Safer banks – safer investment for shareholders

As most companies by now have reported the interim financial results for 2019, we thought it would be interesting to get a better understanding as to how Malta’s two leading banks have fared since the beginning of the year, how they compare to each other, and perhaps what to expect going forward.

Starting off with the largest capitalised bank listed on the Malta Stock Exchange, with a total equity value of just under €1 billion as at end of June, and a total market capitalisation[1] of €620M as at mid-August, Bank of Valletta plc (BOV) reported its much anticipated interim results on July 31. Its peer, HSBC Bank Malta plc, followed suit on August 5, 2019.

The profit before tax reported by BOV stood at €54.3M, which translates into an annualised return on equity (ROE) of 10.7%. At face value, this compares well when compared to the same period of 2018, having registered a profit before tax of €13.5 as a result of a hefty litigation provision of €75M. However, one would attain a much better understanding analysing the bank’s operating profit of €45.1M reported for the 2019 six-month period and the €84.2M figure reported for the comparable period in 2018. The €39.1M decline over the period can be explained by three main contributory factors.

First, net interest income dipped marginally from €79M to €77.6M despite the overall increase in capital held with the Central Bank of Malta, treasury bills and cash from €3.4 billion to €3.64 billion as at June 2019. It was in fact reported that the current low to negative interest rate environment together with a capital optimisation programme undertaken by the Bank on its proprietary portfolio led to an overall decline on interest earned. It is interesting to highlight that such figure accounts for almost 61% of total operating income (June 2018: 61.7%).

Secondly, costs increased by 27.4% from €63.9M to €81.5M, predominantly on the back of a new collective agreement signed with the bank’s employees, and general administrative expenses, which the board seems to be attributing to HR and IT related expenses. Tying in with the latter is also the fact that the bank has embarked on a multi-year Core Banking Transformation project in view to strengthen the Group’s IT infrastructure following last February’s Cyber-attack incident.

Another contributing factor to such a sharp decrease in operating profit is the impairment charge of almost €1M reported for the six-month ended June 2019. This sharply contrasts with the net impairment reversal of €20.2M, that positively impacted the results reported in 2018.

The €75M litigation provision accounted for in 2018 reflects three material litigation cases, which are continuously kept under review to assess the Bank’s position as any developments materialise. The Bank’s most pronounced litigation case is categorically the €363M Deiulemar Trust case; and to a lesser extent, the defunct La Vallette Multi Manager Property Fund, as well as the Falcon Fund SICAV.

Uncertainties surrounding the above, together with the US correspondent bank matter, and the recent downgrade to BBB- have all contributed towards the negative sentiment on the bank’s equity price, up to a point were we had to witness a decade-low trading price of €1.055 reached on August 9. It is also true that most local investors have weighed heavily on the bank’s share prices since its announcement last year to halt any dividend payments for the foreseeable future following extensive discussions with its banking supervisors.

Nevertheless, the Group remains financially robust, having registered further growth in customers deposits, from €10.4 billion to €10.6 billion, and a comfortably liquidity buffer of more than €4 billion held in either cash or short-term funds. It was also reported that international deposits, both corporate and personal, have decreased as part of the de-risking exercise embarked on since Q3 2018. On the other hand, loans and advances to customers also increased from €4.36 billion to €4.49 billion, while registering a decline in loans and advances to banks from €490 million to €394 million.

All capital ratios remain resilient, with both the Capital Adequacy Ratio (CAR) and CET1 Ratio improving from 21.1% and 18.3% as at end of December 2018 to 22.7% and 19.1%, respectively as at end of June 2019. Moreover, apart from the successful issuance of the recently issued €50M 3.75% subordinated bond, which will strengthen the bank’s capital plan focusing on Tier 2 Capital, it is expected that the bank also further strengthens its Tier 1 capital beyond just ploughing back of profits. In fact, as previously highlighted, the bank is seeking to raise capital by end of year through issuance of a financial instrument eligible as Additional Tier 1.

Within the same industry, had one to analyse the interim results published by HSBC Bank Malta plc (HSBC), one can observe some improving attributes in the bank’s financials. The bank did in fact report a higher profit before tax of €20.9M for the six-month period ended June 2019 (€16.1M June 2018). This represents a ROE before tax of just under 9%.

On the other hand, loans and advances to customers increased by €73M over the six-month period to €3.18 billion, as a result of strong growth in the Retail Banking and Wealth Management mortgage portfolio and to a lesser extent in the commercial lending book. Meanwhile, customer deposits declined by €38M to €4.85 billion as increases in Retail deposits were offset by a reduction in Commercial Banking deposits.

