During 2002, Bank of Valletta continued with its three-year strategic plan which has three main pillars.
First, there are the sales-related strategies, namely, developing new revenue sources in investment banking, fund management, bancassurance, and card payments, seeking out new opportunities in the Euro-Mediterranean region, and investing in multiple distribution channels to reach new customers or further activities of existing customers. These strategies also have the objective of diversifying the income stream.
Second, there is the improvement of asset quality, including credit management and the BoV brands.
Third, there is greater customer focus with customer relations management taking centre stage.
These three strategies reinforce one another and involve substantial investments in human resources, marketing and systems. Investment involves sacrifice today for rewards tomorrow.
In BoV's case, the investment came at a time when the economy is subdued and international standards in financial services - which have to be adopted by all reputable financial centres - are imposing disciplines which local operators may consider superfluous given the structure and customs in the local economy.
The group's results, therefore, have to be seen in this context. Furthermore, in comparing this financial year's results to last year's, one has to keep in mind that a major profit centre of the group, BOVI, is being taxed at a higher rate and one cannot therefore compare figures directly.
The following analysis is based on the financial statements for the year ended September 30, 2002, which have been published and approved by the annual general meeting held in December.
Interest receivable fell from Lm98.6 million in 2001 to Lm92.4 million in 2002, a fall of six per cent. The fall in interest receivable was mostly buttressed by a fall in interest payable, which fell from Lm67.2 million to Lm61.9 million, or eight per cent. As a result of these two components, net interest income, the main source of revenue for the group, fell by three per cent, from Lm31.4 million to Lm30.6 million.
The fall in interest receivable was mostly due to less interest being received on loans and advances from customers which, for 2002, was Lm44 million (down by Lm5.6 million on 2001, or 11 per cent) even though the amounts of loans and advances outstanding at the end of the respective years increased from Lm722.7 million to Lm763.3 million, or Lm40.6 million.
Conversely, interest payable on customer accounts fell by Lm4.2 million even though the amount of deposits increased by Lm137.8 million, closing 2002 at Lm1.4 billion. This is in line with the looser monetary conditions prevailing in the economy.
The interest received on debt and other fixed interest securities held by the group, as expected, was more stable falling only from Lm42.3 million to Lm40.2 million. For 2002, interest income on bonds represents 45 per cent of total interest receivable (Lm92.4 million). Interest from securities, therefore, provided an important cushion to BoV's revenue, thus showing the wisdom of BoV's build-up of bonds in past years, 75 per cent of which issued by local government and banks.
Interest payable at Lm61.9 million was down by eight per cent from last year's Lm67.2 million since deposit rates followed the downtrend in general interest rates. During the initial phases of interest rate liberalisation, it was thought that cutting the rates paid on customer deposits was bound to meet with considerable inertia and local banks were reluctant to be the first to cut. Eventually, though, floating rates became accepted as the norm.
Net interest income, as a result, fell by three per cent from Lm31.4 million earned last year to Lm30.6 million. This is the main source of BoV's income, being 65 per cent of operating profit. Last year, net interest income was 67 per cent of operating income. The diversification of the income stream away from net interest income is one of the objectives of local banks and in this regard, therefore, BoV continues to be on the intended path.
Other income included net fees and commissions earned at Lm7.6 million (2001: Lm7.7 million) and trading profits at Lm8.1 million (2001: Lm6.0 million), the improvement coming mainly from foreign exchange activities.
Operating income was Lm46.8 million (2001: Lm46.6 million), a slight increase, but a significant one, in my opinion. In the current environment, it is hugely difficult to maintain earnings, and to do so in an ubiquitous group like BoV requires leadership and very effective management.
Again - and this brings us to the next item - net impairment losses this year came in at Lm5.7 million compared to last year's Lm6.4 million.
Loan and investment write-downs came to Lm18.6 million (2001: Lm10.9 million), Lm10.8 million of which in the form of bad debts written off. Against these there were reversals of previous write-downs amounting to Lm13.0 million (2001: Lm4.5 million), the bulk of which were in specific allowances.
It is very obvious here that BoV got caught between past commercial practices and the directive issued by the Central Bank in line with international developments, especially the so-called Basle agreements.
For a long time, for better or worse, we had a system which was predicated on collateral, primarily land and buildings. Land in Malta is assumed never to fall in value. So, the bank got as much land and building as it could negotiate to cover the loan and then monitored the loan via regular financial statements. Normally, if a businessman had a good reputation and kept the banker informed, all was well. If one missed an instalment, no big deal, one made up for it the following month.
Some individuals sort of "abused" the system, of course, knowing that if you owe your bank a little money, the bank owns you, but if you owe the bank a lot, you own the bank. Others borrowed, built up blocks of apartments, put up a price sign, and let the interest on the loan compound until the right buyer came along. Meanwhile, with the price of property increasing, money was made by all around.
Unfortunately for this system, international regulation was built on different assumptions. First, international property values fluctuate and are not as positively inclined as the local variety has been.
Second, the world financial system has become so complex and interlinked that, like a rubble wall, a major default could bring the whole structure down.
It was therefore thought prudent that banks should recognise and make provision for the non-repayment of scheduled amounts immediately and in an automatic manner. This reasoning, and the regulations resulting therefrom, eventually arrived in Malta.
The result is that while, in the past, because that was the normal practice, the banker had the discretion to be patient and had the discretion to choose the persons to be patient with, this is no longer the case, and banks now have to charge their profit and loss accounts in an automatic matter. Furthermore, this clash of culture took place at a time when economies around the world, including Malta, are weak.
Fitch's slight lowering of BoV's rating, therefore, has to be looked at in this context.
Profit before tax was slightly higher than last year's, that is, Lm14.5 million compared to Lm14.4 million. Tax, however, came in at 35 per cent, up from last year's 20 per cent. Previous years' average tax was low due to the special five per cent rate applicable to offshore banks and this lowered BoV's average tax rate since BoV used to have Bank of Valletta International as a subsidiary, which has now been merged into the Bank.
As it is, profit after tax attributable to shareholders came in at Lm9.2 million, down by 16 per cent on 2001's Lm10.9. Earnings per share was 19c9 (2001: 23c6).
For comparison purposes, had the tax rate remained at 20 per cent, profit after tax attributable to shareholders would have been Lm11.6 million, an improvement of seven per cent over 2001. This is, of course, purely for illustration purposes because the Inland Revenue, as shown in contingent liabilities, are making claims against BoV, which the directors are deeming unfounded.
Loans and advances to customers increased by six per cent to Lm763.3 million, while customer deposits were up by 11 per cent, and at the end of last September these stood at Lm1.4 billion. Loans to government-owned entities amount to Lm125.8 million and, of these, Lm102.5 million (81 per cent) are guaranteed by the government.
Dividends proposed and approved for the financial year were 11 cents per share plus a special dividend of five cents per share. BoV also made a bonus issue of one share for every five held as at close of business on January 3, out of the share premium account.
Paul V. Azzopardi is corporate stockbroker of Bank of Valletta plc.