The COVID-19 pandemic has brought the world into exceptionally difficult and largely uncharted waters. In reality, this pandemic has forced governments across the globe to introduce aggressive and severe emergency measures and restrictions in a robust attempt to contain the spread of COVID-19. Undoubtedly, such measures have however been a particular threat to several industries, including the banking sector.
Banks came into the coronavirus pandemic stronger than they went into the global financial crisis, but will the capital and liquidity buffers they have built be sufficient to see them through such difficult economic climate?
Much will depend on both the duration of this crisis and the extent of the impact on the global economies as well as, the scale and effectiveness of mitigating measures provided by the relevant authorities. Additionally, in line with the growing list of economies (including Malta) which are currently taking tentative steps to ease restrictions or publishing indicative timetables, it would be interesting to see how global economies will react.
As Malta’s leading bank, BOV is an essential attribute to the successful recovery of the local economy.
BOV’s litigation cases
Prior to the COVID-19 outbreak in Malta, BOV seemed to be gradually addressing previous concerns, namely in connection to their ongoing litigation cases. Following the favourable judgement on the La Vallette Multi Manager Property Fund case in December 2019, BOV remains involved in two material litigation cases, namely the Deiulemar Trust and the Falcon Funds Sicav.
BOV recently announced that these two litigation cases are clearly being impacted by the current pandemic situation and final conclusions may be deferred into the upcoming year (FY21).
In terms of the Falcon case, the Group announced that discussion between parties to resolve the matter are ongoing with both parties agreeing to an independent mediator.
In relation to the Deiulemar case, BOV filed an application before the European Court of Human Rights (ECHR) during FY19 to defend its right for a fair hearing. It is key to mention that BOV is still however facing an enormous amount of local pressure on this specific case.
Moreover, during FY19 BOV increased its provisions pertaining to the cases to €100m, representing an additional provision of €25m over FY18. This leaves the Group with €338m in potential damages (gross of tax) stemming from these outstanding cases.
In view of the fact that both cases are expected to be deferred into the upcoming year, we remain cognisant of the real risk of further litigation provisions.
Financial performance: FY19
In line with growth in mortgages, interest on loans and advances during FY19 increased to €169.8m (FY18 €165.2m). However, the reduction in income from treasury activities, in combination with a higher burden of negative interest rates, drove the bank’s net interest income for FY19 down to €152.9m (FY18: €156.5m).
As part of BOV’s transformation programme, the Group embarked on a de-risking exercise aimed at establishing a new risk appetite, increased internal controls and tighter policies. However, the de-risking measures implemented during FY19 reduced the volume of fees earned on various products. Subsequently, net fee and commission income generated during FY19 dropped by 9 per cent and stood at €73.8m (FY18: €81.1m). The Group deems such decline in net commission income to be in line with expectations.
As a result of the transformation exercise being carried out by BOV, which is circa 50 per cent completed up until April 2020, operating expenses in FY19 increased by 6.5 per cent over FY18, with the cost to income ratio increasing to 61.4 per cent from 49.1 per cent in FY18. When excluding €23.9m investment costs related to this exercise, BOV’s adjusted cost to income ratio for FY19 is 52.4 per cent.
Moreover, in line with the proactive stance adopted in debt management, the bank managed to minimise its non-performing exposures, which resulted in a net impairment reversal of €11.6m. The ratio of non-performing exposures to total lending improved from 5.3 per cent during FY18 to 4.6 per cent as per publication of the FY19 results.
Upon taking the above factors into consideration, except for the increase in the provision for litigations, during FY19 BOV reported an adjusted profit before tax of €114.2m (FY18: €146.2m). BOV’s CET 1 ratio as at FY19 stood at 19.5 per cent (FY18: 18.3 per cent).
It is worth noting that in view of the current pandemic and following a strong recommendation of the European Central Bank (ECB), BOV decided to postpone their initial divided proposal relating to its FY19 performance.
COVID-19 impact and FY20 outlook
BOV recently announced that mainly due to the current COVID-19 climate, the Group’s financial performance for Q1 2020 was somewhat below expectations, as some adverse effects began to emerge towards the end of March due to the consequential economic impact. Likewise, the Group also reported that net interest income generated during Q1 2020 was marginally down in comparison to FY19.
Additionally, the Group explained that the situation on impairment provisions remained favourable up until Q1 2020, but the current difficult trading environment is likely to necessitate further provisions.
Although a clear determination of the overall financial impact cannot be concluded at this stage, we expect the Group to experience additional credit losses during FY20. More importantly, the bank also maintained that there are no concerns in terms of capital adequacy measures and that BOV’s capital ratios currently are at a strong level.
In view of this pandemic situation, although it is relatively early to estimate the pandemic’s impact on the Group’s operational and financial performance, especially as the duration of the current situation remains unknown, we are of the view that a lower income and potentially growing credit losses will lead to reduced profitability for FY20.
Disclaimer: This article was issued by Andrew Fenech, research analyst at Calamatta Cuschieri. For more information visit www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.