Shifting on to HSBC’s liquidity buffer and capital adequacy ratio, an improvement has also been recorded, as both the Capital Adequacy Ratio (CAR) and CET1 Ratio improved from 17% and 14.6% as at end of December 2018 to 18.8% and 16.2%, respectively as at end of June 2019.

A financial institution listed company, having most of its balance sheet items being easily marked to market, one could interpret the Net Asset Value (NAV) per share more objectively than an otherwise non-banking listed company. In the sense that certain balance sheet items on the bank’s balance sheet, such as balances with the central bank or amounts owed to customers, are rather straight forward when it comes to valuing them.  At close of business day last Wednesday, BOV’s share price closed at €1.06. This compares to the bank’s book value per share as at end of June 2019 of €1.70[2], and such value has remained relatively unchanged over the past three years. It is also interesting to highlight, however, that HSBC’s NAV per share stood at €1.17 as at end of June; and has also remained stable over the past three years. This compares to the €1.49 closing market price per share last Wednesday. This implies a price-to-book ratio of 0.62 for BOV, and 1.27 for HSBC.

Clearly the market has penalised BOV for the fact that the bank has refrained from paying any dividends. Investors are also concerned about the uncertainties surrounding the bank’s unsolved litigation cases and implications of the bank’s Core Transformation Programme. Since a year ago, the bank’s market capitalisation has shrunk from close to €920M to around €620M, paving the way to Malta International Airport plc into becoming the largest listed company on the Malta Stock Exchange by market cap (not adjusted for free-float traded shares; i.e. shares held by the general public).

HSBC has already gone through a similar transformation (de-risking) programme over the past years and is now focusing its operations on the optimisation of its capital to support lending, as well as potentially paying higher dividends to shareholders. If we look back at HSBC’s results for the six months to 2013 and 2014 and without considering one off items, the Bank’s profit before tax reached €53M and €40M respectively, and a before-tax ROE of 25.1% and 17.8% as at the respective dates. In 2012 the bank had also reported a profit before tax of €53 million for the first six months of the year. During these years HSBC had started to report increased operational costs which were partly due to the increased regulatory procedures. The de-risking process had started to impact the Bank’s profitability and a reshaping of the business has been ongoing over the years. This is now complete and therefore shareholders are now expecting results to improve even though it is now being selective in the business it undertakes. It would however be unrealistic to expect the bank to reach the profitability of 2012 and 2014, at least in the short-term, given the regulatory environment and the business model of HSBC.

The question is, will BOV results be impacted in the similar manner as it de-risks its business?

BOV’s profit before tax at €54M is similar to that achieved by HSBC in 2013. Net interest of BOV as at June 2019 is at €77.6M compared to HSBC’s €53.6M, while net fees and commissions for the first six months of 2019 generated by BOV amounted to €36.5M compared to HSBC’s €11.1M – Clearly, BOV continues to generate much higher income, and a growing balance sheet size, as highlighted in our article last year comparing the two banks over the previous decade. Even while de-risking its business, it should not result in a significant loss of revenue to the bank. On the other hand, the added costs which one expects as part of the transformation of the bank is surely to have a great impact on the bottom line as was evident in the first half of 2019. The challenge for BOV will be to control these increased costs, while adhering to the regulatory requirements and at the same time, adopting its new business model. Despite that HSBC’s cost efficiency ratio has been seen to increase over the years as it de-risked, the higher revenues for BOV shall aid in containing a relatively more stable cost-to-income ratio. The bank did however indicate that shareholders should expect these changes to impact the bottom line, and we wouldn’t exclude the possibility of some recovery in share price as soon as BOV hints that the distribution of dividend is to be resumed and litigation cases concluded.

Nevertheless, both banks’ equity share prices have been hammered significantly since the beginning of 2019, registering double-digit declines, as investors’ weigh in their concerns on each respective banks’ prospects going forward and in an economic environment where higher interest rates are nowhere to be seen in the foreseeable future. In fact, a similar stance has been witnessed across the broader European banking industry, as subdued profitability is to continue to be expected due to the protracted low interest environment. However, shareholders should also remember that stronger banks make their investment safer.


Jesmond Mizzi is Managing Director and Colin Vella, CFA,is Head of Wealth Management at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. Jesmond Mizzi Financial Advisors are sponsoring brokers of Bank of Valletta plc. The Company is licensed to conduct investment services by the MFSA and is a Member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on Tel: 2122 4410, or email [email protected]

[1] Total shares outstanding multiplied by market price

[2] Total equity divided by total number of shares