions of business compliance, risk management, finance; fully dedicated to manage the local and cross-border exposure looking to all the potential options at defensible price. So this is what we are looking at. Going more into details and having a look to the future as we have mentioned. Local subsidiary, capital-wise we have taken full impact. So 50 basis point in the extreme loss assessment scenario is 46 basis point of impact assuming a full write-down of the participation and the release of the capital. So we have sufficient time in order to assess all the options at the right conditions. Which is the situation? The situation is still net borrowers so we are a net borrower. We'll not support the subsidiary neither from a capital standpoint nor from a liquidity standpoint. Capital liquidity situation local is good, it's sound and the local team is working day by day in compliance with foreign restrictions and -- but also local governance and indication that are changing day by day. But so far, so good. With regards to derivatives, it's important derivative exposure to split in 2. So all the derivatives to our third parties closed, we have not any more exposure. We're only remaining with the intrabook exposure that is towards our subsidiary that is fully collateralized. So in this moment, as a matter of fact, there is no risk. In terms of extreme loss assessment, our extreme loss assessment is, let's say, assuming EUR 400 million that is assuming a further devaluation of the ruble, an important one, and especially not anymore collateral passing from our subsidiary. That currently is not what is happening and also during all the crisis, the collateral costing was always there. Cross-border, so on the cross-border exposure we are at EUR 3 billion -- so around EUR 3 billion. Yes, connecting to your question, I think it's more a matter of geopolitical evolution and overall sanction evolution rather than credit worthiness because the portfolio is really concentrated: top names, critical sectors for the economy. So as a matter of fact, the dynamic of this exposure will fundamentally connected in our opinion to the dynamic of embargo coming back to what I said before as a base case or severe recession scenario. The performance is good because they are all performing. We are conservatively covered because currently we are at around 30%. I mean something like in a likely to pay position even they are all performing. And in our extreme loss assessment scenario, we are expecting to have a recovery of around 40% looking to the quality of the names and the comparable let's say quotes that we can see when there are, let's say, market reference that we can look at. The specific team is there so it's working for both local and cross-border. So we are looking to all the conditions to the risk at the right condition. Important to say that now the opportunities are more limited.

And to the extent that it's possible to put Russia to one side, what are you focused on right now to sort of drive the business in its entirety forward?

Yes. Our focus is fully on the execution of our plan so our Unlocked plan that is based on unlocking the potential of UniCredit as a matter of fact. So the plan is fundamentally assuming and this we are confirming the ambition to have sustainable distribution over the course of the plan. That is linked to the organic capital generation, to the constant organic capital generation and an increased profitability of the business and also with the right investment for further growth. As a matter of fact taking into consideration the current situation and the best case, we are confirming the ambition of and the target of Unlocked plan so not only 2022; but 2022, '23 and '24. So the target that we have for the plan. That is based on the 3 main levers so cost, capital optimization and then net revenues. I was commenting quickly before cost in relation to inflation. Cost is doing well. We have front-loaded some actions. All the agreements with the unions done in Germany, in Austria and in Italy. So as a matter of fact, now we are executing. And if you look the cost dynamic of Q1, this is proving that because dynamic of the cost was really good quarter-on-quarter and year-on-year. Capital optimization, an important element to consider in relation to our capital optimization is that it's not only focused on the contribution from the profit, but is also focused and dependent on the contribution from the risk-weighted asset optimization. And differently from our peers, we do think that we have still opportunity to further optimize our stock of the risk-weighted asset via many actions that by the way we are putting in place. With regard to the net revenues. So the net revenue -- we saw Q1 so Q1 was really strong. We think that the dynamic will remain supportive on the net interest income for the reason I was mentioning before, on fees as well. So we are expecting in 2022 to have a level of fees higher than '21. And also the cost of risk is supportive meaning we have confirmed that a mandate target of this year, we have confirmed also the target of cost of risk excluding Russia between 30 basis points and 35 basis points. So all in all if we are taking into consideration these, the dynamic and the implementation of the plan is on track. Then thinking about considering the focus. The focus and the action also in relation to ESG that is even more important in this environment. So the strategy is done in order to embed ESG in all the activity that we do. ESG is not all E. We are talking several times about E. It's the combination between E&S social that I was commenting before. And so as a matter of fact, we are focusing in order to help and support our clients in the transition and this green transition is even more important in the situation that we have in front of us nowadays.

