BOV posts reduced profits and interim dividend following “toughest period”
The Bank of Valletta Group reported operating profits for the first six months of the Financial Year 2009 (FY 2009) amounting to €10.1 million. This compares with an operating profit of €21.9 million for the equivalent period ended 31st March 2008. The final net profit for the period was reduced by the sum of €3.8 million, being BOV’s share of the results of its Middlesea group insurance associates (2008: profit of €3.1 million). The Board declared an interim dividend of €0.035 per share (gross).
Announcing the results, BOV Chairman Roderick Chalmers said that the period between mid-September 2008 and the end of February 2009 was “unquestionably, the toughest six month period in the history of modern banking and finance” with major banks across both Europe and the United States that were hitherto pillars of the financial establishment having been either nationalised or obliged to seek very substantial financial assistance from governments by way of guarantees and/or additional capital.
The Chairman stated that a semblance of calm appeared to have been restored to the markets since the beginning of March, and that, although sentiment remained cautious and fragile, the hope was that the beginnings of what was likely to be a long drawn out period of recovery were being seen. He went on to say that, as was generally forecast, Malta’s wide open economy had not been immune to the global recession, although the impact to date has been relatively mild. However, Mr Chalmers opined that “a cautious expectation must be that the situation could become more challenging in the short to medium term.”
Roderick Chalmers observed that Bank of Valletta’s conservative funding, liquidity and capital ratio policies have, over the past 18 months, enabled it to “navigate through the unprecedented conditions experienced in the banking markets, whilst at the same time, continuing to provide credit and liquidity to the Maltese economy, and to BOV’s customers in the retail and business communities.” He emphasised that “in keeping with the pledge made last year, BOV, with its strong capital and liquidity positions, has and will continue to support Malta’s economy and business community in a pro-active and responsible manner.”
Review of Performance The Chairman provided a detailed commentary on the results, explaining that these had been influenced by a number of factors including, (i) the strength and commitment of BOV’s core domestic retail and corporate banking business, (ii) the radical measures taken by the European Central Bank (ECB) in an effort to combat growing recessionary pressures, (iii) the disruptive impact of the global financial crisis on BOV’s Financial Markets (FM+I) book, and (iv), BOV’s share of the results of associates and jointly controlled entities.
Mr Chalmers explained that rapidly falling interest rates invariably had a negative effect on bank profitability, due to the delay in the re-pricing of time deposits and the compression of margin on lower cost liabilities. He noted that in the six month period under review the ECB, in its efforts to combat growing recessionary pressures, had lowered its reference rate five times from 4.25% to 1.5 %, with a further 0.25% reduction being announced on 2nd April. This extraordinarily rapid rate of decline in interest rates had, Mr Chalmers said, an adverse impact on bank profits estimated at €6 million.
Net commission and trading income for the six months was marginally above that earned in the previous period, and the Chairman regarded this as a “satisfactory result” given that the March 2008 numbers included €1.4 million of exchange income earned on Euro/Maltese lira transactions during the period prior to euro adoption. He explained that commission income on investment products remained “soft”, but that income from cards and foreign trade business has been “strong.” Management had implemented cost control measures, with the result that “overhead costs for the six months have been maintained at fractionally below 2008 levels.”
The net operating profit from core banking operations for the six months was reported at €42.1 million (2008: €47.9 million), with the reduction in profits being largely attributed to the compression in net interest margin. Mr Chalmers said that the Board expects “a gradual improvement in the net interest margin as deposits re-price, and as measures taken for the modest widening of certain select lending margins are implemented.” He explained that the Board had taken a policy decision not to pass on the last two ECB rate cuts totalling 0.75% (announced in March and April 2009) to either loans or deposits, and that the reasons for this decision were twofold; Firstly, it was felt necessary to maintain deposit rates paid to BOV customers in order to remain competitive, and secondly, the Board was “entirely satisfied” that current lending rates were already competitive, and compared very favourably with rates prevailing elsewhere in Europe.
Turning to the Fair Value charge of €32 million (2008: €26 million), the Chairman observed that these were due to distinct elements. He explained that over 60% of the charge arose from “hedge ineffectiveness” on BOV’s Interest Rate Swaps (IRS). Mr Chalmers explained that the IRS hedged interest rate risk on all fixed rate holdings that extend beyond a defined duration, and reflected BOV’s conservative risk management approach in the conduct of the FM+I portfolio. “In the current disrupted and dislocated market conditions, degrees of temporary hedge ineffectiveness have emerged,” but, Mr Chalmers assured, “the Board is confident that this ineffectiveness (much of which relates to holdings of Malta Government or other sovereign holdings) will reverse over the duration of the holding, and that the technical and unrealised fair value adjustment made under IAS 39 will be reversed, with the bond redeeming at par and the IRS expiring at nil value.”
Roderick Chalmers noted that the balance of the fair value markdowns included the impact on values resulting from the widening of bond spreads as a result of the recent market turmoil. “In the current market environment, investors are demanding higher returns on holdings of credit instruments. Higher yields or spreads translate into lower capital values, and these lower values in BOV’s FM+I portfolio are reflected in the above fair value adjustment” he explained. The Chairman emphasised that BOV’s FM+I portfolio remains deployed across “a wide spread of holdings of moderate duration debt securities issued by quality, credit rated, sovereign, supranational, corporate and financial institutions”, and that the Board’s expectation is that “much, but not all, of the fair value markdowns of €84 million incurred in FY 2008 and the first half of FY 2009, will be clawed back over time, as the credit instruments involved are held through to redemption.” He explained that the Board’s view is “reinforced” by BOV’s experience since the beginning of the financial crisis to date. Mr Chalmers said that over this period “the vast majority of holdings have paid interest and been redeemed at par on due date, with defaults experienced being limited to a very small number of holdings.”
The Chairman said that “between July 2007 and March 2009, over €700 million of bonds (excluding sovereign holdings) had redeemed at par, whilst defaults to date of interest or redemption have been limited to holdings with a nominal value of €23 million (including Lehmans).” Finally, the Chairman noted that Fair Value gains for the period on investment holdings classified under accounting standards as “Available for Sale” amounted to €5 million before taxation (2008: €7.4 million), and were taken directly to reserves.
The share of losses of jointly controlled and associated entities relate to BOV’s share of losses incurred by the Middlesea Group in the six months ended 31st December 2008. Whereas Middlesea Valletta Life has remained profitable, notwithstanding exceedingly difficult capital markets conditions, the Middlesea general insurance businesses have reported a significant loss for the year. Mr Chalmers commented that “as was described more fully in Middlesea’s recent press release issued in connection with its annual results announcement, this has, in the main, been caused by unsatisfactory results arising from Progress Assicurazioni, the Middlesea subsidiary company operating in Italy.”