A renaissance of local bank share prices

There has been a remarkable rise in the share prices of BOV (currently €1.70) and HSBC (currently €1.66) since the lows they registered of €0.76 (April 5, 2022) and €0.70 (October 26, 2020) respectively. This turn around is attributable to the improving fundamentals of both banks.

Profitability has increased substantially on the back of higher interest rates and the main legacy issues having been tackled. This has allowed the banks to revert back to paying dividends once again, which in itself is the principal driver of equity demand on the local stock market.

This phenomenon is not unique, and one can see a similar scenario across Europe as banks emerged from the challenges of COVID and an era of negative interest rates, to take advantage of the positive and steepening of the yield curve. The absence of the onset of recession also helped improve sentiment. Remember that, in the main, banks’ modus operandi is to borrow short term (think your deposits and current accounts) and lend long term (think house loans/corporate lending for say 10 years +). 

With interest rates at 3.75%, banks are effectively borrowing at close to zero (how much are you earning on your current and deposit accounts?) and depositing their cash in bonds yielding 3-4% besides lending for home loans and other loans. That’s quite a margin which is made possible by the high cash balances that Maltese tend to keep at banks.

As shown in the chart below the share price trajectory of BOV and HSBC is broadly in line with the EuroStoxx 600 Banks, since the beginning of 2020. BOV outperformed both HSBC and the Eurostoxx Banks following the publication of their interim results recently. Interestingly though if one had to look at the total return of these shares, including dividends then BOV lags on this metric due to no dividends being paid during the first two years in this period.

After such a strong run it is natural to question whether this trajectory will continue. With interest rates in Europe now being reduced, interest income growth will begin to slow unless compensated for by a higher loan book, higher fee income as well as improvements from underperforming areas. For example, BOV estimates that for every 1% decline in the ECB’s Deposit Facility Rate, their interest income could decline by some €20.8m.

Using the special dividend tool would be a more optimal outcome- David Curmi

Given these dynamics, banks may find it challenging to keep increasing profits from their current record levels. This, however, h does not necessarily mean the share prices will follow as one also needs to look at valuations. This can be done by reference to some key metrics as shown in the table below.

Key valuation metrices

                  P/B    P/E     Div Yield

BOV            0.77   5.80    6.90%

HSBC         1.01   5.90    11.80%

Source: Curmi & Partners

On a price to book of 0.77 BOV potentially looks the more attractive, though one needs to keep in mind the franchise of HSBC vs that of BOV. Both banks have extremely strong capital bases and are earning superior returns on their equity. This allows each of the banks to pay large parts of their profits out, principally, as dividends. HSBC has already begun this process. Over the years, HSBC Malta has consistently paid its surplus cash out as dividends. This is how its parent can earn a cash return on its investment and certainly there is no point in keeping excess capital within the local bank’s balance sheet above the regulatory capital buffers required. As HSBC’s profits swell, HSBC is likely to continue releasing this cash to shareholders, and don’t be surprised if the bank pays out a special dividend from time to time, as it has done in the past. 

BOV tends to keep more capital for a rainy day. This is prudent as it doesn’t have a parent with deep pockets. Yet it continues to sit on a significant amount of surplus capital, beyond even the extra cushioning one would expect, and has stated it will raise further capital with debt instruments. This could be a pathway to begin paying out substantial dividends in the near future. Buying back its shares and cancelling them could also be an option that is being considered. There are advantages to this, although it could be more complex in the eyes of the regulator.

A buyback of shares tends to be undertaken by companies with surplus cash levels who find that buying back and cancelling their shares is a more profitable exercise when faced with a lack of investment opportunities. Share buybacks reduce the level of capital within the bank and reduce the shares outstanding, thus improving return on equity and earnings per share at stable income levels.

Certainly, the message given to the market is a positive one but after such a strong run in the share price is this the right time to be doing this? Using the special dividend tool would be a more optimal outcome.

David Curmi is chief officer – Busines Development and Client Relationships at Curmi & Partners Ltd.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi & Partners Ltd is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.