The major local banks’ half-yearly results were this year reported against an unusual backdrop when the rating agency Standard and Poor’s (S&P) showed concern about “allegations of money laundering against Pilatus Bank, a small Malta-based international bank, as well as a perception of poor transparency at some banks”. S&P argued that this constituted increased reputational and operational risks for the Maltese banking sector generally.

The collateral consequence of this evaluation was the downgrading of the long-term rating of BOV by one notch to BBB. At the same time, Malta’s largest bank reported record operating profits of €88.5 million in the first half of 2018 – an increase of 30 per cent over the same period last year.

The fly in the ointment for BOV are legacy issues that landed the bank in legal disputes with the main one relating to the setting up of three trusts for Italian shipping families in Torre Annunziata in 2009. BOV made a provision of €75 million given these legal disputes and confirmed that it would not be paying any dividends this year.

HSBC is in a different stage of its de-risking process that started a few years ago. It reported half-yearly profits of €16.2 million – a decrease of 38 per cent when compared to the same period in 2017. The bank increased lending and deposits marginally while its costs to income ratio increased from 63 per cent in the first half of 2017 to 74 per cent in 2018. HSBC will be paying a dividend of 2.6 cents per share net of tax.

Both banks are pursuing a de-risking strategy as regulation becomes tighter and the emphasis on capital consolidation increases. BOV has disposed of some of its unprofitable business including trust services that carry a high risk with minimal return. Undoubtedly, they will continue to do so by pruning unprofitable services that were introduced at a time when risk awareness did not feature prominently in their strategic thinking.

Banking regulation will continue to be stricter with more emphasis placed on the consolidation of risk capital

Concurrently BOV will want to build buffers of risk capital not only to satisfy regulatory demands but also to enable it to restart paying its shareholders dividends as early as possible. There will, of course, be a cost to raising capital but this cost is more than justified to enable the bank to maintain its dominant position in the Maltese market.

S&P made an encouraging comment when it stated that “despite the €75 million extra provision in the first half of 2018, we anticipate BOV’s resilient profitability and contained credit losses will enable it to maintain by 2020 its risk-adjusted capital ratio of 12.3 per cent”. I would not be surprised if BOV’s board will consider measures that will achieve this risk-adjusted capital ratio mentioned by S&P even before 2020 to reinforce the loyalty of shareholders in the bank. As stated by S&P, the “government’s 25 per cent ownership of BOV should enhance depositors’ confidence in the bank and contribute to its stability”.

As for HSBC, the objective is to “move into a new strategic phase characterised by a return to growth and value creation”. This strategy will be challenging as during the past few years when the bank was implementing its business model transformation, BOV and other banks captured market share from HSBC.

Banking regulation has never been tighter in Europe. But the good news for those who hold bank shares is that the industry is becoming safer even if profitability may suffer in the short term. As recently confirmed by Fitch, Malta’s economy continues to perform well. This is the ideal scenario for Malta’s major banks to review their business models, beef up their capital base and exploit sustainable growth opportunities.

Investment in equities should be based on one’s long-term objectives. Short-term issues have to be seen in the context of the bigger picture that will include the prospects of a positive trend in returns as well as capital growth over a period of years.

Bank stocks are not an exception to this maxim. Those who have a risk appetite that can tolerate occasional setbacks in the performance of a company must keep themselves updated on operational developments and not react emotionally to every single event that may come from the company whose shares they own.

One thing is sure: banking regulation will continue to be stricter with more emphasis placed on the consolidation of risk capital. Both of our largest banks are taking the necessary steps to de-risk their business models while at the same time compete for market share.


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