ISNPY - Intesa Sanpaolo: A Quality Bank With Generous Dividend Yield

2023-09-16 06:36:45 ET

Summary

• Intesa is a high-quality bank with improving risk metrics and profitability, distributing above-average dividends despite that fact. The company is for sale at a good discount of 22.5%.
• Intesa's Q2 results showed a rising operating margin, high cost-to-income ratio, and improving capital ratios.
• I give a buy rating only because of the political uncertainty about the windfall taxes. They will impact the bank's long-term stability and its dividend policy.

Thesis

Investing in banks has its caveats. The risks are multiple: liquidity, credit, market, and operational. However, one more risk is creeping behind the corner during good times. The political risk related to levying windfall taxes. It is a populist move with a steep price because it adversely impacts even the most profitable enterprises.

Intesa Sanpaolo (INSPY) is among the most prominent Italian banks. The bank reported solid results in line with the Italian banking sector last quarter. The government wasn`t late to notice and proposed to levy additional tax on banks' profits. Intesa is a high-quality bank with improving risk metrics and profitability, distributing above-average dividends despite that fact.

On top of that it is for sale at a good discount of 22.5 %. I give a buy rating only because of the political uncertainty about the windfall taxes. It will affect banks' stability during economic downturns and their ability to pay dividends if approved.

European Bank's Stress Test

The European Banking Authority has announced the results of the 2023 EU-wide stress test, which included 70 institutions from 16 EU and EEA nations and represented 75% of the assets of the EU banking sector. By using this stress test, supervisors can assess the ability of EU banks to adjust over three years in both a best-case and worst-case scenario. The adverse scenario is characterized by negatively skewed shocks to economic growth and increased unemployment correlated with rising interest rates and credit spreads. The outcomes for each bank are considered when making supervisory decisions in the EU, which helps promote market discipline.

There have been a few notable advancements compared to last year's stress test. Among these changes are the inclusion of 20 additional banks to the sample, the addition of top-down components for net fees and commission income, and a comprehensive analysis of banks' sectoral exposures.

The image below represents the results. The most important is the declining NPL and growing CET1. Both are crucial for a bank`s ability to survive during economic downturns.

The Tax

Windfall taxes gained traction last year with commodity producers. The banking sector in Europe had strong quarters that attracted unwanted attention. The image below from the Intesa presentation illustrates the impressive results:

Intesa is not alone; most major Italian banks have improved significantly in profitability.

Last month , media sources stated that Italy would begin taxing net interest margin earnings, or money earned from the difference between lending and deposit rates, only in 2023 and require payment by June 30, 2024, at a rate of 40%. This tax will apply to 40% of the NIM that Italian banks generate in 2022 or 2023, depending on which year's total is higher.

Although the bill has received government approval, the Parliament still needs to vote on it. The final draft is, therefore, not yet accessible. But the tax will likely have two basis points: 5% in 2022 and 10% in 2023. In 2022, if banks' NIM increase exceeded 5%, any additional revenue would be subject to a 40% tax withdrawal. The tax is said to provide the state with revenue close to €5 billion.

ECB criticized levying additional taxation on banks. However, among the Italian politicians, the idea is not scrapped yet. Prime Minister Meloni`s opinion supports the proposition. Below is a quote from Financial Times Article :

Meloni has repeatedly defended the one-off tax, which she said was necessary to curb lenders’ “illegitimate profits” from failing to raise deposit rates even as the ECB’s policy rates have increased. In a social media video, she called the move “a tax on an unfair margin”.

I believe windfall taxes are populist measures to appeal to the electoral majority. They hurt the businesses long-term because they will face difficult times sooner or later. Extra liquidity saved during good times will help enterprises to weather the storms. However, if the government levies additional taxes, it will strip the company`s excess liquidity. The latter is the mentioned lifebuoy, so much needed in a crisis.

Intesa Q2 Results

Intesa's operating margin did well in terms of the P&L, which was once again aided by a reduced increase in operating expenses (only plus 0. 9%), with costs reaching €5.21 billion. Additionally, efficiency is relatively high, with a cost-to-income ratio of 42%. One of the best ratios among European banks is this one.

Intesa Sanpaolo produced a net of €4.22 billion in H1, an increase of 80% annually from H1 2022's. With ISP's payout ratio in mind, the value generation for shareholders in 2024 will already total €3 billion in dividend accruals. The intention for 2024 is to pay shareholders €5.8 billion. This includes the buyback's second tranche, the interim dividend due in November 2023, and the customary Q2 dividend payment.

The Common Equity Tier 1 ratio was 13.7% at June's end, considering the €3 billion dividend. Later in the article, I will dig deeper into Intesa`s capital structure.

