BOV’s financials severely dented by COVID

Article #689 by Edward Rizzo - Published Weekly

The annual financial reporting season continued last week with the main highlight being the publication of the 2020 financial statements of Malta’s largest bank, Bank of Valletta plc. Those Maltese companies having a December financial year-end have until the end of April to publish their Annual Report. Although all the large caps have now already published their financials, various other medium and small-cap companies still need to do so in the coming weeks.

The BOV Group reported a profit before tax of €15.2 million during 2020, a decrease of €74 million (or -83%) when compared to the previous financial year.

Although it was understandable for investors to anticipate a sizeable negative impact to BOV’s profitability as a result of the pandemic and the banking sector landscape, it is worth highlighting some of the material items which characterised the financial year.

BOV reported that the adjusted profit after excluding these material items amounted to €100.7 million which still represents a reduction of €37.4 million (-27%) from the previous year. BOV’s CEO Mr Rick Hunkin described the underlying performance as “strong despite an interest rate environment which is creating persistent headwinds”.

The most substantial material item that clearly stands out in the financial statements is the amount of specific expected credit losses or provisions recognised by the bank totalling €77.9 million. BOV explained that this can be segregated into two parts – an amount of €38.1 million in provisions predominantly related to the impact of COVID-19 and additional impairments of €39.8 million arising from legacy non-performing loans (NPL’s) outstanding for more than 7 years.

In respect of the COVID-related provisions, the probability of defaults for the calculation of expected credit losses across the entire loan portfolio are based on economic forecasts prepared by central banks. These are naturally highly subjective and the CEO pointed out that although the duration of COVID-19 is still uncertain, one could expect to see some potential releases of some of these provisions in due course. A number of financial support measures were provided to certain sectors by the Government which were deemed to have been most severely impacted by the pandemic. Once support from the Government is terminated in the months ahead, the solvency of several businesses can be gauged in a better manner which could determine the extent of any releases of such credit losses.

Meanwhile, in the Annual Report, BOV’s CEO argued that the €39.8 million provision on the legacy loans was necessary “in line with recent regulatory changes and financial reporting standards” as the recovery of these loans may be prolonged in the current economic environment.

Another major item that dented the performance of the BOV Group in 2020 was a cost of €15.8 million in the ongoing ’Transformation Programme’ which aims at lowering the risk profile whilst strengthening the long-term sustainability of the bank’s business model. In 2019, the amount allocated to the ‘Transformation Programme’ amounted to €23.9 million. In the 2020 Annual Report, CEO Rick Hunkin states that the “risk appetite now reflects a better balance of risk and reward and such investment is critical to a sustainable bank”.

Meanwhile, net interest income declined by 4% to €146.8 million and non-interest income contracted by 12.5% to €84.8 million due to declines in net fee and commission income (-8.9%) and trading profits (-25.2%) mostly as a result of the significant disruption that COVID-19 had on economic activity. Furthermore, BOV recorded lower income from its associate investments (namely Mapfre MSV Life plc and Mapfre Middlesea plc) which amounted to €10.5 million compared to €15.9 million in 2019.

Given the financial performance in 2020, coupled with the strong recommendation by the European Central Bank to all European banks to limit or refrain from distributing dividends, it should not be surprising that BOV elected not to declare a dividend to shareholders. Moreover, the resumption of dividends seems to be strongly linked to the resolution of the multi-million litigation case related to failed shipping line Deiulemar. In fact, BOV’s Chairman Mr Gordon Cordina clearly explains that “the resumption of a steady dividend policy thus requires clarity on the outcomes of the COVID-19 event and the major litigation case, coupled with the successful implementation of the transformation strategy to generate sustainable profitability going into the future”.

On his part, CEO Rick Hunkin gave a detailed update on the situation with respect to the Deiulemar litigation and he confirmed that during 2020 the bank made a settlement offer to the counterparty (which was not accepted), “without prejudice and with no admission of liability, in an effort to close out this litigation once and for all”. The CEO explained that until the litigation is settled, the bank needs to maintain “sufficient capital resources to withstand any possible adverse outcome” and this “surplus capital carries a cost for the bank”. In fact, BOV’s CET1 ratio of 20.9% remains comfortably above regulatory requirements and would need to remain elevated until the litigation case is resolved.

BOV’s Chairman also provides a clear indication on the possible timing of the resumption of dividends. In his address to shareholders, Mr Cordina notes that the bank’s strategy “aims to target the maximisation of shareholder value in the medium term, with a vision to restore the payment of dividends at levels that are adequate, stable and predictable”.

The Annual Report also makes ample reference to the 2023 Strategic Plan. The CEO explains that the plan is “focused on ensuring that the bank is well positioned to deliver future growth and more consistent and sustainable performance once the operating environment stabilises”. The strategic plan is based on 3 key pillars: (i) transform and digitise the operating model; (ii) rebalance the balance sheet and (iii) bring superior value to customers.

With respect to the restructuring of the balance sheet, as has been highlighted in my articles over recent years, BOV continues to maintain excessive liquidity as demonstrated by the advances to deposits ratio of only 42.1% as at 31 December 2020. Over the past 5 years, customer deposits increased by just under €2.1 billion while customer loans rose by €740 million placing increased pressure on the bank’s main source of income.

In view of the current negative interest environment, this idle liquidity represents a considerable cost for BOV. In fact, the Annual Report indicates that as at 31 December 2020, a total of €4.28 billion were held in investments subject to negative interest rates, while customer deposits amounted to €4.7 billion. BOV’s CEO indicates that action is being taken “to achieve a better loans-to-deposits ratio in the longer-term”.

In the past, BOV was generally regarded as a consistent dividend-yielding equity by the local investing community. The bank paid dividends regularly to shareholders from the date of the listing of its shares on the MSE in 1992 until 2018 (in respect of the financial year to December 2017). However, following the litigation provisions that surfaced in 2018, dividends have been suspended and shareholders will not be receiving a dividend for the third successive year (after the recommendation of a dividend for 2019 was also withdrawn in line with ECB guidance). Since more than 20,000 investors hold shares in BOV, it is pivotal for the bank to successfully complete its transformation strategy at a time of unprecedented challenges due to the economic shock caused by COVID and also put behind it the major litigation case. BOV is a bellwether of the domestic capital market and the success or otherwise of the bank is likely to continue to effect overall investor sentiment.

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