Questor: take a punt on this Italian bank – the (many) risks are fully reflected in the price

Richard Evans 4 July 2018 • 6:51am

Carlo Messina, chief executive officer of Intesa Sanpaolo, leaves the Bank of Italy's annual meeting in Rome on Wednesday, May 31, 2017. — Carlo Messina, chief executive of Intesa Sanpaolo, leaves the Bank of Italy's annual meeting in Rome on May 31 2017 Credit: Alessia Pierdomenico /Bloomberg

Investors of a nervous disposition may want to look away: today we recommend shares in an Italian bank.

Not only are we venturing into a country where economic growth is minimal and where a new populist government seems to be itching for a fight with the EU, but we are choosing a bank – the very type of business that will be in the eye of the hurricane if the government, as it has threatened, ends up printing a rival currency and Italy leaves the eurozone as a result.

Why are we taking what seems to be such an enormous risk?

Part of the answer is that the biggest Italian banks have, rather unexpectedly, very robust financial shock absorbers.

“Intesa Sanpaolo is one of the best capitalised of all eurozone banks,” said Isabel Levy and Ingrid Trawinski, who run the Metropole Selection fund, a pan-European portfolio, from Paris. Questor was put in touch with Metropole by SEI Investments, the wealth manager, which allocates some of its clients’ money to the firm.

Intesa’s key capital ratio before the recent election was 13pc, compared with the 9.5pc minimum set by the European Central Bank. In other words, it had about 37pc more than the minimum.

The election caused Italian government bond “spreads” – the difference between what the Italian government pays to borrow and what the German government pays – to rise by about a percentage point.

This, the two fund managers said, was likely to take about 0.3 of a percentage point off the capital ratio.

Read Questor’s rules of investment before you follow our tips. See Questor's tips every day at twitter.com/DTquestor

“Even if the spread went back to the crisis level of five percentage points seen in 2011, when there were real fears that the eurozone would break up, we would expect the capital ratio to fall to 11.5pc, which would still be well above the ECB’s minimum,” they added. Such large capital reserves will allow the bank to deal with its large number of loans at risk of default.

Normally, the rising spread would also make it more expensive for Intesa to raise funds, affecting its profit margins, but it has recently completed a major refinancing to carry it over for the next few years, so there should be no impact on margins.

In fact, the “net interest margin”, the gap between what the bank pays for funds and how much it charges for its loans, could well rise in future as the ECB normalises monetary policy. Italian borrowers normally pay rates linked to the “Euribor” interbank rate, which is currently negative but could rise to zero as the central bank reins in its easy-money programmes.

Intesa’s profitability as measured by return on equity is currently quite low at about 9pc but if circumstances do normalise it could improve to about 13pc, the fund managers estimated.

Reader Service: Easily manage your investments with the online platform AJ Bell Youinvest

On the question of Italy quitting the single currency, they said: “The holders of Italian government bonds are largely domestic. I’m not sure they would be willing to leave the eurozone.” The formation of Italy’s radical new government sent Italian bank shares falling by about 20pc and although they have since recovered somewhat, they still look cheap.

“They currently trade at about 0.9 times the bank’s net assets and our price target is 1.4 times,” Levy and Trawinski added. This implies the potential for a 55pc rise in the share price.

“Our approach is to look at capital and at the risks. We are not looking for growth in Italy,” they said. “We think there is a lot of potential relative to the risks.” There is also a healthy yield of about 8pc and the managers said the dividend was covered by earnings and not in danger.

Clearly there are risks – the political situation could spiral out of control – but they seem to be well reflected in the price.

Questor says: speculative buy

Ticker: MTA:ISP

Share price at close: €2.52

Update: Tesco

The steady recovery in Tesco shares continues and the announcement this week of a purchasing joint venture with Carrefour of France can only put further wind in its sails, Questor believes.

The initiative should lead to significant cost savings without all the regulatory uncertainty and potential disruption involved in Sainsbury’s alternative approach – its proposed merger with Asda. Hold.