All Italian Banks Aren't Created Equal

Valerio Baselli: In June, the European banking sector was the worst asset class in terms of monthly performance. Actually, European financials stocks have been suffering for a quite long time, with the industry down 23% year to date. In particular, Italian banks, who have lost nearly 50% over the same period of time, are the center of investors' concerns.

After the Brexit shock, Italy will hold in October a referendum on several constitutional reforms, and this--with the results on the stress tests expected for late July--will be crucial appointments.

If the Italian system has been the most affected it is because it's considered the weakest, and the reasons lie in structural problems with deep roots, like the very competitive environment, the inefficient cost structure, and the excessive number of branches.

Morningstar analysts believe nonperforming exposures for the system are at peak levels, around EUR 340 billion, and expect them to decline to around 220 billion over the next four years as capital is finally provided to the system and the banks can then write off the loans.

Nevertheless, this uncertainty also creates opportunities for investors. Mediobanca is our top pick in the Italian banking system, and based on the Morningstar stock research it is about 50% undervalued. Its clean balance sheet means it doesn't have to raise capital, and it is also positioned to benefit in multiple ways from the system's reform.

As for the two major Italian banking groups, Unicredit and Intesa Sanpaolo, Morningstar analysts invite for caution since the two institutions are in need of at least 15 and 14 billion of euros of new capital, respectively. According to our research UniCredit is slightly undervalued, and Intesa Sanpaolo is fairly valued, but overall we prefer Mediobanca because of its higher-quality loan book and better business mix.