Unicaja: the bank should squeeze its balance sheet, not just its customers

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Belt tightening and deleveraging are increasingly the norm for Spanish consumers. This is rational given interest rates at 20-year highs. A 55 per cent decline in new mortgage lending still surprised Unicaja shareholders on Monday.

The share price dipped by as much as 5 per cent in response. That was despite a 35 per cent rise in third quarter net profits that beat market expectations. 

Spanish bank shares have outrun most European peers this year. One reason, yields on their lending books track the central bank’s interest rates. Geared towards the mortgage market, Unicaja is benefiting; average loan yields rose 50 basis points over the quarter to 3.09 per cent.

Meanwhile, Spanish banks have only slowly passed on higher rates to their depositors. Deposit costs at Unicaja rose just 10bp into the third quarter to just 0.47 per cent, one of the lowest pass-through rates in the sector. Even without further central bank rate rises, net interest income should grow next year boosting profits.

Investors are ambivalent. Unicaja shares are stuck at a steep discount to book value, partly due to a low 6 per cent return on equity. Yet they trade on a relatively high price-to-earnings ratio for European banks.

That leaves new chief executive Isidro Rubiales Gil with a dilemma. Unicaja’s common equity tier one ratio was 14.2 per cent in the third quarter, well above an established 12.5 per cent target. He should have about €500mn of spare capital, almost a fifth of the current market capitalisation. He can pay this to shareholders, buy some growth or fix the balance sheet to improve the returns on capital.

Buying back shares at a 60 per cent discount to tangible book value makes sense, but could also lift its seven times price to forward earnings ratio. This tops the range for European banks.

Balance sheet repair offers a better use. Foreclosed real estate assets valued at a net book value of €500mn linger from past downturns. Their disposal, covered by excess capital, should shrink capital.

Better returns on capital and a higher valuation should follow. That promise should support Unicaja’s shares.