The Central Bank of Malta (CBM) published the seventh edition of the Financial Stability Report (FSR) on September 3, 2015.
The FSR reviews and assesses the macro-financial conditions and developments of the Maltese financial system. It also evaluates the resilience of the system and identifies sources of potential systemic risk. In the FSR, the CBM also makes the necessary recommendations to preserve and also enhance the resilience of the financial system.
The latest FSR is based on data as at end of 2014 and the CBM once again confirmed that the five core domestic banks that remain the most systemically-relevant credit institutions in Malta are Bank of Valletta, HSBC Bank Malta, APS Bank, Banif Bank (Malta) and Lombard Bank Malta. Meanwhile, Mediterranean Bank will be considered as a core domestic bank from the next FSR which will be published in the coming months based on developments and data as at June 30, 2015.
The FSR is a lengthy publication which I am quite sure most investors will not be reading in detail. As such, today’s article is intended to highlight the main findings of this report since there are a number which should be given due consideration.
At the outset it is worth noting that the CBM believes that during 2014, the financial sector in Malta “displayed ongoing resilience in the face of the challenges from the external macroeconomic environment and those inherent to its own industry”. The CBM expects this resilience to be strengthened further due to favourable developments in the local economy and the adoption of various regulatory measures aimed at strengthening the capital and liquidity positions of domestic banks.
The strong liquidity across the financial system is a well-known fact and it has been mentioned in various articles and press releases over recent months. The CBM confirmed that “core domestic banks continued to operate with abundant liquidity”.
The main form of funding is resident customer deposits which increased by 11.8 per cent during 2014. The report notes that the average customer loan-to-deposit ratio of the core domestic banks at the end of 2014 was of 61.7 per cent.
The exposure to banking equities by many investors has grown in excess of generally accepted allocation levels
It is interesting that the CBM also makes reference to the eurozone average customer loan-to-deposit ratio which stood at 103.2 per cent at the end of last year.
This reveals the difference between the funding sources of Maltese banks compared to their international peers which, notwithstanding the challenges faced by European banks in the onset of the 2008/2009 financial crisis, are still very much dependent on wholesale funding apart from retail customer deposits.
In previous FSRs, the CBM referred to the requirement for banks to reduce their level of non-performing loans (NPLs) and improve their loan loss provisions. It had laid particular emphasis in previous years on the high level of non-performing loans in the construction and real estate sector. However, during 2014, the rate of increase in NPLs in the construction and real estate sector declined compared to recent years. In fact, the increase in NPLs was of just below two percentage points compared with the rise of almost five percentage points in 2013. The CBM attributed this to positive developments across the real estate sector and prudent lending practices adopted by banks in recent years.
Notwithstanding the reduction in the rate of growth in NPLs, the construction and real estate sector remains the largest contributor to NPLs at 45.5 per cent followed by wholesale, transport, storage and accommodation at 20.8 per cent and households at 17.6 per cent.
Meanwhile, the overall NPL ratio of the core domestic banks peaked in mid-2014 at 9.5 per cent and eased to 9.3 per cent by the end of the year, thus lowering the credit risks on banks’ lending portfolios. Despite the slight decline recorded in 2014, the CBM continues to encourage banks to “use this period of economic growth and stability to continue to strengthen their capital buffers and augment their loan loss provisions”.
The FSR also analyses the profitability of the banks within the domestic financial system. The report explains that the very low interest rate environment exerted downward pressure on the profitability of core domestic banks, which is expected to persist through 2015. The decline in profits also resulted from higher impairment charges (due to increased provisioning of past loans, reflecting more rigorous provisioning policies) and additional compliance and regulatory costs.
The large core domestic banks incurred substantial costs related to the comprehensive assessment exercise by the European Central Bank prior to the launch of the Single Supervisory Mechanism in late 2014.
Although the profits of Malta’s banks weakened on average by 17 per cent in 2014, the performance was still strong and higher than the average of EU banks of comparable size. The FSR indicates an average return on equity of 10 per cent for Maltese banks (representing a decrease of 3.1 percentage points over 2013) compared to small EU banks at only 2.9 per cent.
The 2014 FSR also touches upon the capital requirements of the core domestic banks. The CBM concluded that the capital position of the local banks remained healthy with the Capital Adequacy Ratio at 14.1 per cent (albeit down from 14.9 per cent in 2013) and the Tier 1 Capital Ratio of 10.5 per cent.
Although the CBM is of the view that the stabilisation of credit risk and a recovery in credit growth will to some extent relieve the pressure on bank profitability, “banks are encouraged to continue exercising prudent dividend policies and to build up reserves to sustain capital buffers under the new regulatory framework”.
This continued reference by the CBM to more prudent dividend policies could have wide implications for the numerous local investors who have partially relied on their exposure to banking equities for stable and attractive dividend income over the years.
Although the majority of local investors have a general preference towards fixed income securities as an alternative to bank deposits, a large number of investors also have exposure to equities. Since the banks were among the first companies privatised by the government in the 1990s, the exposure to banking equities by many investors has grown in excess of generally accepted allocation levels over the years following the strong upward movement in share prices until 2006.
However, this may need to be revisited given the more onerous capital requirements being placed on banks going forward by the ECB as the single regulator including the revised obligations of Banking Rule 12 regarding concentration risk. Local investors will therefore require other alternative investment opportunities to achieve a better diversified portfolio and more stable income levels.
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.
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Edward Rizzo is a director at Rizzo, Farrugia & Co. (Stockbrokers) Ltd.