Company Financials

Intensa has a robust balance sheet with adequate assets and liabilities composition. The table below shows the ratios I use to assess the bank`s balance sheet quality. The data is from the last company`s report .

Loans structure is well diversified, as seen in the chart below.

The heaviest position in the Intesa loan portfolio is mortgages. Small and medium-sized enterprises ((SMEs)) are the second largest banks' borrowers. Another significant portion of the loan portfolio is global corporate and structured finance. All three counterweight each other, thus distributing the bank`s risk among borrowers: small businesses, individuals, and corporations. They have different risk profiles and respond to economic changes in distinct ways. Loans structure by sectors is well diversified, too. The largest exposition are financial companies with less than 8 %. The remaining is scattered among all the economic sectors.

NPL at 1.0 % is an excellent achievement. Intesa is in the best quartile compared to its peers, as shown below:

European Bank's stress test results show that Italian banks are not as bad as their reputation is. Intesa is not an exception. Its risk metrics confirm that statement. The banks have adequate solvency and liquidity to survive in the long term. The table below illustrates the company`s Basel III ratios. The data is taken from the Q2 financial statement.

As mentioned above, the windfall tax can effect on a long term the bank stability. Instead, improving its balance sheet composition, thus mitigating the credit and liquidity risk the company has to pay the government.

Intesa is one of the most efficient banks measured in cost-to-income ratio—the image below compares the company with its major competitors.

Ration below 50 % is excellent. Intesa achieved beyond that, 42 %. The table below illustrates the bank`s profitability using TTM Net income. The data is taken from the Q2 financial statement.

Cost to income lower than 50 % translates into better return on capital ratios. Intesa`s five average ROE is 6.5 %.

Intesa traditionally distributes dividends with adequate yield.

The chart below compares Intesa with UniCredit ( UNCRY ), ING Groep ( ING ), Banco Bilbao ( BBVA ), and Banco Santander SA ( SAN ) dividend metrics.

The current dividend is above the industry's average. Another issue with the windfall profit tax is the adverse impact on the company`s ability to pay dividends and buy back its shares.

Company Valuation

The bank has a long tradition of distributing dividends. Hence, to calculate ISNPY value with the Dividend Discount Model, I have to measure the price of the company's equity and levered beta.

Assumptions and inputs:

• Risk-free rate equals the 5Y average of USA long-term Government bond Rate, 2.2%.
• Growth rate, g, equals the 5Y average of the USA long-term Government bond Rate, 2.2%.
• Italy's equity risk premium is 8.33 %
• ISNPY' unlevered Beta 1.2
• ISNPY Debt/Equity ratio 382 %.
• Italy's effective tax rate is 24 %.
• ISNPY dividend per share ((TTM)) € 0.99

1. Calculate Levered Beta with the formula below:

Levered Beta = Unlevered Beta * (1+D*(1-T)/E).

2. Calculate the discount rate (discount rate as the cost of equity) using the resulting value for leveraged beta. The formula I use is:

Cost of Equity = Risk-Free Rate + (Levered Beta * Equity Risk Premium).

3. Calculate the Terminal Value of dividends considering the Cost of Equity and Expected dividend growth:

Terminal Value = Dividend per share * (1 + expected dividend growth) / (Cost of Equity – Expected Dividend Growth)

4. Calculate the Present Terminal Value assuming a constant discount rate for ten years.

For ISNPY, I get the following results:

Intrinsic value per share = € 20.40

Current market price = € 15.86 (Sept 15, 2023)

I compare ISNPY with other large EU banks.

Based on Price to Book Value, hold the middle ground position. Using P/E ((FWD)) is in the middle, too. However, the dividend yield is second to BBVA.

Risks

Intesa carries all the risks typical for banks: liquidity, credit, market, and operational risk. Besides that, the political risk is another factor to consider. Windfall taxes are among those variables, notably increasing the political risk.

The liquidity risk is the bank`s ability to face its debt obligations. Credit risk is the potential for the borrower or other bank`s counterparty to be unable to meet its obligations by the agreed terms. Regarding the liquidity risk, Intesa has a robust balance sheet structure with a sufficient cash-to-deposit ratio. Improving capital ratios additionally mitigates such risk. On the other hand, the credit risk is diversified among various borrowers across industries and risk profiles. One notable improvement is de-risking exposure to Russian loans. It has decreased by more than 75% and now only accounts for 0.2% of all customer loans made by the company.

Conclusion

Intesa is a high-quality bank with improving risk metrics and profitability, distributing above-average dividends despite that fact. The company is for sale at a good discount of 22.5 %. I give a buy rating only because of the political uncertainty about the windfall taxes. They will impact the bank`s long-term stability and its dividend policy.

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