Banking matters

Article #798 by Edward Rizzo - Published Weekly

Journalists in Malta rarely cover matters related to capital market developments unless a company specifically convenes a press conference. Unfortunately, only some of the larger companies organise press conferences on the day of important company announcements and publication of financial statements. This leads to a situation in which many important financial results announcements by various companies fail to reach the mainstream media. In view of his lack of coverage, I had taken the initiative to publish my weekly contributions to the media which started way back in 2007. This helps fill the void in the coverage of financial market matters for the benefit of the retail investing public thereby helping to promote investor education.

It was therefore surprising to see a media article last Thursday specifically related to the performance of Lombard Bank Malta plc. As I had mentioned in my own contribution to the media last week, Lombard was among the companies to publish its 2022 Annual Report just before the deadline of the end of April.

The article alleged that Lombard hid investment losses totalling “more than €25 million” since this information was not referred to specifically in the company announcement referring to the publication of the Annual Report. Moreover, the article explained that within their report, the Directors Report made quick mention of this loss without making reference to the actual size of the unrealised loss.

Although it is true that the company announcement did not specifically mention the ‘Other comprehensive income’ section of the Income Statement, the fact that the media article specifically mentions in the title that Lombard “spins positive results, hides investment losses” is rather misleading and may lead to a certain amount of anxiety and uneasiness among the retail investing public.

Journalists or media contributors who publish articles on all companies whose securities are quoted on the Malta Stock Exchange need to ensure that the articles present a fair overview of the financial performance and strength of a company. This takes on a much wider dimension when dealing with banking institutions especially at this moment in time when we have witnessed a banking crisis unfold in the US in early March followed by the forced takeover of the Swiss banking giant Credit Suisse AG by its larger rival UBS AG shortly afterwards.

For the benefit of the investing public, I believe it is worth mentioning the reason behind such investment losses incurred by Lombard (and also other banks) and how these are treated in the financial statements.

The income statement takes into account the core business of retail banks, namely net interest income and non-interest income sources, as well as expenses, impairments or expected credit losses. In a simplistic manner, these items determine the reported profit or loss generated in a specific financial period. This reported profit is then used in the calculation of the earnings per share (EPS) which is a very important financial metric for any company reporting its financial statements.

The media article makes reference to the ‘Other comprehensive income’ section of the Income Statement which is displayed after the reported profit which is the main highlight referred to in all reporting matters both in Malta and also overseas.

Since a large portion of the treasury portfolio of a credit institution is measured at fair value through other comprehensive income, which is a rather technical matter, any changes to the value of the portfolio are reported in the 'Other comprehensive income' section. This is the part of the income statement where the media article indicates that Lombard suffered an investment loss of more than €25 million. This is indeed correct and although Lombard’s treasury portfolio is in the large part composed of Malta Government Stocks, investors who follow financial markets ought to be aware of the huge impact on all sovereign bonds worldwide following the unprecedented hike in interest rates by the major central banks as from mid-2022.

It is important to highlight that such an unrealised ‘investment loss’ was not only suffered by Lombard Bank. In fact, within the recent Annual Reports published by Maltese banks, such losses are clearly visible in the 'Other comprehensive income' section of the Income Statement. APS Bank plc suffered a net impact of €23.5 million in 2022 and HSBC Bank Malta plc €23.2 million. The situation with Bank of Valletta plc is very different since the large part of their sizeable portfolio (totalling over €4.45 billion as at end of 2022 with over €1 billion in Malta Government Stocks) is measured at amortised cost which is different to the classification of other banks and reported in yet another manner. Moreover, in all these cases, the ‘book losses’ shown in the 'Other comprehensive income' are not given any mention whatsoever.

While this adjustment does not impact the reported profit, it is however duly accounted for in the calculation of the equity or total shareholders’ funds. In fact, while Lombard Bank reported a record profit for 2022, the bank clearly highlighted that the group net asset value (NAV) per share decreased to €1.50 from €1.53 in 2021. Here again, this is exactly in line with international accounting standards.

The CEO of APS Bank made reference to the market movements in his statement to shareholders by explaining that the effect of the rising interest rates had a “direct, negative impact on reserves (through ‘other comprehensive income’)”. The CEO also reiterated that these movements are unrealised and are expected to reverse over time since APS and other banks hold such bonds until maturity.

In the light of recent developments in the US it is fair to mention that similar market movements on a bank’s treasury portfolio were not reported in the same manner for all banks in the US. In fact, one of the major criticisms of the recent banking crisis was that Silicon Valley Bank and other so called regional banks did not require to show such market movements in their financial statements following a change in regulation in 2018 for ‘smaller’ banks.

The banking sector is clearly based on trust as was very evident in the US and Switzerland over recent weeks. Media contributors need to be aware of the repercussions of sensational reporting. While it is true that Lombard and also other banks suffered these unrealised losses, thankfully Maltese banks are extremely liquid and well-funded by large volumes of retail deposits. It is therefore virtually impossible for Maltese banks to suffer the same fate as the regional banks in the US which needed to liquidate these sovereign bonds following a sizeable outflow of deposits.

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This article was produced by Edward Rizzo, Director at Rizzo Farrugia, which is a company licensed to undertake investment services in Malta by the MFSA under the Investment Services Act, Cap. 370 of the Laws of Malta and a member of the Malta Stock Exchange. The company’s registered address is at Airways House, Fourth Floor, High Street, Sliema SLM 1551, Malta.