Banca IFIS — Update 28 January 2016

Trade receivable finance

Divisional net banking income rose 2% y-o-y to €159m. Loans rose by 16% (driven by customer number growth, the pharmaceutical and multi-utility initiatives), while the margin fell by a similar percentage. The latter was significantly affected by a change in pricing strategy to attract pharmaceutical business, with purchases of receivables at par and income being generated from late payment interest (previously bought at a discount). Looking forwards, more of the loan growth seen in 2015 should feed through to interest income in 2016 given the timing of late interest payments and the utilities agreement. The net result from financial operations rose 12% to €137m (from €122m). The key driver to the latter was a €12m reduction in impairments with continued improvements in excellent asset quality (NPL to loans 1.1% vs 1.3% at end 2014). There have been a limited number of individual losses in Q415, but no general trend for deterioration in lead indicators.

IFIS saw turnover rise by 22% to €10.1bn with customer numbers up to 4,487 (from 4,200 at end 2014). The company has now disclosed the mix: 696 sole traders, 3,022 SMEs with turnover less than €10m, 545 with turnover of €10-50m and 224 with turnover of more than €50m. This is important as the competitive pressures have to date been largely confined to the large corporate space.

In 2010, IFIS started a new business for pharmaceutical companies wishing to transfer non-recourse receivables due from public administration. Its presence in this market was significantly expanded in 2015 as on 17 June, when it announced the hiring of a team of nine specialists, including two credit analysts, who have had relationships with about one-third of this market, and that it was aiming to gain about 500 new pharmacy clients a year (there are c 15k pharmacies across Italy, so the target does not appear unreasonable). The group will provide short and medium-term financing.

In December IFIS, targeted a new sector of public debt. It entered into an agreement with an unnamed leading market player, which saw debt added to the balance sheet but, given the timing, little income recognised in the period.

As noted below, IFIS has been active in DRL acquisitions with the gross book value of loans up from €5.6bn at end 2014 to €8.2bn at end 2015 despite the sale of €1.4bn of DRLs in December. It now has over 1 million positions (with debtor numbers of over 850k). Net banking income rose to €56m in FY15 from a restated €33m in FY14 and the net financial result increased to €53m (from €31m). FY15 included €6.5m of non-recurring income and €4m of non-recurring costs associated with the negative impact of update cash flow simulation models – income down €8.4m – and the sale of €1.4bn DRLs – gain on sale €14.9m – costs €4m higher. Additionally, there was a revised accounting treatment of expected cash flows on receivables classified as bad loans previously recognised as impairment: income up €3.2m, impairments down €3.2m, net financial result zero. In business terms, the number of clients moving towards bills of exchange and expressions of willingness (ie more likely to pay) rose to €244.5m from €122.2m faster than the nominal book growth and is indicative that new collections procedures are working. Management also notes that its Legal Factory operations (where debtors with some income from pensions or new employment face a judicial collections procedure) had accelerated debt collection time from three years to 18 months, now with the potential to go to 12-15 months. Management believes that over time 15-25% of its portfolio will have some type of income to which repayment will be attached, and that collection rates should be very high through the Legal Factory.

IFIS has been active in selling portfolios. In December it announced the sale of three portfolios with a total face value of €1.4bn (137k positions). The gain on sale was €14.9m although costs of €4m were also recognised. The net gain on disposal (0.8% of nominal value) is a fraction of the profits we would expect from the residual book and reflects:

The gain on sale reflects the mix of positions sold. Two-thirds were very dated while the residual third will already have seen some profit recognised and is in accounts in the lowest expected recovery channel. These should not be viewed as reflective of the portfolio as a whole.

Net banking income rose to €20.3m from €11m in FY14 but Q415 included a one-off gain of €5.2m. The underlying business saw an improvement in cash flows.

The centrals division reported full-year net banking income of €172.7m (2014 €84.3m) including €124m one-off gains from restructuring the bond portfolio. The ongoing contribution is modest (Q415 €5.8m vs Q114 €17.8m) given the lower coupons on the reinvested bonds. We do not consider this a key driver of the group anymore. The historic positioning was extremely profitable and generated equity, which is now being deployed to generate growth across the group.

Retail deposits come via its Rendimax and Condomax brands. Balances are now more than €3.1bn (2014 €3.3bn, 2013: €3.8bn). Balances were down in 2014/15 as it has been widening spreads materially. It was previously towards the top of best-buy tables, but now targets the higher end of second-quartile pricing. It is noteworthy that IFIS’s attrition is very different to that of, say, EGG, an early UK-based rate-dependent savings institution whose customer loyalty proved to be minimal.

As a retail bank, credit risk accounts for 90% of IFIS’s regulatory capital requirements. It has adopted the standard approach, so most of its customer exposure is 75%-weighted, with a zero weighting for Italian government debt and exposures. The Core Equity Tier 1 ratio is 14.7% (FY14 13.9%), and is all equity and reserves. There is no debt within Tier 2 capital.

We use approaches that are based on long-term assumptions and our current forecast period (two years). For a company such as IFIS this is somewhat unfair as we expect meaningful increases in profit beyond this current forecast period. Moving our base valuation year from 2016 to 2017 sees the benefit of expanding the pharma business, greater delivery by acquired DRLs and lower headwinds from falling bond profit, and material equity retentions. The average of our valuation approaches is now €22.3 (previously €20.3), driven by moving our base year forwards.

Peer comparisons

IFIS does not have any immediate peers in terms of business model. Banca Sistema (BST.IM) is the closest comparator, but it only came to market in early July 2015. Investors wishing to consider smaller Italian banks may look at Banca Finnat (BFE.IM), Banca Popolare dell’Etruria e del Lazio (PEL.IM), Banco di Desio e della Brianza (BDB.IM) and Credito Valtellinese (CVAL.IM). In terms of trade finance plays, there is also Tungsten in the UK (TUNG.LN), although it has recently announced it is selling its loss-making bank. Looking at comparisons with these banks, we need to bear in mind their very different operations, capital and funding structures.

Gordon’s growth model

As a specialist house in a niche area of financing, and with a material element of service income that does not attract the same regulatory capital requirement as lending, we believe IFIS should generate returns above its cost of capital. For the purposes of our valuation, we have assumed a sustained ROE of 15% against a cost of capital of 12% (including a premium for Italian risk, which may be expected to reduce over time). We have assumed long-term growth of 4%, around nominal GDP, generating an expected price-to-book of 1.4x. Our near-term premium remains 30% to better capture the core business growth continuing into 2018 and remains well ahead of our assumed growth of 4%. While our 2017e ROE is in line with our long-term forecast, higher earnings into 2018 may be expected to see the ROE above our long-term assumption. Our valuation rises to €22.92 from €21.07 with an increase in equity from rolling forward our base year from 2016 to 2017.

Dividend discount model

We take explicit forecasts for 2016 and 2017. For 2018 we make two adjustments: firstly, we make a step change in dividend pay-out to 73% (reflecting our long-term return on equity of 15%, but growth in equity of 4%). Secondly, we have an incremental 2018 growth of 25% to reflect core business growth in that year to try and capture growth beyond our forecast period. Beyond that we continue to grow this dividend at the expected 4% rate for 10 years. These cash flows are discounted at cost of capital (12%). We also make an upfront pay-out to bring the initial core Tier 1 down to 10% (value €3.6 per share, previously €4.0). This approach indicates a value of €21.7 (previously €19.5), again primarily driven by rolling forward our base year.

Changes to forecast

The changes to our 2016e normalised PBT and EPS forecasts are negligible. We have included a small gain on sale of portfolios helping income, allowed a small improvement in credit losses offset by further costs.