So you touched on this topic right at the beginning and also just now, but I wanted to come back to it. So clearly in recent weeks and months, spreads have widened and asset quality is obviously in a better position now than it was in the past. But I wondered if you could just dive a little bit into more detail on the points you mentioned in terms of asset quality and cost of risk as it pertains to both UniCredit and to the client base.

Yes. I mean in relation to spread widening and more specific to, let's say, in Italian govies, maybe I can comment a couple of points. One is the impact that we might have on capital and the second one is asset quality. So let's look to our investment portfolio. Our investment portfolio is around EUR 140 billion. Italian govi exposure is EUR 41 billion nowadays. Which is the duration? The duration is below 4. More than 55% is held to collect. That means no volatility to the capital, which is a sensitivity. Every 10 basis point asset spread widening essentially to capital is around 2 basis points. So not an important one and we are not expecting to have a meaningful change in the exposure neither on the investment portfolios nor on the investment portfolio related to the Italian govies. Now looking also to the spread widening in the situation, I think it's important to comment on 2 or 3 topics. One I think is the consideration in relation to the fact that when we looked to the previous crisis and the peak of the previous crisis, the geopolitical -- the political situation in Italy was different in comparison with now and also the link to reaffirm that the next generation plan is giving is also a good support from that standpoint. Second important point is that as a matter of fact if you look, the foreign investor is around 20% of the total stock of the debt so 80% is in Italian investor and ECB and this is also giving us support. And finally, considering ECB and considering the stance communicated of ECB, they will also look and check to avoid the market fragmentation. So all in all, this we think will be supporting in order to avoid an important and permanent structural widening of the spread while we think that we might have some volatility especially taking into consideration the change in the monetary policy. Let's go to the asset quality and the impact on the asset quality and let's look to our asset holdings. So if we look our NPE, NPE ratio is 3.7%. Looking EBA methodologies is 2.5%. Coverage is really high, 52%. The performing portfolio, we have around 20% of the portfolio in Stage 2, one among the best I think in Europe in relation to the coverage of the performing portfolio that is 1% total portfolio is more than 4%, it's close to 5% Stage 2. Cost of risk dynamics so far really good. Q1 excluding Russia close to 0. It was 5 basis points and the default rate is low as well. If you look then to Italy, it's important to bear in mind that if you look our exposure, close to 30% of our corporate exposure is represented by state guaranteed loans. So currently we're around EUR 25 billion. It's an important element to be taken into consideration when you need to take into consideration the potential evolution of the cost of risk in Italy. So -- and when you look to the future so let's say to the new production, the expected loss on the stock is around 35 basis points. But when you look to the new production, you expect the loss of the new production is around 27 basis points and also the Italian one is fundamentally similar to last year. So as a matter of fact, currently we're not seeing any sign of deterioration and also the impact potential deriving from spread widening in the Italian part of our portfolio, we don't think it will be meaningful for the dynamic of the cost of risk.

So let's pivot slightly to capital allocation because clearly with asset valuations having gone where they've gone, both repurchasing your own stock is incredibly compelling, but so too are potential asset combinations with other participants. So maybe talk us through how you think about the balance between M&A and share repurchases.

