Bank of Valletta plc changed its financial year end from September 31 to December 31 and, as a result, the financial statements published last Friday afternoon cover the 15-month period from October 1, 2016, to December 31, 2017. It is therefore difficult to compare the figures to the previous financial statements for the 12-month period to September 30, 2016. Furthermore, during the financial year ended September 30, 2016, BOV had registered a one-off gain from the sale of its stake in Visa Europe amounting to €27.5 million which further distorts the comparison between the two financial years.

While BOV reported a pre-tax profit of €174.7 million for the 15-month period ended December 31, 2017, the best comparison between the last two financial years was provided by the bank’s CFO Elvia George during a presentation to analysts on Friday afternoon.

The graph she presented depicts the pre-tax profits generated by the BOV Group during the past five financial years highlighting the normalised pre-tax profit of €118 million in September 2016 which excludes the €27 million earned from the sale of shares in Visa Europe. Furthermore, the graph indicates that during the final three months of the last financial year (i.e. between October and December 2017), the BOV Group generated a pre-tax profit of €31 million. As such, the normalised profit for the 12-months between October 1, 2016, and September 30, 2017, amounts to €144 million and represents an increase of 22 per cent over the comparable figure of the previous year.

The two main items that led to this superior performance were the overall amount of impairment reversals of €6.2 million compared to provisions of €23.1 million the previous year as well as the strong improvement in the share of profits from the insurance associate companies (Mapfre MSV Life plc and Mapfre Middlesea plc) amounting to €19.3 million compared to €3.7 million achieved in the previous financial year.

It is important to highlight that this was not only due to the better performance of these two companies but also due to the change in the bank’s accounting year. As a result of this change, the figure reported for the financial year under review of €19.3 million represents the share of profits for an 18-month period.

The financial statements continued to show the adverse impact of the negative interest rate environment on the bank’s performance. Although net interest income increased by 22.9 per cent to €182.9 million, largely reflecting the additional three months in the financial year under review, net interest income contracted by 1.7 per cent on an annualised basis.

In comments to the press last Friday, BOV’s chairman Taddeo Scerri was reported to have stated that “the negative interest rate is costing us €12 million a year”. This comment clearly indicates that once the European Central Bank lifts the deposit rate from the current -0.4 per cent towards zero, the bank stands to benefit in a meaningful manner.

Although the BOV chairman also stated that he does not believe there will be much variation in interest rates in the short to medium term, many international financial analysts are anticipating a gradual rise in the ECB’s deposit rate in 2019 once the quantitative easing programme comes to an end later this year. An increase in the deposit rate would be very beneficial to banks, especially those with high levels of liquidity. BOV reported that it held €3.6 billion in cash and short-term funds as at December 31, 2017.

The financial statements continued to show the adverse impact of the negative interest rate environment on the bank’s performance

This was the first set of financial statements since the successful €150 million rights issue in December 2017 and the main focus for investors should be the level of Tier 1 capital following the significant capital injection and the bank’s dividend policy. In fact, BOV’s Tier 1 ratio improved to 16.1 per cent as at December 31, 2017, following the rights issue compared to 12.8 per cent in September 2016. BOV’s total level of shareholders’ funds amounted to €962 million as at December 31, 2017, and it will be the first company listed on the Malta Stock Exchange to surpass the €1 billion level in shareholders’ funds shortly.

The Tier 1 ratio of 16.1 per cent is now above the average of European banks but, since BOV is a systemically important bank, it requires to hold a high level of capital. This ratio is very much the main determinant of the bank’s dividend policy going forward.

In fact, the new dividend policy which BOV refers to in its press release is conditional on the growth of the Tier 1 ratio over a number of years. It is, therefore, very hard to establish the dividend payout ratio from one year to the next. While BOV has stressed on the importance of giving a good return to investors, achieving a strong capital ratio is its main aim and a gradual growth in capital will arise from the retention of profits.

BOV’s CEO Mario Mallia confirmed that the Tier 1 ratio should approach and settle in the high teens over the next few years. As such, the dividend payout is calculated as the resultant balance in excess earnings once the targeted Tier 1 is achieved each year. Despite the relatively low dividend payout ratio of less than 30 per cent during the last financial year, the annualised net dividend yield is 3.2 per cent based on a current share price of €1.86.

In order to accelerate capital retention, BOV announced a scrip dividend issue last Friday. Essentially, shareholders will have the right to receive the final net dividend of €0.052 per share either in cash or in new shares at an attribution price that will be determined on April 12. The attribution price will be based on the average of the trade weighted average prices for the trading sessions that will be held on April 9, 10 and 11 (the first three days when the equity starts trading ex-dividend) and this will be discounted by five per cent.

 Another important revelation during last Friday’s meeting was that the impact of the new financial reporting standard (IFRS 9) dealing with the provisioning policy is only €8 million and will be reflected in reserves. All the details of IFRS 9 will be published in the 2017 Annual Report which will be available to shareholders ahead of the Annual General Meeting due to be held on May 10. This is much less than initially feared since, at the time of the publication of the interim financial statements to March 31, BOV had mentioned that “the adoption of IFRS 9 may have a material impact on the Bank’s financial statements”.

Moreover, another very important highlight was that BOV plans to refinance part of the subordinated bonds that are up for redemption in the coming years through the issuance of new bonds. The bonds nearing redemption are the €55.4 million 4.8 per cent bonds due on August 27, 2018, the €40 million 4.25 per cent bonds due on May 17, 2019, the €50 million 5.35 per cent bonds due on June 15, 2019 and the €70 million 4.8 per cent bonds due on March 15, 2020.

Since the new bonds forming Tier 2 capital will be subordinated and subject to the BRRD regime, they will be classified as complex financial instruments. Apart from these BOV bonds coming up for redemption, HSBC Bank Malta plc also has a €30 million subordinated bond due in October 2018. Under the MiFID II regulations, the distribution of complex financial instruments to retail investors poses additional challenges since such investors are prohibited from applying for these bonds unless they are able to demonstrate a level of knowledge and experience in the technicalities of ‘subordination’ and ‘BRRD’.

Meanwhile, BOV’s announcement earlier this week regarding the Italian court case is likely to dominate investor sentiment in the near term.

Rizzo, Farrugia & Co. (Stockbrokers) Ltd (Rizzo Farrugia) 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. Rizzo Farrugia, its directors, the author of this report, other employees or Rizzo Farrugia 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 Rizzo Farrugia, 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.

© 2018 Rizzo, Farrugia & Co. (Stockbrokers) Ltd. All rights reserved.

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