Supannee U-prapruit
Introduction
A little more than a month ago, the Italian government announced a windfall tax on the extra net interest profits banks are making thanks to higher rates. After Spain, Hungary, the Czech Republic, and Lithuania, yet another European government decided to go this way.
Now, the European Central Bank (ECB) while announcing another 25 bps interest rate hike also delivered its opinion on the Italian tax to warn of negative side effects.
Since I looked at the two major Italian banks, Intesa Sanpaolo (OTCPK:ISNPY) and UniCredit (OTCPK:UNCRY), taking their financial statements and calculating the real impact of this tax, I think an update is needed given the developing situation.
Summary of previous coverage
Of course, the day after the first announcement Italian bank stocks dropped. Two days later, the Italian Department of The Treasury issued a note giving some reassuring detail on this tax, making it less strict as it was at first perceived. In particular, further details were given to explain how the tax would have been calculated. After this note, I was finally able to do some rough estimates and what the impact would be. At that time, it seemed like Intesa would have ended up paying around €945 million, while UniCredit would have paid €825 million.
It seems like my estimates were correct, since a few weeks later, Intesa itself declared the impact of the tax would have been less than €1 billion.
At the end of the day, what I wanted to show was that the tax would have not hit the banks as bad as at first the market thought. No wonder Intesa and UniCredit stocks started to recover, as the prices on the Italian Stock Exchange reported in this table show:
| closing price August 7th | opening price August 8th (% diff from August 7th) | closing price September 15th (% diff from August 7th; % diff from August 8th) | |
| Intesa Sanpaolo |
€2.56 |
€2.338 (-8.67%) | €2.469 (-3.55%; +5.60%) |
| UniCredit | €22.625 | €21.320 (-5.77%) | €21.685 (-4.15%; +1.7%) |
What The ECB Said On The Tax
The ECB delivered its opinion upon request from the Italian Ministry of Economy and Finance for an opinion on the Decree Law introducing, among other, the extraordinary tax applicable to banks.
The ECB pointed out that
… from a monetary policy perspective, credit institutions play a special role in ensuring the smooth transmission of monetary policy measures to the wider economy. In this context maintaining an adequate capital position helps credit institutions to avoid abrupt adjustments to their lending to the real economy. Evidence shows that net interest income typically tends to expand on impact as policy rates increase. This effect is faster the greater the weight of short-term or variable interest rate loans within bank balance sheets. However, as the tightening cycle proceeds, this positive income effect can be offset by lower lending volumes, a higher cost of funding, losses recorded in the securities portfolio and an increase in provisions resulting from potential deterioration of the quality of the credit portfolio.
In other words, the ECB stated that yes, banks are now benefiting from rising rates, but as the impact of the rate hikes penetrates into the economy, the banks will not find a favorable environment, with lower lending volumes, higher cost of funding and a potential deterioration of credits.
In fact, in a recent statement, the European Central Bank explained it raised its interest rates by another 25 bps to further combat inflation, still at 5.3% in August. As a consequence, the ECB has clearly stated that “the economy is likely to remain subdued in the coming months” after “it broadly stagnated over the first half of the year and recent indicators suggest it has also been weak in the third quarter.” In particular, what matters most for banks is that “the impact of tight financing conditions is dampening growth, including through lower residential and business investment.” This means banks already are lending out less money than usual.
On a side note, I expect the ECB to stop raising rates because in the coming months, the sharp price increases recorded in the autumn of 2022 will drop out of the yearly rates. This will inevitably be pulling inflation down, giving the central bank new data to consider.
New data to calculate the impact of the tax
But back to our banks.
After the ECB’s take, Italy said it can correct the levy, but there will be no backtrack. However, a significant change was given. The government now expects the tax to yield around €3 billion, instead of the €5 billion that were announced back in August.
In addition, it seems like the Italian parliament will have to discuss drafting proposals to soften the impact of the tax. Among these, the government might end up allowing banks to partly deduct this windfall tax from the overall corporate bill. Smaller banks should be exempted from paying the tax. Also, it seems like the calculation of the extra profits on net interest margin might take place excluding the interest from State bonds.
This is a big change and needs us to revise once again what impact this tax will have on Intesa and UniCredit. In fact, in my previous article, the total both banks combined would have paid was around €1.77 billion. But these two banks, though the largest in Italy, can’t give by themselves more than half of the total yield the tax is now supposed to give.
For example, Intesa, in its last annual report, declared it holds €26.9 billion of government bond with an average duration of around 6.1 years. Currently, the Italy 5-year bond yields 3.992%. Probably, the bonds Intesa now has had a lower average, since yields started to go up last year.
UniCredit, at the end of FY 2022, reported €34.8 billion of Italian sovereign debt securities. I haven’t been able to find the average duration. However, I expect it to be similar to Intesa’s.
In any case, altogether, we have more than €60 billion in bonds, generating a yield of around 1.5% in a conservative case. This means that something like €600-900 million could be excluded from calculation of the tax both banks owe. In other words, the combined amount they have to pay could be actually cut in half, depending on how this proposal is drafted and approved by the government.
So, at the end of the day, Intesa could end up paying €650 million instead of the €945 million and UniCredit, having more Italian bonds and thus benefiting more than Intesa from this new scenario, could end up paying around €450 million instead of the previously calculated €825 million. Overall, the two banks would yield around a third of what the government expects from this tax, instead of financing half of the forecasted amount.
Dividends
One of the reasons investors are in the two stocks are the nice shareholder returns the two banks provide, though in different ways. Over the last decade, Intesa first and now UniCredit have made their distribution policy more appealing while maintaining a safe approach and a healthy balance sheet, coupled with strong de-risking activities.
Now, Intesa has a dividend policy that pays in dividends 70% of the annual net income. Year by year, the bank evaluates what to do if there’s extra cash. For example, the bank finished back in April a €3.4 billion buyback program. A month ago, the forecast was that Intesa would have had a FY 2023 net income of €6.9 billion, meaning €4.8 billion are going to be paid in the form of dividends, resulting in a €0.26 per share (11% yield at that time). Now, we could actually expect a net income of at least €7.1 billion which should bring the dividend up by one penny, leaving the dividend yield a little above 11% even though the share price has increased since the announcement back in August. Therefore, I see Intesa just as interesting as a month and a half ago.
UniCredit targets to pay 35% of its profits as dividends, while it wants to pay around €16 billion from 2021 to 2024, mixing dividends and share repurchases. Since we’re almost at the end of the plan, we know UniCredit still has to return €4 billion to its shareholders. UniCredit will probably end with a FY net income of around $8 billion, given the recent developments. With a 35% return policy, UniCredit should return €2.8 billion in dividends. This is a 7.2% yield, not counting at least €1.2 billion to be returned as share repurchases. Therefore, UniCredit has become even more interesting and more valuable in this past month and a half.
As partly expected, from the first day the tax was announced to now, many developments are mitigating, opening up the possibility to pick up some shares at a little discount compared to a few months ago.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.