It may tell you what you need to know about the Italian banking industry that the stock price chart below depicts best-in-class player Intesa Sanpaolo (OTCPK:ISNPY). Intesa has really not done well this past more than a decade, but neither has it produced the kind of permanent capital destruction that many of its peers in the Italian banking space and the wider eurozone have. From a pretty bad bunch, this is one of the best names.
At the root of the company’s woes is the national banking landscape. Credit quality has, simply put, been abysmal, while yields on interest-earning assets like loans have been shockingly low. Sure, the bank has a nice basic deposit franchise, and it also has significant non-interest revenue streams, but that hasn’t been enough to offset the broader problems in the domestic banking industry. retail/commercial.
While the above means Intesa doesn’t look pretty, it’s pretty cheap right now, having fallen over 30% since hitting a multi-year high in February. There’s also a great capital return story to offer, and management’s 2022-2025 strategy targets further add to what looks like an interesting medium-term investment case. To buy.
A horrible environment
Intesa doesn’t have much coverage here, but with total assets over a trillion euros, it’s actually a huge bank.
The company reports on six segments: Banca dei Territori; Corporate and investment banking; International subsidiary banks; Private Bank; Asset Management; and Insurance. Banca dei Territori encompasses Italian retail/commercial banking activities, while International Subsidiary Banks represents its non-Italian retail/commercial banking subsidiaries (11 Central and Eastern European markets plus Egypt). The others are probably self-explanatory.
As you can see, the domestic banking business is the biggest part of the group. It has also been plagued with serious problems for the past ten plus years, reflecting the horrendous environment of the wider Italian banking market. On the one hand, credit quality has been abysmal. In 2014, for example, Intesa had group-wide gross loans of around €370 billion, of which more than €60 billion were classified as non-performing (“NPL”)! Naturally, provisioning for bad debts has been a major expense here, and more than 40% of the Banca dei Territori’s net interest income has gone to provisions during this period.
By itself, a relatively higher level of NPL is not necessarily very informative (although the ratio above is obviously very high), as a bank may also earn higher returns on riskier loans to offset things . This was not the case here. Indeed, yields have been chronically low, with the bank reporting net interest income of around €7.9 billion last year on around €800 billion of interest-earning assets.
The bank has a nice base deposit franchise and low funding costs, with around €430 billion in current accounts and other retail deposits, while also having significant non-interest revenue streams ( ~54% of 2021 revenue, excluding revenue insurance). Even so, that wasn’t enough to offset the headwinds outlined above, and Intesa ultimately released some pretty lackluster profitability metrics.
Right the ship
The good news is that things have improved significantly in recent years. Yields are still very low, of course, but asset quality has improved considerably, with gross exposure to NPLs amounting to around €15 billion last year (around 3-4% of total loans), compared to 21 billion euros at the end of 2020 and more than 60B euros in 2014/15.
Provisions for loan losses fell to €2.77 billion in FY21 (~0.59% of customer loans), compared to €4.49 billion in 2020 (~0.97% ), and this helped to increase net income to €4.2 billion for the year, from €4.49 billion €3.3 billion in 2020. Management expects provisioning another windfall for net profit this year.
I would like to see higher coverage – around 54% NPL coverage seems very light to me, certainly compared to continental peers like BBVA (BBVA) (~75% NPL coverage), but the situation is certainly much better than it was in the not too distant past.
The bank is also well capitalized, with a fully loaded CET1 of around 14% at the end of last year. Subtracting 2022 redemption cash (see below) brings that down to around 12.9%, which is still solid.
Reasonably cheap and returning money
While the bank certainly had its issues, I think stocks are reasonably cheap right now. Going forward, lower provisioning levels are expected to push 2022 net profit to over €5 billion, pushing the bank towards a double-digit return on tangible equity. Intesa has a small direct exposure to Ukraine and Russia – about 1% of total loans – even if it is the potential ripple effect in terms of an increased risk of recession that is the main concern.
As a result, these stocks have sold off a bit, losing about a third of their value since hitting a multi-year high in the first quarter. At around €1.97 in Milan, Intesa stock is trading at around 0.7x tangible book value (“TBV”) and 9x 2021 EPS. The dividend yield is 7.7%, with this being based on FY21 payout of 15.1¢ per share.
In the medium term, management sees its strategic efforts – cost control, growth in operating profit and lower provisioning levels – translate into an annual net profit of approximately 6.5 billion euros by 2025, which would be good for a solid tangible double-digit return on investment. own funds (“ROTE”).
Of course, there’s a big “jam tomorrow” element to that. After all, 2025 is still far ahead of us and there is no guarantee that the bank will actually achieve its goals. I mean, let’s face it, even though the story has gotten a lot better in recent years, a European bank falling short of its profitability targets wouldn’t really be new.
Still, based on its current ROTE profile and P/TBV, there is little downside for the stock right now. In a bad scenario, Intesa continues to earn high single-digit ROTE and investors don’t benefit much from an expanding valuation. If he hits his strategic goals, those stocks trade closer to TBV and investors get over 30% of the multiple expansion.
At the same time, the bank is shipping large sums of money to shareholders. Planned redemptions for 2022 amount to €3.4 billion, or around 9% of the current market capitalization alone. Assuming net income grows in line with the bank’s objectives, shareholders could be looking at 22 billion euros in capital returns from dividends and 22 buyouts through 2025, which alone would represent annualized returns at two digits.
In the worst case, shareholders are getting high single-digit annual returns from the current yield without much growth. Best-case scenario, they get about 11-12% annualized from dividends and current buyback, plus a boost from multiple expansion. To buy.