Let's say our M&A strategy is really clear. So no change in relation to that, completely in line with what we have communicated in Investor Day. So can be an accelerator or can be value accreting, but only at the right conditions. 3 conditions so fundamentally strategic consistency, business strengthening and accretion. What do we mean accretion? Accretion to the profitability and to the distribution capacity over the long term. All the 3 condition has to be met otherwise I mean we are not looking at potential M&A. And if we look our franchise, as a matter of fact, we are Top 3 in our 4 countries. That plan is not embedding any M&A. So as a matter of fact, we can execute the plan and achieving all the right target without adding M&A. On top of that, I have to say that the plan has been built with a capital buffer above 12.5%, 13%. The buffer was there in order to cope with extraordinary impact, to cope with an increased level of distribution, i.e., higher than EUR 16 billion and to cope with potential M&A. We had an extraordinary impact so a portion of that capital buffer has been absorbed by Russia. And at this level of the stock, as a matter of fact if you look, share buyback and so on, the bar is higher. So if you are taking into consideration on one hand that we have, let's say, the buffer is still there but is lower and the level of the stock, the bar for M&A is higher.

And I think before we go to audience Q&A, the EUR 16 billion target that you have, the commitment that you have which you recently reconfirmed in Q1, I think that remains a cornerstone for the investment thesis in many people's minds. So maybe just walk through sort of the assumptions and what are the main moving parts from both the macro and operational and also a supervisory perspective to get comfortable with that EUR 16 billion number?

Yes. As I will comment before so we are confirming targets for the plan based on our base slowdown scenario and this is including also distribution so at least EUR 16 billion. What about the 2021 one? EUR 1.2 billion cash dividend paid, the EUR 1.6 billion buyback is ongoing and we have already accrued EUR 400 million of the dividend in relation to the profit this year. This is accrued looking to the net profit ex Russia. So if we are looking at the distribution so this is really important. If you look at the distribution for this year in comparison with the market cap is 12% of the market cap not taking into consideration the further EUR 1 billion of buyback. If we also take into consideration the further EUR 1 billion of buyback is 16% of the market cap. When we are looking then to the EUR 1.6 billion, so far we have purchased more than 30 million shares that is around 1.6%. We are expecting to finalize the buyback the EUR 1.6 billion by the end of July. In relation to the actions, all the actions that we have put in place are supporting, let's say, the distributions. For example the organic capital generation last year we did 200 basis points, first part of Q1 was 57% overall capital generation. We are confirming the organic capital generation for the year at 150 basis points and all the action that we will put in place are such that we'll be on track in relation to what was embedded in the plan in terms of specific portfolio management action. So then we're looking to regulators, let's say, or let's say approval process, as you know, cash dividend is different in comparison with the buyback. We have constant dialogue with the regulators. Having said that, taking into consideration that we are expecting to have an important organic cash generation, meeting the capital target and with this level of capital, we do think that the discussion with the regulator will be supportive from this standpoint. So all in all, we think that we have the right strategy in this moment to, let's say, finalize the plan, to deliver from stakeholders standpoint even if as a matter of fact the future is clouded, but we are confident that we will go through.

Okay. We have 10 minutes remaining so I think it's the time to turn to audience Q&A. We have a question right here at the front. It was easy for me to spot. And I think the microphone is coming up all the way from the back.

One simple question following on distributions. Given where the stock price is at the moment, don't you think that makes sense to rethink the mix between dividends and buyback?

Let's say the mix has been defined and communicated. The mix is also dependent from the different shareholder discussion that we have so the mix between cash dividend and share buyback. As a matter of fact, I was commenting before in relation to the level of the stock and to the level of the accretion to EPS and DPS and share buyback is doing. So as a matter of fact, we are okay with this approach. We can execute to fine-tune the mix over time, but all in all nowadays we are confirming the mix.

I was speaking towards that maybe it makes sense to make more buyback and less cash. That was my question really.

I think if you look currently, the amount I was mentioning to you -- the amount of buyback in compared with the market caps. For example this year EUR 1.6 billion. It will take a while including also the EUR 1 billion is also taking a while. We think that the composition is well balanced in this standpoint. So it's providing a well balance between the accretion, but also combining with a cash dividend is important for part of the shareholders.

