Changing times for Malta’s leading banks

By Jesmond Mizzi

Bank of Valletta plc shareholders have a few more days to consider whether to take up their rights to acquire more shares at a discounted price or whether to lapse their rights or assign them to someone else. Bank of Valletta recently announced their interim twelve month financial statements to September 2017, in which they reported a pre-tax profit of €143.9million for the period, as core profits grew by almost 23 per cent.

On the other hand two weeks ago HSBC Bank Malta plc,published its interim directors’ statement, in which it stated that during the period from July 1 to November 15, 2017 it registered a decline in profit before tax compared to the same period in 2016. The report further stated that although profitability was lower during the period, it remained broadly in line with management expectations, consistent with the bank’s prioritisation of risk management actions in 2017.

In view of the above diverging scenarios we will analyse the performance of Malta’s two largest banks over the last decade.

Back in 2006, Bank of Valletta plc (BOV) and HSBC Bank Malta plc (HSBC) had respectively, €5.42 billion and €4.4 billion in total assets.  BOV had by far a much larger increase in asset value over the 10 years that followed, doubling its balance sheet size to €10.72 billion, a compounded annual growth rate of 7.1 per cent, as opposed to an annual growth rate of 5.2 per cent registered by HSBC – with total asset value of €7.31 billion as at financial year-end 2016.

It is known for a fact that banks’ profitability tends to improve in an economic environment were interest rates are higher. However, since the 2008 financial crisis, interest rate levels trended lower, reaching record low levels up to a point where banks’ cash balances held at the Central Bank are being charged 0.4%. Moreover, more stringent banking regulations have also negatively impacted banks’ profitability as a result of increasing compliance costs, and higher levels of capital being required. Notwithstanding this fact, both banks emerged out of the global financial crisis strong enough, maintaining a healthy stream of regular dividend payments,  increasing the size in absolute terms of their core business , that is, loans and deposits – while maintaining a Tier 1 common equity ratio well above the minimum stipulated by banking regulation. The latter minimum threshold was introduced way back in 2014, to act as a precautionary measure to the economy in the event of another financial crisis.

Nevertheless, it is evident the different trajectory both banks have taken along the years. Starting off with net interest income, back in 2006, HSBC recorded €109.4 million, while BOV’s figure stood at €114.4 million. Fast forward to 2012, up to which BOV had registered a growth of 4.4 per cent per annum in net interest income, as opposed to a 3.3 per cent growth registered by its peer. In the four years that followed, interest rate levels have continued to put pressure on the banks’ margins, albeit BOV still managing to register a marginal growth from €147.8 million (2012) to €148.8 million (2016). The same cannot be said with respect to HSBC. Net interest income had peaked to €133.1 million in 2012, following which it has fallen to €126.4 million by 2016.

 

How has profitability changed?

In 2006, BOV’s profit before tax stood at €89.4 million, or €7 million lower than what HSBC had recorded at the time. In the last financial year-end results (2016), this income statement item had declined by around 38 per cent to €59.4 million for HSBC, whereas BOV’s figure increased to €118.4 million. Both figures were adjusted to reflect one-off exceptional gains of VISA sale. Which factors contributed towards this divergence? HSBC’s bottom line was primarily impacted as a result of loan impairment charges and operational costs, particularly in relation to regulatory fees and additional compliance investment. On the contrary, BOV’s negative impact from the low interest rate environment was more than offset as a result of the continued growth in their balance sheet (including loans portfolio); an increase in fees and commission income; increase in trading profits; and favourable movements in the bank’s financial markets investment book.

This is also reflected when comparing the two banks’ cost-to-income ratios. In 2006, HSBC’s and BOV’s ratio were more or less the same, at around 45 per cent. Over the years, this ratio increased in the case of both banks, for reasons mentioned earlier; however, BOV managed to maintain this figure lower than 50 per cent as at the end of 2016, whereas that for HSBC shot up to just under 60 per cent.

 

What about the Banks’ balance sheet growth?

Albeit both banks have registered a growth in balance sheet over the 10-year timeframe, BOV’s growth has been of a much larger magnitude when compared to HSBC’s rate of growth, as tabulated below. The Government concessions on stamp duty to first time home buyers together with the general property boom we have been experiencing across the property sector has significantly played a role in boosting the amount outstanding with respect to loans and advances to customers for BOV. On the contrary, not much growth was registered in terms of loans and advances for HSBC, particularly since 2010, where the figure had already reached the €3.3 billion mark. It is also worth mentioning that the exponential increase to BOV’s figure with respect to loans and advances to banks predominantly reflects a significant increase in term placements with the Central Bank of Malta since 2015.

