Moody's fears negative pressure for HSBC Malta

Moody's credit agency said that although the outlook for HSBC Malta's D+ financial strength remained stable, this could come under negative pressure should the deterioration in the bank's loan portfolio quality continue.

In an analysis on HSBC Malta, Moody's says that the outlook for the deposit ratings is negative, reflecting the negative outlook assigned to the country ceiling for Malta, mainly due to the weakening fiscal and external position of the Maltese economy.

Moody's said that after taking control of HBM (HSBC Bank Malta), HSBC applied a much more stringent approach in classifying its inherited loan portfolio and in valuing the level of collateral held against loans, leading to a significant increase in the level of non-performing loans.

Over the past few years, the ratio of non-performing loans to gross loans jumped from 5.2 per cent in 1998 to eight per cent in 1999 and 12 per cent in 2000.

This rising trend continued during 2001,with the ratio rising to 12.9 per cent, reflecting the difficult operating conditions in the country.

In terms of the quality of HBM's loan book, and compared with HSBC's worldwide standards, Moody's said it believed that future HBM lending would be rather cautious with an intention to improve the loan portfolio.

This may lead to declining market shares, reflecting the lack of high-quality lending opportunities in Malta. However, Moody's does not view this potential loss of market share as having any rating implications, since improving asset quality would bolster HBM's financial fundamentals.

Despite the significant increase in the level of non-performing loans, the growth in the level of loan loss provisions was not as high.

As of December 2001, HBM's loan loss reserves covered 3.3 per cent of gross loans, up from three per cent the year before. As a result, the ratio of net non-performing loans to shareholders' equity jumped from 34.4 per cent in 1999 to 89.6 per cent in 2001.

The low coverage of non-performing loans reflects the fact that a significant part of the bank's loan portfolio is secured by immovable property, in line with other banks in the system.

Nevertheless, Moody's expressed concern over the safety of lending against property, as the value of collateral seems to be rather uncertain in Malta due mainly to a limited market and modest levels of demand.

In addition, the situation was exacerbated by the slow speed of court decisions and executions in the event of the bank using this vehicle against non-payers.

According to the management, although the legal process was long, the bank has been successful in residential property lending, with losses remaining at minimal levels.

In the case of industrial and commercial property, the bank was very conservative in valuing collateral, leading to higher loan loss provisions.

Moody's said that the D+ financial strength rating of HBM reflected its strong domestic franchise as one of the two banks dominating the Maltese banking system, the other being Bank of Valletta.

HBM's franchise was further enhanced by the fact that it was 70 per cent owned by HSBC Holding - one of the largest global banking and financial services groups.

Moody's said that the financial strength rating also captured the banks' growing problematic loan resulting from the weakening economic environment, and the adoption of HSBC's more prudent classification and provisioning policies.

HBM's deposit ratings were set at the A3/Prime 2 ceiling for foreign currency deposits in Malta, incorporating strong external support from both the bank's controlling shareholder, HSBC, and the Maltese authorities.

This year's interim results showed HBM's consolidated net income growing by 32 per cent to Lm7.02 million, reflecting a 12.2 per cent increase in net interest income and a 6.4 per cent decrease in operating expenses.

Moody's said that HSBC uses the 'wealth management' approach worldwide to capture and strengthen its retail market share. It secures access to retail customers by offering competitively priced personal mortgages and builds on this by offering other products such as life and property insurance, credit/debit cards, asset management and brokerage.

It said that HBM has been following a similar strategy in Malta and has been successful in capturing a significant share of the mortgage business on the island.

Moody's views positively HBM's additional efforts towards diversifying its income sources.

It says that the importance of non-interest income has been steadily growing in the last few years and represented over 39.8 per cent of operating income in 2001.

Moody's said that while Malta was gradually preparing for accession to the EU, a large part of the domestic industrial sector remained heavily subsidised and protected by high import tariffs.

Although non-competitive by international standards, a significant number of companies in these sectors have traditionally flourished in the protected environment.

In particular, this might be the case for furniture, textile, food and chemical industries.

According to the association agreements with the EU, Moody's said, Malta was required to lift all levies by year-end 2003. In this context, Moody's believes that the following factors may come into play:

¤ The abolition of tariffs would allow the country to import cheaper and/or higher quality products;

¤ A reduction of government subsidies and protection of domestic companies would fuel competition from abroad. This would in turn pressure domestic companies who fail to adapt to a more liberal and competitive environment. Moody's expects these pressures to lead to a deterioration in the bank's loan portfolio quality and it will therefore monitor this process carefully.