HSBC’s final dividend hit by new ECB rules

HSBC Bank Malta plc kicked-off the annual financial reporting season on February 19 and given the decision by HSBC Malta to re-introduce the publication of Interim Directors’ Statements in November 2017, the headline figures should not have surprised the market.

During the first half of 2018, HSBC Malta reported a drop in both net interest income as well as non-interest income which led to a 38 per cent decline in pre-tax profits to €16.2 million. In the Interim Directors’ Statement published on November 9, 2018, HSBC explained that its profitability had declined when compared to the first nine months of 2017 as a result of the continued low interest rate environment, a reduction in the corporate loan book and the full year effect of risk management actions undertaken during 2017. HSBC also reported that its performance during the first nine months of 2018 was also dented by higher operating expenses reflecting investments in regulatory programmes and anti-financial crime as well as business growth initiatives.

The 2018 annual financial statements published on February 19 clearly reflect the trends experienced by the bank throughout the year. Net interest income generated during 2018 dropped by 10 per cent to €108.6 million and non-interest income also declined mainly due lower returns from insurance operations. HSBC reported overall pre-tax profits of €38.6 million representing a 22.6 per cent decline from the previous year. The €23 million drop in pre-tax profits was essentially due to the following factors: (i) a €12 million decline in net interest income; (ii) a €4.7 million decline from insurance operations and (iii) a €4.7 million movement in expected credit losses (impairment provisions).

A comparison of the first half results and the annual financial statements shows that the bank’s performance is not impacted by any seasonality with net interest income at just over €54 million in both the first six months of the year as well as during the second half. Net fee and commission income generation as well as operating costs were also very similar. On the other hand, loan impairment charges were much higher in the first half of the year when compared to the second six months. Moreover, during the second half of the year, HSBC accounted for a positive movement of €2 million in the provision for brokerage remediation. This had originally been recognised in 2016 to the tune of €8 million.

The major surprise in the announcement on February 19 was in the overall dividend being proposed for approval at the upcoming annual general meeting on April 17 even when excluding the impact of the special dividend distributed last year which some investors may have hoped could have also been repeated for the 2018 financial year. In August 2018, HSBC declared a net interim dividend of €0.026 per share. Although the interim dividend represented a decline of almost 15 per cent from the dividend declared in respect of the 2017 interim results, the dividend payout ratio remained high at 65.4 per cent.

Meanwhile, two weeks ago, HSBC announced that it is recommending a final net dividend of €0.012 per share, representing a decline of just over 50 per cent from the ordinary final net dividend per share of €0.025 for 2017. Despite the drop in profits, it was immediately evident that there was a change in the dividend payout ratio from one period to the next. The dividend payout ratio in the second half of 2018 is of 30 per cent compared to 64.5 per cent in 2017.

During the press conference held on February 19 following the publication of the annual financial statements, HSBC Malta’s CEO Andrew Beane provided a clear explanation on the reason behind the decline in the final dividend.

The CEO explained that new regulations recently introduced by the European Central Bank (ECB) require the bank to hold additional capital for any unsecured non-performing loans aged over two years, as well as secured non-performing loans aged over seven years that are not entirely provided for and regardless of the security held. Mr Beane claimed that in order to ensure that HSBC Malta has sufficient capital to support its future growth initiatives, the overall dividend payout ratio was reduced accordingly.

Malta’s current legal framework for the recovery of security in the event of default requires reform

HSBC’s CEO also argued that given the new ECB requirements relating to the treatment of non-performing loans, Malta’s current legal framework for the recovery of security in the event of default requires reform. Unless this legal reform takes places, all banks will be required to hold additional capital even against fully secured non-performing loans. The requirement to hold additional capital due to the length of time to recover security through current legal processes will negatively impact bank shareholders. Unfortunately, this will lead to a lower return on equity and moreover, HSBC will be unable to use that capital for higher dividend distributions to shareholders.

In April 2018, after a nine-year absence, HSBC had paid a special dividend amounting to a net dividend of €0.0555 per share. Many local market observers may recall that HSBC Malta had distributed a series of special dividends between 2004 and 2007 and some of the current shareholders may have hoped that this trend would repeat itself following the special dividend distribution for the 2017 financial year. The statement made by HSBC Malta in its Interim Directors’ Statement in November 2018 that its capital ratios continued to exceed regulatory capital requirements despite the redemption of a subordinated bond on October 7, 2018 may have raised such hopes. However, at the time, HSBC Malta had also indicated that it will provide an update on its medium-term capital plan in the fourth quarter of 2018 and on December 14, the bank announced that it secured a €62 million subordinated loan from HSBC Bank plc as part of its Tier 2 capital. The very brief announcement on December 14 ought to have somewhat suppressed any hopes of another special dividend to shareholders.

In the recent press conference following the publication of the 2018 financial statements, Mr Beane once again made reference to the reputational damage suffered by Malta’s financial services sector and appealed to all market participants to ensure that “anti-money laundering standards are fully implemented without delay in order to avoid more significant long-term risks”.

The CEO claimed that on their part HSBC built a world-class compliance function in Malta by investing sizeable amounts in customer due-diligence systems and as a result, HSBC Malta is now focused on some measured growth initiatives which may take time to filter through to improved profitability especially in view of the negative interest rate environment.

Given the unexpected news regarding the ECB rules, Maltese equity investors with exposures to the banking sector are understandably anxious to see how this very recent development will also impact Bank of Valletta plc which has a sizeably larger loan portfolio compared to HSBC. Moreover, given the other important factors impinging upon the overall risk profile of BOV, the publication of the bank’s preliminary statement of annual results on March 15 should be a very important event for the Maltese capital market.

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