Italian Banks
Analyst: Alessandro Roccati alessandro.roccati@fpk.com +44 20 7663 6055
2009: Capital and liquidity manageable, gloomy earnings
• We believe that Italian banks’ revenues will suffer broadly in line with the other European banks,
due to the current market turmoil. We estimate that capital and liquidity are manageable but the
earnings outlook is gloomy: net interest income and asset quality are particularly at risk.
• On earnings, we estimate an average ROE of 5% in 2009e. We are mostly concerned about net interest
income, which we expect to suffer from low volume growth (c. 2-3% in 2009e) and a deterioration in the
spread (due to liability spread compression). We are neutral on the cost of risk: we estimate average LLC
of 80-90bp for domestic lending in 2009e. We do not expect LLC to reach the 180bp peak of the previous
cycle. In our view, 2009 net profits remain highly sensitive to asset quality: we estimate that for every 10bp
increase in LLC, net profits decrease by c. 10%. On the positive side, we believe operating costs remain
firmly under control.
• The capital position is weak but the business models are safe. Italian banks’ capital is stretched, with
an average core Tier 1 of 6.2% in 2008e, increasing to 6.5% in 2009e due to c. 39bp average operating
capital generation thanks to sustainable business models and limited exposure to toxic assets.
• Our top pick is Intesa Sanpaolo (Outperform). We upgrade BPM from In Line to Outperform. We
downgrade Banco Popolare from In Line to Underperform. Our Outperform ratings on Intesa Sanpaolo
and BPM are based on our belief that the two banks are safe, as they show low leverage, relatively strong
funding and cost-cutting potential. We rate UniCredit In Line due to uncertainties about MIB earnings and
CEE cost of risk and UBI In Line as it shows resilient earnings but is expensive. We rate both Monte dei
Paschi (MPS) and Banco Popolare Underperform, as the former may need to raise capital and is, in our
view, expensive, trading at a 60% P/E premium to the sector, while visibility on the latter is low and bad
news on Italease is likely to continue.

Executive summary
In this document we look at the three components of the current credit crisis – liquidity,
capital and earnings – and the impact on Italy’s domestic banks. Our conclusion is that
liquidity and capital are manageable, while earnings remain under pressure and could
see further downgrades. We therefore foresee valuations of Italian banks moving from
book value based models (P/BV, P/NAV) to earnings-based models (P/E) in 2H09. On
this basis, with an average ROE of 5% and a cost of equity of c. 8.5% we would expect
the six largest Italian banks to trade at a c. 20% discount to book value in line with the
current P/NAV of 0.8x. Our top picks are Intesa Sanpaolo and BPM.
Liquidity
Italian banks show, in general, good levels of liquidity, with an average loans/core
deposits ratio of 134% in 2008e, in line with the estimated European banks average of
132%. We do not expect structural interbank deficiencies in 2009: the net interbank
position of the six largest domestic banks is positive or moderately negative with the
exclusion of UniCredit (EUR71.8bn negative). The Italian banks under our coverage
show EUR106bn or c. 20% of wholesale debt expiring in 2009. UniCredit and Intesa
Sanpaolo show the lowest percentage of expiring wholesale funding in 2009, while MPS,
UBI and BPM the highest. We note, however, that BPM has a strong retail franchise and
good securities placing power with its retail network.
Capital position
We estimate an average core Tier 1 ratio of 6.2% at the end of 2008e increasing to
6.5% at the end of 2009 due to c. 39bp average net operating capital generation. We
believe that the capital positions of UniCredit and Intesa Sanpaolo – although not
strong – are correct taking into consideration their business risk profiles. We expect
Monte dei Paschi, Banco Popolare and possibly BPM to raise capital, using funds
provided by the government.
The exposure to structured products and toxic assets is negligible for all our Italian
banks universe but UniCredit. UniCredit’s asset-backed securities (ABS) totalled
EUR10.3bn in 3Q08 and the company did not disclose the marks taken. Intesa
Sanpaolo’s exposure to structured credit products is, in our view, not a concern as
the bank showed EUR2.0bn ABS in 3Q08. The total exposure to the Madoff funds for
the six largest banks was minimal at c. EUR0.1bn. The domestic retail household
sector loss could be up to EUR0.8bn, mainly through funds of hedge funds. The total
exposure to Lehman Brothers for the six largest banks was EUR0.6bn in 3Q08, or
1-4% of PBT. Consob, Bank of Italy and ISVAP (Italy’s insurance watchdog) estimate
the impact of the Lehman Brothers fallout at c. EUR0.7bn (0.5% of equity) for the 20
biggest banks. The retail household sector loss could be up to EUR4bn, mainly
through index-linked products.
Earnings
Net interest income: almost flat
We believe that Italian banks’ NII (representing c. 66% of total revenues in 2008e) will
record a significant slowdown in 2009 but not contract. We estimate average NII
growth of 1-2% for our Italian banks universe, driven by 2-3% domestic loan growth
and spread compression. We expect NII to be supported by two factors: low loan
volume correlation with GDP growth and an only marginally deteriorating spread. We
believe liability spread compression will be partially counterbalanced by a widening of
the asset spread.

Table of contents
Executive summary................................................................................................................................................ 4
Liquidity ..........................................................................................................................................................................4
Capital position...............................................................................................................................................................4
Earnings .........................................................................................................................................................................4
Ratings ...........................................................................................................................................................................6
Liquidity................................................................................................................................................................... 8
Loans/deposit leverage ..................................................................................................................................................8
Interbank position ...........................................................................................................................................................8
Wholesale funding needs ...............................................................................................................................................9
Placing power with the retail network ..............................................................................................................................9
Capital.................................................................................................................................................................... 10
Potential rights issues...................................................................................................................................................10
Capital improvement via sale of Bank of Italy stake ......................................................................................................11
Core Tier 1, Tier 1, capital generation ...........................................................................................................................12
Exposure to toxic assets limited......................................................................................................................... 13
Exposure to structured credit products.........................................................................................................................13
IAS 39 reclassification ..................................................................................................................................................13
Exposure to Madoff funds.............................................................................................................................................14
Exposure to Lehman Brothers......................................................................................................................................14
Earnings ................................................................................................................................................................ 15
NII slowdown ................................................................................................................................................................15
Fees dragged down by slow death of mutual funds ......................................................................................................19
Operating costs well under control ...............................................................................................................................20
Provisioning and cost of risk.........................................................................................................................................21
Provisioning and the previous cycle ..............................................................................................................................22
Appendix: Estimates and investment theses ..................................................................................................... 25