It looks likely that Unicredit will be entering into a shotgun wedding with Mone dei Paschi di Siena (MPS). Unicredit will be compelled by the Italian political and monetary authorities to act as a White Knight.
MPS just failed its European Banking Authority Stress Tests but then it has been flat broke for years.
For a putative White Knight, Unicredit is in no great shape itself.
We studied Unicredit’s capital position both at the time of its “recapitalization” Rights Issue in 2016/17, and in late 2018.
In our estimation Unicredit had a shortfall in late 2018 of €35 billion between its stated capital and the amount of capital needed to form an adequate loss cushion.
Both Unicredit and MPS overstate the adequacy of their capital cushions. Both have survived previous Stress Tests only because of their questionable accounting for the Non-performing loans that they retain and for the Non-performing loans that they have supposedly securitized, and because they understate the risk in all of their on- and off-balance sheet business.
The banks’ on- and off-balance sheet business is in each case put through a Basel III Advanced Internal Ratings-Based methodology. This methodology contrives to convert each piece of business into a Risk-Weighted Asset that is far too small compared to the actual risk inherent in it.
This process shrinks the risk in the business to such a degree that the depleted capital of these banks appears adequate to it, when it is far from that.
Both banks have repeatedly claimed to have a surplus of Common Equity Tier 1 (CET1) compared to internationally-agreed norms when the true test of their value – their Market Capitalization – has been far lower.
It really will take a bazooka (from the person organizing the merger of Unicredit and MPS) to forge a new bank that has an adequate capital cushion. €60 billion might be enough to cleanse Unicredit/MPS to a degree that would enable it to pass future Stress Tests with ease, but if the new bank wanted to have a long-term credit rating with an A in it and not just Bs, one should budget for €100 billion.