Bank of Valletta's crew may be "battered", but the people at the helm of Malta's largest financial institution are proud that their organisation's fitness has been proven in such extraordinary, testing times.

With its financial year ending September 30 - unusual on the world's banking circuit - Bank of Valletta was among the first institutions to report on its 2008 performance on October 31. It announced profits of €40.6 million, significantly lower than the previous year's record €101.8 million. On the day, chairman Roderick Chalmers hoped the results would be regarded as "respectable in all the circumstances".

And there was good reason for disappointment. Until mid-September, there was much to indicate that Bank of Valletta was heading towards a profit for the year of over €65 million. That was until Lehman Brothers filed for bankruptcy on September 14.

"On August 1, we had issued an announcement saying that between March and June, the international capital markets had seen a renewed bout of volatility, predominantly in the equity sector, but that the fixed income markets were being impacted much less," Mr Chalmers tells The Sunday Times.

"We pointed out that any additional required markdowns during the period had been comparatively modest. The company announcement added that, subject to the volatility not spreading to the fixed income sector, it was expected the results for the second half of the financial year would show a significant improvement over the first.

"On September 15, we felt it was necessary to issue a correcting statement on the one we had made six weeks earlier - in effect, a profits warning. The Lehman Brothers collapse was a shock to the market, and our judgment was that this would have widespread repercussions.

"Coming so close to Bank of Valletta's financial year end, we felt it was 'likely that these conditions would have a material, adverse impact on the results of the last quarter of the financial year'. That was the principal reason we made that announcement on September 15 - less than 12 hours after Lehmans filed for bankruptcy. We were the first bank out of the blocks to indicate we believed this event would impact on our results, and that our portfolio included senior Lehman paper.

"Nobody can suggest that Bank of Valletta is not transparent. According to the best information we had at the time, we estimated that we would recover between 40 and 60 cents in the dollar, and that Bank of Valletta would take a hit of between €6 and €7 million. Our management accounts indicated that profits for the 11 months to the end of August were €57 to €58 million. On the basis of the information we had then, we stated that (the Lehman hit) would be 'modest in the context of the profits for the year to date'.

"On the basis of information available later on, the expectation was that the recovery would be 15 cents in the dollar, so that the impact on our financial results was €12.5 million.

"After the September 15 statement, we were repeatedly asked to provide details on our Lehman holding. We declined - banks do not disclose their portfolio holdings, any more than they would provide information about customers' loans or investments.

"As far as the disclosure of the 'Lehman hit' in the annual accounts is concerned, this is another matter. We have an obligation to make sure that our accounts are meaningful. €12.5 million is material in the context of a €40 million profit, and it is necessary for us to disclose (in the accounts) that a single holding has had that impact on the results. It was for this reason that we disclosed the impact of the Lehman's holding, not because we had relaxed our standards of confidentiality."

Fair valuation accounting regulations dealt Bank of Valletta's 2008 results a blow of their own. Had the bank reported on an amortised cost basis from July 1, the profits for the year would have been €58 million.

"We have taken a hit for the year on our financial markets book of €53 million: €12 million for Lehman Brothers which we don't expect to recover, and €41-42 million for unrealised markdowns on the rest of our book. We would hope to claw back a significant proportion of that amount on those securities we choose to hold through to redemption. Of that €53 million, €26 million happened in the 15 days between September 15 and the end of our financial year.

That is the impact of the effective 'cardiac arrest' that the global financial system experienced as a consequence of the Lehman failure. It shows how right we were on September 15 to issue the announcement."

Mr Chalmers, an accountant by profession, believes that fair value accounting is "the right way to go" but that mark-to-market may not be appropriate in the current environment.

"Because of the de-leveraging that is taking place and the lack of availability of credit, there is a very lopsided market out there, where many are trying to sell and very few people are willing to buy," Mr Chalmers explains.

"Even the Bank of England says that the lack of liquidity in the secondary market and de-leveraging means that market prices quoted are well below the true economic value of the assets being transacted. Bank of Valletta and others do not have to sell, but are being obliged to mark to this artificial, frozen market. The big political debate is that this is having a self-sustaining, downward spiral effect on the sector.

"What the proponents of the suspension of fair value rules say is that if financial institutions can demonstrate that they have the ability to hold the assets, and that the assets they hold are not impaired, then the mark-to-market rules should be suspended, instead carrying the assets at amortised cost. For some extraordinary reason, the IASB, although it gave relief on fair value accounting on trading books (at an emergency meeting it held in October), did not give similar relief on investment books. Many believe that an investment book is more deserving of relief, as there is a clearer intention to hold such a book for the longer term."

Bank of Valletta continues to hold its own in the local market, despite stiff competition from HSBC and others. Mr Chalmers says, half jokingly, that customers think of Bank of Valletta as the "local local bank", one that understands Maltese culture. Mindful of the fact that Bank of Valletta does not have Big Daddy in New York or London to bail it out in lean times, it has continued to go about its business prudently.

"Particularly over the last three years when our profits were very buoyant, we were facing enormous pressure from the investment community and from our shareholders to adopt a liberal dividend policy, as had other banks," Mr Chalmers pointed out.

"Banking is a cyclical industry. We chose to adopt a sensible, prudent, conservative dividend distribution policy. After tax, we pay half our profit to our shareholders, and we keep half to build our balance sheet. As a result, we have added €100 million to our reserves over the last three to four years, and we have a capital ratio of 11.5 per cent, which is well above most other European banks. This approach has stood us in good stead in the current environment"

Mr Chalmers says visibility on future profitability is less clear than in the past. Is the worst over?

"The critical, potentially terminal, threat to the global banking system is behind us," he remarks. "It had a near death experience at the end of September and early October, and the robust, if somewhat belated, political and policy response means that the worst is hopefully over in that area. However, I do not think the worst is over on the broader economic front. The policy makers took so long wrestling this beast to the ground that a severe global recession is inevitable and it is just starting."

"We are committed to supporting Malta's ongoing economic development, to the Maltese businessman and to our customers. We have the significant advantage of strong liquidity, a low loan-to-deposit ratio, and a strong and growing depositor base.

"We have the ability to extend credit, and we will continue to do so responsibly. This will be an added defence against the impact the global economic recession will have on Malta."