HSBC Malta’s profitability dented by interest rates and management actions

Article #498 by Edward Rizzo - Published Weekly

On Monday 31 July, HSBC Bank Malta plc published its interim financial statements. The announcement by HSBC Malta coincided with similar announcements across other stock exchanges around the world by other HSBC Group companies, namely in Hong Kong and London.

As is customary with only a few of the companies listed on the Malta Stock Exchange, a meeting for financial analysts and the press was convened that same day where the CEO and also the CFO provided additional details on HSBC Malta’s financial performance during the first half of 2017.

It is worth highlighting that HSBC Malta’s performance in the comparative period for the six months ended 30 June 2016 included the one-off gain of €10.8 million relating to the disposal of the shareholding in VISA Europe and therefore the headline figures related to the changes between one period and another would need to take this into consideration.

In fact, while HSBC Malta reported a profit before tax of €25.9 million during the first half of 2017, representing a decline of 37% (equivalent to €15.4 million) over the first six months of 2016, the adjusted results taking into account the one-off gain which was not repeated in 2017, show a decline of 15%.

At the start of the meeting, HSBC Malta’s CEO Mr Andrew Beane immediately commented that the decline in profitability of 15% on an adjusted basis was actually slightly ahead of management expectations.

In essence, two major factors impacted the financial performance during the first half of 2017, namely (i) pressures on revenue due to the negative interest rate environment and (ii) risk management actions which led to both a decline in non-interest income as well as higher compliance costs.

In a detailed presentation by CFO Mr Rashid Daurov, it was explained that the overall impact from the unfavourable interest rate environment amounted to €3.6 million. In various articles over recent years, I had commented that the negative interest rate environment is a significant challenge for the banking sector as surplus deposits are placed at negative rates with the European Central Bank and at the same time banks are now being forced to hold higher levels of capital by their regulators.

HSBC Malta’s CFO displayed some interesting charts to explain the extent of the impact of the current interest rate environment on the bank’s performance. First, Mr Daurov showed a graph indicating that although the loan book was marginally unchanged at circa €3.2 billion over the past 5 years, interest income has declined by 25% during the same period. Likewise, from an investment perspective, the investment income on the bank’s portfolio has also dropped by 30% during the past 5 years.

Mr Daurov commented that the risk management actions taken in recent years to align the bank with the more stringent regulatory landscape has resulted in an overall impact of €2.6 million during the first half of 2017 representing costs associated with the implementation of new procedures being adopted. The CFO also highlighted the increased burden of compliance costs on the bank’s performance with a hike of almost 4 times over the past two years only. In fact, the savings brought about by the early voluntary retirement programme have been offset by the growth in compliance costs.

Both the CEO and the CFO also made reference to changes in the statement of the financial position (previously referred to as the balance sheet). The major highlight was the 3% decline (equivalent to €98 million) during the past six months in net loans and advances to customers to a total of €3.2 billion. It may also have been somewhat surprising to some investors that this was attributed to a decline “in the corporate loan book driven primarily by early repayments by several clients who secured alternative funding through bond issuance”. Meanwhile, HSBC Malta reported that lending to residential property customers (the mortgage book) continued to perform positively although lending margins remained under pressure due to sustained competition and low interest rates.

On a more positive note, the interim financial statements of HSBC Malta reveal that the bank’s fully-owned subsidiary HSBC Life Assurance (Malta) Limited generated a profit before tax of €4.4 million during the first six months of 2017 representing a significant improvement from the €2 million profit in the first half of 2016.

Moreover, interest expenses during the first half of 2017 declined by 26.7% mainly due to the redemption of the 4.6% subordinated bond issue on 1 February 2017 of €58.2 million and to a lesser extent the 2.6% (equivalent to €130.7 million) drop in customer deposits.

Likewise, the level of non-performing loans continued to decline to a total of €191 million as at 30 June 2017 compared to €216 million at the end of 2016. HSBC Malta’s CFO remarked that the overall level of non-performing loans (at under 6%) is already below the threshold stipulated by the European Central Bank and as transposed into Banking Rule 09 late last year.

Another very positive metric is the level of tier 1 capital which improved to 13.9% as at 30 June 2017, up from 13.2% at the end of 2016 and more interestingly from below the 10% level in 2013.

As a result of the strong capital level which continued to exceed existing and upcoming regulatory requirements, the CEO argued that HSBC Malta sustained its high dividend payout ratio at 65% - well beyond the dividend payouts of many other local banks. In fact, a net interim dividend of €0.03 per share will be paid on 11 September to all shareholders as at the close of  last Tuesday’s trading session (8 August). Possibly, many shareholders will be comparing the upcoming dividend with the 2016 interim dividend which represents a decline of 33.8%. However, it is also fair to say that last year’s dividend was also boosted by the one-time gain on the sale of shares in VISA Europe.

The CEO concluded the meeting by stating that the headwinds to profitability are unlikely to abate in the near term since negative interest rates are expected to continue well into next year. Mr Beane however also hinted at some exciting developments during the second half of the year which will help HSBC Malta to grow its profitability over time without unduly increasing risk. The CEO once again placed a lot of emphasis on the quality of the underlying profits generated by the bank and he remarked that HSBC Malta’s strategy was the correct one in this highly regulated environment. Mr Beane further added that HSBC Malta’s strategy is also vital for Malta’s financial system.

While many analysts ought to have anticipated a decline in profits during 2017 as a result of the significant positive impact on the sale of shares in VISA Europe in 2016, few investors may have expected adjusted profits to have declined by 15%. However, the Bank was expecting such a decline as HSBC’s CEO admitted that this was marginally ahead of management expectations. Investors across international financial markets generally dislike being surprised by company developments.

In recent months, I strongly advocated for increased communications by the companies listed on the Malta Stock Exchange to ensure that investors are kept regularly informed of developments and financial expectations. I had also questioned the reason behind the discontinuance of the semi-annual publication of Interim Directors’ Statements by several companies including HSBC Malta.

In my view, all companies should emulate the investor relations strategy of Malta International Airport plc and provide financial guidance to the market so as to avoid any unpleasant surprises such as that experienced by numerous HSBC shareholders last week. Had HSBC issued financial guidance at the start of the year warning of an expected double-digit decline in profits, shareholders would have been adequately informed.

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