I'm just wondering it's been a decade since we've seen rate hikes in Europe. What gives you confidence that within your geographies, the banking sector won't compete away the benefits of these rate hikes that they will hold on to some of these profits?

Let's say if I look in general for banks, a situation where there is rate hikes is positive especially taking into consideration that usually that you have a positive net interest income sensitivity as I was commenting in our case. In the euro zone if the level of rates increase is what we are currently expecting, as a matter of fact, is supportive for the top line for the net interest income and is not creating an issue from cost of risk standpoint and to the growth. You might have situation where the rates are clearly higher. In our case for example, Czech Republic and Hungary. In such a case, the impact on the top line is even more and you might have some impact in relation to the demand of credit. So if the rates are really high, the demand of credit can also be impacted. But then if the asset quality is really good, overall within that situation is all in all for the region where we're working really supportive for the dynamic of the bottom line.

Mark Hoge from BDL. Just a question on buybacks and how we should think of that in terms of a potentially deteriorating economic environment. The reason I raised the question is during COVID, we had the European dividend -- European banks dividend ban. So I guess my question is how confident can we be that you plow through with your approved buybacks given the rapidly deteriorating economic situation and the potential for that to get worse and then kind of gas disruption for example?

Let's say leading as a regulatory consideration as a matter of fact, but just commenting politically about it. The ECB stance at least in comparison to what they have communicated was different in COVID in comparison with this situation. So in this situation, as a matter of fact, it's more looking to a case-by-case situation. So looking to a case-by-case situation and looking to our situation as a matter of fact. In a slowdown situation so slowdown of the growth as a matter of fact. If you look at our capital work this year, as a matter of fact, in that situation and assuming also a distribution level that's similar to 2021 with an organic capital generation of 150 basis points that we are expecting this year. As a matter of fact notwithstanding the fact that we are also assuming to have regulatory headwinds for around 50 basis points for the full year, we will arrive to a level of capital that is around 12.5% -- 12.9%, sorry, so close to 13%. It is in the upper end of our 12.5%, 13%. So that's why it was commented that in a situation of slowdown so where there is slowdown of the growth with the strategy that we have as a matter of fact and with the organic capital generation capacity that we have, the organic capital generation per se will support the distribution levels that we have embedded in the plan. And this is true for '22, but it will be true for '23, '24. In a recession scenario, that can be different because the overall impact can be different in comparison to a slowdown scenario.

Can you just remind us the expectations for RWA growth in the plan? And then is there a scenario where we actually see far higher loan growth demand as companies invest in needing more working capital, inventories and sort of reshoring or building new plants within the new footprint and does that change the organic capital generation that you have embedded in the plan?

I don't think so. The lending growth dynamic was well supported in Q1. As a matter of fact, the lending leverage stock of lending risk was around EUR 8 billion more less in all the geographies and both on households and corporates. We need to take into consideration the slowdown scenario I was referring to you before. So as a matter of fact with a lower GDP, we're also expecting to have a lower dynamic of the lending. So from that standpoint, as I was commenting before, we are not expecting let's say a dynamic of the lending and the consideration of risk-weighted asset higher than what we are expecting in the plan. If I look at the business mix so probably lower from the standpoint. And on the other hand, all the portfolio management actions that were put in place on the stock like securitization and so on are confirmed in a way. The spillover effect in relation to regulatory headwinds we might have. For example in case or a recession, we think that will be fundamentally mitigated in comparison with the assumption on the plan from a reduction in the lending role. So all in all, that's why we are confident to confirm the overall dynamic of the risk-weighted assets. So we are not expecting a meaningful change in the overall dynamic of the risk-weighted asset in comparison to what we were embedding in the plan.

I think we have time for one final question. No. Otherwise I think let's wrap it up. Thank you so much for spending your time coming here and sharing those insights. That's hugely helpful and we look forward to seeing you again. Thank you so much.

My pleasure. Thank you.