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Morningstar | A Good Bank in a Bad Place

Intesa is the best-run bank in Italy, but the weakness of the Italian banking system erodes whatever competitive advantage Intesa may have. The strong share price performance from Italian banks since the beginning of 2017 would suggest that the market is currently less concerned about the risks they face, but we are not convinced. Yes, the banks are reducing nonperforming loans, and yes, we have seen some steps towards regulatory reform, but the key problem remains that some of Intesa’s competitors exhibit irrational loan pricing that do not allow for adequate risk-adjusted returns. This explains why Italian banks have the thinnest net interest margins in the eurozone, despite having the highest nonperforming loans ratio over the past decade. Previously, the market’s main concern with regard to Italian banks was the vast pile of nonperforming loans--a third of the eurozone’s nonperforming loans are Italian. Intesa has started to address its nonperforming loan book, and its nonperforming loans ratio is the lowest in Italy. Yet its nonperforming loan book is still large enough to wipe out all the provisions for bad debts on its balance, as well as the bulk of its equity. We are satisfied that Intesa is well capitalized, but a downturn in the economy and an uptick in new nonperforming loan formation could change the picture dramatically. We cannot disregard the possibility of a capital call from Intesa. We agree with the strategy that Intesa has followed and believe that increasing capital-light fee income from the asset management and private bank cluster, combined with increased overall efficiency, will support profitability. We do not, however, believe that this is sufficient for Intesa to consistently generate returns exceeding its cost of capital.