 

2006

2016

% Change HSBC

% Change BOV

 

HSBC[1]
€ '000

BOV[2]
€ '000

HSBC[3]
€ '000

BOV[4]
€ '000

Loans and advances to banks

596,459

444,738

1,077,859

2,098,439

80.70%

371.80%

Loans and advances to customers

2,623,168

2,299,376

3,320,332

4,001,656

26.60%

74.00%

Customer deposits

3,436,874

3,898,696

5,000,836

9,181,047

45.50%

135.50%

Customer deposits of BOV were always higher than its peer, HSBC; however, the divergence became more apparent by 2016.

 

Changes to capital adequacy ratios

Following the 2008 global financial crisis, whereby financial institutions, and banks in particular were at the midst of it all, more stringent banking regulation came into force. Regulation that required banks to hold additional capital to act as a buffer and better protect the interest of bank creditors (including bank depositors) in the event of unexpected losses. One popularly quoted ratio which is often made reference to when banks announce their financial results is the so called Common Equity Tier 1 (CET1) ratio. This ratio mainly consists of a bank’s core capital, namely common shares and retained earnings, which are in turn taken into account against the bank’s risk-weighted assets. Weighted in the sense of different inherent credit and market risk each asset represents. Back in 2014, BOV and HSBC had undergone the Eurozone-wide stress test, whereby a review carried out by the European Central Bank had shown that both banks were in good financial health exceeding the eight per cent threshold set by the ECB and the 5.5 per cent established minimum threshold.

Since then, both banks have managed to further strengthen their CET1, with HSBC and BOV quoting a ratio of 13.2 per cent and 12.8 per cent as at the end of 2016, respectively. 

Last June, BOV announced its intension to change the accounting year end from September 30 to December 31. Consequently, the bank’s board of directors decided to voluntarily provide early disclosure of summarised financial information for the interim six-month period ended June 30, 2017. In this manner, going forward, analysis across both banks can be carried out on a more comparable basis, notwithstanding the lack of cyclicality inherent in the banking industry.

 

Six-month interim results ended June 30, 2017 review

BOV, as a Group registered a profit before tax of €68 million, equating to a Return on Equity (ROE) of 18 per cent – €5 million, or 8 per cent higher when compared to the same period last year after adjusting for the one off gain of €22 million arising on the disposal of the Bank's interest in Visa Europe. Meanwhile, net interest income for the period under review amounted to €72 million, a decline of 5.3 per cent from 2016. This was mainly due to the even lower interest rate environment experienced in 2017.Analysing into further depth the Group’s different segments, the increase in profit arose predominantly as a result of improved profitability within the Personal Banking & Wealth Management division (up by +26%) and Corporate Banking division (up by 11.1%).

The Bank is planning to strengthen its capital base by issuing €150 million in a fresh issue of share capital, in order to strengthen its capital buffers, and to enable the bank to undertake new investments, sustain lending activity and distribute appropriate dividends to its shareholders. The CET1 figure for the bank as at the end of June rose to 13.3 per cent. BOV’s total assets as at end of June showed €11.61 billion (up by €478 million from December 2016) –as customer deposit base increased further (+€562 million to €10.03 billion), allowing the bank to grant more credit facilities to its clients which in turn contributed towards an increase in bank’s assets.

Meanwhile, HSBC, as a Group registered an interimprofit before tax of €25.9 million, compared to a profit of €41.3 million registered in the comparable period of 2016, ended June. On an adjusted basis, after excluding the €10.8 million investment gain on the sale of Visa Europe last year, profit was down by 15 per cent. Adjusted return on equity decreased from 8.5 per cent for the six-month period in 2016 to 7.1 per cent for the six-month ended in June 2017. Net interest income for the period under review amounted to €60.3 million – down by 5.6 per cent from 2016. Earnings per share (EPS) decreased from €7c5 to €4c7, and a net interim dividend of 3 cents net of tax per share will be paid on September 11 to shareholders on the bank’s register as at August 10, 2017 – in-line with the current dividend pay-out ratio of 65 per cent. The CET1 figure for HSBC as at the end of the period read 13.9 per cent. Total assets as at the end of period stood at €7.07 billion (down by €238 million from December 2016 due to lower loans and advances to banks and customers).

Clearly, HSBC’s risk management actions in recent years has been the bank’s priority whereas it is evident that BOV’s ambitions are to grow the business further by the continuing revision of their business models, whilst reducing higher risk/lower yielding segments of the business and thus being more prudent.

With this in mind, eligible shareholders would do well to take up their rightsthus avoiding dilution,after seeking professional advice by their trusted financial advisor to ensure that this is in line with their financial objectives and risk appetite.

 

[1]HSBC Financial year-ended December 31,2006

[2]BOV Financial year-ended September 30,2006

[3]HSBC Financial year-ended December 31,2016

[4]BOV Financial year-ended September 30, 2016