HSBC Malta CEO Mark Watkinson.The half-year results published by HSBC Bank Malta plc on August 4 show a 25 per cent decline in pre-tax profits to €39.6 million.
The €13 million reduction in profits is mainly attributable to: (i) €5.2 million as a direct result of a reduction in net interest income (the core business of a traditional retail bank) due to the low interest rate environment; (ii) approximately €4.5 million as a result of the non-occurrence of the one-off gains registered during the first six months of last year (from the insurance subsidiary and the lower gains on sale of investments); and (iii) approximately €2.5 million as a result of increased regulatory fees primarily related to the comprehensive Asset Quality Review of the European Central Bank conducted in recent months.
HSBC Malta’s net interest income, the largest revenue contributor, dropped by 8.2 per cent during the first half of the year to €58.3 million. This decline reflected the lower amount of interest earned on loans and advances to customers due to the reduction in interest rates by the European Central Bank. The ECB lowered its official interest rate three times over the past 18 months. In May 2013 and in November 2013, the ECB reduced interest rates by 25 basis points on each occasion with the official rate dropping from 0.75 per cent to 0.25 per cent. On June 11, the ECB announced a further reduction to a new historic low of 0.15 per cent. As such, the €5.2 million reduction in net interest income must be viewed in the context of the significant difference in the level of official interest rates between the first half of 2013 and the first six months of 2014. The decline from 0.75 per ent to 0.25 per cent for most of these two periods led to a lower level of income earned on outstanding customer loans. This trend is likely to persist, albeit at a slower pace, during the second half of 2014 and 2015 due to the further reduction in the ECB’s official rate as from June 11 to 0.15 per cent.
The low interest rate environment is being aggravated by the subdued growth in the overall loan book. HSBC Malta’s CEO Mark Watkinson explained that although gross new lending improved substantially over last year, net loans and advances to customers declined as a result of a high level of repayments by a number of customers. According to the CEO, this was particularly the case in the retail mortgage lending area possibly as a lack of investment opportunities led to a number of customers repaying some or all of their borrowings. On the other hand, there was an evident pick up in confidence in the commercial sector but the new facilities on some large projects take a long time between the approval of the loan and the actual draw-down. As such, this will only filter into the bank’s income statement gradually in future years once the facility is utilised.
The bank’s other revenue sources also declined during the first six months
This challenging operating environment for the banking sector is expected to continue as the ECB confirmed again last week that interest rates will remain at the present historic low levels for “an extended period of time”. The recent weakening economic data from Germany, France and also Italy (which officially dropped back into a recession) coupled with inflation at an almost five-year low was exacerbated by the increasing concerns over the impact of the Russian counter-sanctions on Europe’s already fragile economic recovery. Russia announced that it will ban all imports of fruit and vegetables from Europe for one year (Russia is the largest buyer of European fruit and vegetables) after the recently imposed actions by the EU targeting Russia’s banking, oil and defence sectors.
Moreover, the lower interest rate environment also impacted the income earned on the bank’s investment portfolio as the proceeds of higher yielding maturing bonds were re-invested at the prevailing lower rates.
The bank’s other revenue sources also declined during the first six months of 2014 with HSBC Malta reporting a 5.9 per cent decline in fee and commission income as well as an 11.7 per cent drop in income from foreign exchange activities.
Another factor that led to a reduction in profitability was the weaker performance from the life insurance subsidiary and the lower level of gains made on the sale of investments. The contribution from this life insurance subsidiary was mainly due to the lower level of non-recurring items compared to the first half of 2013.
Apart from the overall decline from most revenue sources, HSBC and the other banks in Malta and across Europe were impacted by higher regulatory costs. HSBC Malta reported that while discretionary cost items were contained, the higher regulatory fees mainly related to the Asset Quality Review which led to a higher level of expenses during the first half of 2014.
Additionally, the level of impairments increased due to a lower level of recoveries that took place in the first half of 2014 compared to the first six months of 2013. Otherwise, HSBC reported that new impairments were roughly on the same level as last year.
The interim dividend declared by HSBC Bank Malta plc on August 4 not only reflected the lower level of profits but also the requirements under the MFSA’s Banking Rule 09. The gross interim dividend of €0.045 per share (net: €0.029) represents a 50 per cent decline over the adjusted interim dividend declared in 2013 of €0.09 per share. HSBC’s CEO confirmed that the Board of Directors maintained a 55 per cent payout ratio which implies that the interim dividend excluding the impact of BR09 would have been €0.068 per share, ie 25 per cent lower than last year’s dividend reflecting the exact decline in profitability. However, although BR09 allows for a three-year transitory period to achieve the required additional capital, HSBC adopted a more conservative view and this year’s interim dividend not only reflected the impact of the requirement for the 2014 financial year in full but also half of the requirement for 2015. As such, the reduction in the interim gross dividend of an additional €0.022 per share brings HSBC to a threshold of 85 per cent of the total additional reserving stipulated under BR09. The remaining 15 per cent (or circa €1.5 million) would need to be set aside by the end of 2015. Since the bank’s equity is mainly regarded as a dividend play by the local investing community, HSBC’s directors possibly took the decision of taking the major part of the reduction in dividends immediately so as to create less uncertainty on the extent of future dividend payments assuming the bank maintains a 55 per cent payout ratio.
Following the conclusion of the interim reporting season which comes to an end on August 31, the immediate focus of investors will then turn to the results of the Asset Quality Review and the stress tests sometime in October.
As yet, the ECB has not established the date when the results of around 150 banks across Europe will be published. The market will be watchful for any recommendations being made by the European Central Bank or the European Banking Authority on whether the level of capital held by Malta’s largest retail banks is adequate in the circumstances or whether additional capital is required.
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 company/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, and may also have other business relationships with the company/s. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.
© 2014 Rizzo, Farrugia & Co. (Stockbrokers) Ltd. All rights reserved.
Edward Rizzo is a director at Rizzo, Farrugia & Co. (Stockbrokers) Ltd.