BoV’s H1 profitability up 9 per cent despite increased loan provisions

In recent months, sentiment has been pretty subdued across the local financial market as evidenced by the gradual decline in the equity market to a three year low on weak volumes despite some encouraging financial performances from a number of companies listed on the Malta Stock Exchange. The weak investor sentiment could be partly attributed to the political uncertainty which has gripped the local scene over recent months but also due to the European sovereign debt crisis which continues to drag along.

BoV reported its second best interim performance and its highest level of first-half profits since the previous record in March 2007- Edward Rizzo

Despite the international economic environment, the major global equity markets have recovered strongly from the lows of last October and this possibly indicates that the reason for the lackluster performance of local equities may be more “homegrown” rather than due to the wider global uncertainties.

Given this backdrop, the publication of the interim financial statements by Bank of Valletta plc last Friday afternoon was a key development to gauge the state of Malta’s second largest listed company. It was also important as a possible catalyst for improved investor sentiment. BoV reported its second best interim performance and its highest level of first-half profits since the previous record in March 2007, shortly before the start of the international financial crisis.

During the first half to March 31, 2012, pre-tax profits of the BoV Group advanced by nine per cent to €49 million despite a sharp rise in loan provisions to €15 million. Net interest income surged by 14 per cent to a record of €77.3 million however this was largely due to the exceptional inflow of €5.2 million in interest income on loans which had previously been provided for. During a meeting held shortly after the publication of the financial statements, BoV chairman Roderick Chalmers explained that this reflected the cautious approach taken in the past and boosted the first half performance following the interest income received from these customers. Otherwise, the higher interest income reflected the growth in the loan book and other assets from one period to the next.

Net fee and commission income was once again marginally lower due to the weak sentiment across financial markets affecting the brokerage business as well as the continued lack of bond issuance activity in Malta following the listing policies enacted by the MFSA in August 2010.

Following the strong rates of growth in the past two years, profit from foreign exchange activities dropped by 9.8 per cent to €7.7 million as margins on foreign exchange business narrowed due to an increased competitive environment.

The wild movements across the international bond markets since the financial crisis in 2008 exposed BoV’s financial performance to significant volatility from one period to the next in view of the accounting procedures in place. The recoveries or mark-downs from the bond portfolio have impacted BoV’s profitability in recent years. In the Interim Directors’ Statement published on January 27, BoV had reported that it had recognised “some unrealised fair value markdowns” during the first quarter of their financial year between October and December 2011.

This was confirmed by Roderick Chalmers last Friday when he acknowledged that the “very negative number in Q1” was offset during the subsequent three months following the intervention by the European Central Bank in December 2011 through the liquidity injection via the Long Term Refinancing Operations (LTRO). The interim financial statements published last Friday showed that BoV registered a gain of €0.5 million in contrast to the €5.6 million fair value loss during the first half of last year.

The other major line item that impacts a bank’s performance is the overall level of impairments taken on the loan book. Loan provisions recognised during the first half of the year climbed to €15 million, 44 per cent above the impairment in the comparative period and just below the overall €16 million charge taken in the last entire financial year. BoV’s chairman explained that €13 million was set aside as a collective provision to reflect the cautious view that the overall economic environment is likely to get tougher during the second half of the Bank’s financial year. Specific impairments only amounted to €2 million and in fact BoV reported that the overall credit quality improved during the period under review as the level of non-performing loans dropped to 4.1 per cent of overall loans as at March 31 compared to a level of 5.1 per cent in September 2011 and a recent high of 5.3 per cent as at March 2011. The level of non-performing loans by Malta’s two major banks compares very well with international benchmarks despite the evident slowdown across a number of sectors most notably construction, real estate and retail.

During the first half of the year, BoV’s performance was also negatively impacted by the higher level of expenses which grew by 10 per cent to €45 million due to a number of factors including a new collective agreement, higher professional expenses and increased IT costs. Although some of the expenditure related to the revised collective agreement was a one-time adjustment to reflect a hike in the previous financial year, the cost to income ratio of 41.3 per cent compares well with BoV’s ratios in past years. Mr Chalmers also compared BoV’s cost efficiency ratio to the average across EU and US banks. BoV’s cost to income ratio of 41.3 per cent is significantly better than the ratios of well over 60 per cent across the EU and the US.

The insurance associates also generated a lower return in the interim financial statements. From a profit of €3.8 million arising from MSV Life plc and Middlesea Insurance plc in the first half to March 31, 2011, this was reduced to only €1.63 million during the last six months. However, in view of the different financial year-end of BoV compared to both insurance companies, this reflects the June to December period and therefore the improved performance across international financial markets during the first quarter of 2012 is not yet reflected in the insurance contribution.

Despite the significant increase in loan provisions, higher costs and lower contributions from the insurance companies, BoV’s profit after tax for the six months ended March 31 increased by 5.4 per cent to €31.9 million.

The balance sheet as at March 31 shows total assets of €6.7 billion with net loans increasing by €87 million during the first half of the year to €3.7 billion. Customer deposits advanced by €94 million to €5.62 billion with BoV reporting modest growth in deposits from retail customers as well as institutional clients. An important indicator across the banking industry is a comparison of the overall level of advances compared to deposits. As at March 31, BoV’s loan to deposit ratio stood at 68.7 per cent and the chairman explained that this indicates that the bank is not reliant on money markets or other short term funding solutions. On the other hand, Mr Chalmers compared this to the European landscape where despite the “de-leveraging” that has been taking place, the average loan to deposit ratio is still high at 110 per cent. The chairman reported that this shows that banks across the EU are in constant need to re-finance themselves and this is one of the reasons for the LTRO programme. BoV’s chairman also stressed on the importance of liquidity and once again re-iterated that the Tier 1 Capital of 10.8 per cent shows the healthy liquidity position of BoV.

BoV’s share price which has been on a downward trend in recent months reacted positively to the higher profits registered in the first half of the year. Last Monday the share price closed 1.9 per cent higher at €2.15 although the equity touched a high of €2.20 shortly after the commencement of trading. BoV continues to be among the highest dividend yielding equities in Malta and the strong Tier 1 capital ratio indicates that the dividend payout ratio of 50 per cent can be maintained also at the full-year stage.

Rizzo, Farrugia & Co. (Stockbrokers) Ltd, “RFC”, is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the issuer/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results.

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Mr Rizzo is a director at Rizzo, Farrugia & Co. (Stockbrokers) Ltd.