Last Friday afternoon, BOV announced pre-tax profits of €117.9 million during the 2014/15 financial year which came to an end on September 30, 2015. This is a record performance and represents an increase of 13 per cent over the pre-tax profits generated in the 2013/14 financial year. It is also €2.1 million higher than the previous record of €115.8 million in the 12 months to September 30, 2013.
A deeper analysis of the financial statements is necessary to understand the trends across the main business segments. Core profits of the BOV Group improved by 4 per cent (€3.4 million) to €91.3 million.The bank registered strong double-digit growth in both net interest income as well as net commission and trading income. Despite the low interest rate environment, net interest income grew to €144.8 million (the highest level since the record of €147.8 million in 2012). BOV benefited from the reduction in interest payable as customers continued to opt for shorter term deposits despite the minimal rate of interest.
Net commission and trading income improved by 17 per cent to €87.3 million with the bank reporting a strong performance across all business lines, including investment-related services, credit cards and foreign exchange activities.
The double-digit growth in income was sufficient to offset the increase in operational costs and the large rise in impairments. Operating costs rose by 16 per cent to €108 million on the back of the new regulatory environment, the increased contributions towards the Deposit Guarantee Scheme and the Single Resolution Fund as well as the higher costs in human resources and IT. The pressure on costs is not likely to abate in view of the stiff regulatory environment, the necessary investment in IT infrastructure and human resources as well as the collective agreement that ought to come into force in the near term.
Moreover, BOV revised the methodology towards its provisioning policy following the Asset Quality Review and the stress tests carried out by the European Central Bank (ECB) last year. The individual assessment of the loan exposures that are deemed to have higher specific risks resulted in an overall impairment charge of €32.7 million, a significant increase of €13.3 million over the impairments recognised in the previous financial year.
The BOV Group’s financial performance was boosted by the positive conditions across the financial markets, mainly the bond market. Fair value movements including the profit on sale of Malta Government Stocks arising from BOV’s participation in the quantitative easing programme amounted to €14.8 million, an increase of €5.8 million or 64 per cent over last year.
A larger capital base will make it harder for the bank to continue to register double-digit returns on equity
The buoyant performance of the bond market also positively impacted the share of profits from the insurance associate companies. In fact, the contribution from MSV Life plc and Mapfre Middlesea plc improved by €4.6 million to €11.8 million.
While the record profit figure is partly due to the robust performance across the bond markets, some other financial indicators continue to point towards the strong fundamentals of the BOV Group. The improvement in the cost-to-income ratio to 41.8 per cent and the post-tax return on equity of 12.4 per cent are strong indicators by international standards. Most banks across the eurozone do not manage to operate with such a good cost efficiency ratio and few institutions manage to generate a double-digit return on equity.
On the other hand, the drop in the loan-to-deposit ratio to 47 per cent is a matter of concern. Although this shows the very high levels of liquidity and the trust placed by many depositors, it presents serious challenges to the bank when managing such levels of liquidity during a period of historically low interest rates – including negative rates for banks placing overnight deposits with the ECB.
In fact, BOV’s chairman John Cassar White and chief financial officer Elvia George both warned about the challenging times ahead. In his address to the financial community last Friday afternoon, Mr Cassar White repeatedly highlighted the very big changes that are occurring across the European banking industry following the new regulatory regime as from November 2014.
In respect to the continued decline in the loan-to-deposit ratio following the extraordinary €1.4 billion increase in deposits and the relatively weak loan growth, the chairman also hinted at the possibility of introducing high charges for customers for handling deposits as well as negative interest rates to discourage further growth in the deposit base.
Mr Cassar White also laid out a number of issues that need to be addressed by BOV as a result of the new regulatory landscape. The top priority relates to the bank’s capital requirements. He explained that so far BOV had adequate levels of capital in terms of Tier 1 and Tier 2, but this will change in the coming years. By way of example, the chairman noted that in 2016 capital must also be set aside for the growing custody business. CEO Charles Borg noted that the €150 million subordinated bond programme, which forms part of Tier 2 capital, will be completed by early next year and this will be followed by an increase in the equity base (Tier 1). Mr Borg indicated that the bank wished to complete this equity issuance well in advance of new capital requirements coming into force in January 2018.
The news of the bank’s plans to raise additional equity is consistent with the messages from both BOV’s chairman and CEO in recent years. They had both talked about the possibility of a rights issue for the past two years. Last Friday’s revelation of the more urgent need to raise fresh equity should not therefore be a major surprise to observers of local market developments.
Mr Borg maintained that a decision needs to be taken after giving due consideration to the appetite of the current shareholders, especially the larger ones. This may be rather delicate given the present shareholding structure with the government owning 25.23 per cent of the issued share capital and Italian bank Unicredit SpA, the second largest shareholder, with a stake of 14.55 per cent. The remaining 60.22 per cent is held by over 18,000 retail and institutional investors.
The chairman indicated that the upcoming increase in Tier 1 and Tier 2 capital will also have implications on the future dividend policy and overall profitability levels. A larger capital base will make it harder for the bank to continue to register double-digit returns on equity. Moreover, Mr Cassar White acknowledged that the bank struggled to convince the regulators to allow them to maintain this year’s final dividend at the same level as the previous year. Although the absolute dividend is unchanged from last year at €0.08 per share net of tax, the increase in profits naturally resulted in a further decline in the dividend payout ratio. A further reduction in the payout ratio in the years ahead is therefore expected due to the need for additional equity to be retained by banks across Europe. BOV’s chairman also hinted that future dividends may also take the form of scrip issues (as opposed to standard cash dividends) to encourage shareholders to retain capital within the bank.
The need for additional equity via a mix of a reduction in dividends as well as rights issues or a new equity injection is evident across the European banking landscape.
Following the news of the upcoming capital raising exercise by BOV, market participants and the bank’s wide shareholder base will be more attentive to announcements related to the method, the amount required and the timing of the Tier 1 equity plans.
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