BOV warns rate cuts will impact profitability

Bank of Valletta said today that while it had passed on to customers much of the rate reductions made by the European Central Bank, this would have an adverse effect on its profitability.

In a long interim directors' statement to the Malta Stock Exchange, it also reported that with regard to retail and home loans it had seen no evidence of any significant deterioration in credit quality, but a modest slowdown in the demand for credit, particularly on the home loans side, had been seen.

Demand for investment and insurance products had remained subdued, although there had been something of an improvement since the turn of the year.

In its statement, BOV said the first quarter of the current financial year (which started on Oct 1) witnessed a continuing period of extreme nervousness and volatility in the international financial markets, as governments around the world took exceptional measures in an attempt to stabilise the global financial system following the widespread fallout in the wake of the failure of Lehman Brothers in mid-September 2008.

In this environment, the markets had continued to re-price risk and to turn attention and concerns to the likely impact of the impending recession on the wider economy.

This, together with the substantial ongoing deleveraging being undertaken by financial institutions and hedge funds, had kept both bond and equity prices under considerable pressure.

"Heightened risk aversion has served to cause dysfunctional market behaviour and a marked absence of liquidity. As anticipated, the impact of the above has been that Bank of Valletta’s Financial Markets portfolio has witnessed further unrealised fair value mark downs during the period under review, following the application of the current requirements of International Accounting Standard (IAS) 39," BOV said.

"These unrealised mark downs have in part been mitigated by increases in the value of investments held under the Available for Sale (AFS) category. However, pursuant to IAS 39, these AFS gains are booked directly to equity, and not through the Income Statement."

It said that notwithstanding this volatility, the general belief was that the radical actions being undertaken by governments was in the process of securing the global financial system, and had demonstrated the determination of the G20 governments that no more Lehman-type failures should be permitted to occur.

BOV said its financial markets portfolio continued to be deployed across a wide spread of holdings of predominantly highly rated sovereign/supranational, corporate and financial sector debt securities of moderate duration, and the expectation of the board remained that much, but not all, of the unrealised mark downs would be clawed back over time, as the majority of holdings were retained through to redemption.

"To date, the experience has been that all but a very small number of the holdings in the portfolio have and continue to pay interest and meet redemption obligations on due date."

INTEREST RATES

Turning to interest rates, BOV pointed out that between October 1, 2008 and the end of January 2009, the European Central Bank intervention rate had been reduced by 2.25%, from 4.25% to 2.0% - an adjustment in rates unprecedented in both speed and severity.

"BOV has passed on much of this rate reduction to our customers, and this will have an adverse effect on the profitability of the bank – both because of the lag or delayed time effect on the re-pricing of term deposits, and also because continuing competition for deposits has resulted in a compression of the net interest rate margin."

The bank said the re-pricing of credit through the application of margins appropriate to the current environment was under way, but would necessarily be a gradual process.

BOV said that on the corporate, retail and home loans sides of the business, there had, to date, been no evidence of any significant deterioration in credit quality, but a modest slowdown in the demand for credit, particularly on the home loans side, had been seen. Demand for investment and insurance products had remained subdued, although there was something of an improvement since the turn of the year.

Commission income on other banking services had shown a satisfactory increase over the corresponding period last year.

The bank said costs remained under tight control, running at close to FY 2008 levels.

Satisfactory growth in customer deposits had been sustained throughout the period under review.

"Overall, and as expected in the present international environment, BOV has experienced a particularly difficult start to FY 2009.

"The current levels of volatility being experienced on the international markets on an almost daily basis makes it extremely difficult to forecast forward performance, as does the global economic recession that is presently unfolding. However, the expectation remains that FY 2009 will be a very challenging year for the BOV group."

The bank said it had continued with its conservative policies insofar as balance sheet management were concerned, and liquidity and capital ratios were being maintained at levels well in excess of prudential regulatory requirements.

As already announced, it said it would boost its Tier II capital level through a subordinated loan issue during 2009, both to replace its current subordinated loan capital (redeemable in 2010) which was now gradually being amortised through to redemption, and in anticipation of international regulatory encouragement for higher capital ratios overall.

"BOV remains wholly committed to supporting Malta’s economy and our business community in a responsible manner through the current economic downturn, and the conservative loan to deposit ratio and liquidity policy adopted by the Bank means that credit is readily available for our customers. As always, BOV management and staff will continue to be assiduous in the support, care and attention extended to our corporate and retail customer base," the bank said.