BOV profits down by 60% with a direct hit of €12.7 million from the Lehman failure

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BOV profits for Financial Year 2008The Bank of Valletta Group profits for Financial Year 2008 (FY 2008) amounted to €40.6 million, compared with profits for the previous year of €101.8 million. Announcing the results, Bank of Valletta Chairman Roderick Chalmers stated that “after several years of reporting record profits, it was disappointing, but not at all unexpected, to report a downturn in profits for the year just closed.” Mr Chalmers went on to observe that “the conditions encountered throughout the last year – and particularly in the second half of September – have been unprecedented and truly extraordinary, representing as they did the most profound financial crisis of a generation.” “In the prevailing circumstances” the Chairman said “it is hoped that the reported profits for the year of just over €40 million will be regarded as being respectable.”

Mr Chalmers noted that the unprecedented political and policy response of early October by the US, EU and British authorities had served to calm financial markets and stabilise the international banking system. Borrowing rates were reducing and credit activity was gradually being restored. “However, whereas there are signs that stability is returning to the banking markets, institutional and retail investment funds (including money funds) are facing heavy redemptions, and a massive de-leveraging (debt reduction) exercise is also being undertaken by banks and hedge funds. Furthermore, there is no doubt whatsoever that the financial crisis will exact a price on the wider global economy – with recession almost guaranteed to hit every major economy in the last quarter of 2008 – and continuing through 2009” said Mr Chalmers, observing that all these factors were being reflected in the current extreme volatility in the equity and credit markets. “There are differing opinions on how severe and how long the downturn will be, and much will depend on how successful the authorities are in stimulating the flow of credit back into the system, and with it the return of much needed confidence to the markets” he concluded.

Providing a comprehensive background to the financial year, Mr Chalmers stated that, “Bank of Valletta went into FY 2008 knowing that it was facing a challenging year. The adoption of the euro was expected to have an adverse short term impact on the profits of the bank, as well as bringing keener competition to the local banking market. It was also noted that the underlying tone and sentiment of the international capital markets remained fragile. However, what has happened over the past year – and especially since mid September 2008 – has been truly extraordinary, a period that commentators have described as the most profound financial crisis since the 1920’s. Having said this, policies adopted and precautionary measures taken by BOV ahead of or in anticipation of the impending storm have served to greatly mitigate the impact of the crisis on the Bank.”

Dividend and Bonus Issue

Mr Chalmers went on to explain that the Board of Directors has over recent years articulated a policy whereby dividend distributions will be related to results, and that, to the extent possible, the Board would adopt a policy whereby a third of profits would be paid in taxation, a third distributed to shareholders as dividends and a third retained in the business. It was felt that this was a good and prudent model to follow, as it would secure a fair dividend distribution to shareholders, whilst at the same time enabling the capital resources of the Bank to grow. “This policy has certainly stood the Bank in good stead in the current financial environment” said Mr Chalmers.

Given the marked reduction in profits being reported for FY 2008, Mr Chalmers explained that the Board of Directors feels obliged to propose a lower final dividend distribution for the year. Mr Chalmers said that the Board regretted having to reduce the dividend distribution from that paid in FY 2007, but noted that this was inevitable given the reduced profits for the year. Accordingly, the Board of Directors is recommending a final gross dividend to shareholders of €0.0675 per share, which taken together with the gross interim dividend of €0.1350 per share paid on 28th May of this year, makes for a total gross dividend of €0.2025 per share for FY 2008. The dividend for the year will be 1.5 times covered by the profits for the year. The Chairman added, “this temporary relaxation of the stated 2 times cover dividend policy can be justified by the surpluses over that cover brought forward from recent years”.

The Board is also recommending, effective 15th January 2009, an increase in the nominal and paid up value of the Ordinary shares in issue from €0.75 to €1.00 per share, the increase to be funded by a capitalisation of reserves amounting to €33.33 million, and a bonus issue to shareholders of 1 share for every 5 shares held. The bonus issue will be funded by a capitalisation of reserves amounting to €26.67 million. “These two moves will serve to further strengthen the balance sheet through the increase of the permanent paid up capital of the Bank to €160 million, and will also serve to enhance the affordability and liquidity of the Bank’s shares” said the Chairman.

Bank of Valletta and the International financial crisis

The Chairman of BOV described the international financial turmoil as a “hurricane that has swept through the global banking sector”, a reflection of the sentiments expressed worldwide to depict the volatility of a financial environment undergoing a crisis on a scale that has not been experienced for almost a century. The Chairman explained that Bank of Valletta had weathered the storm relatively well due to the policies it had adopted and measures taken which had served to mitigate the effect of the financial crisis. These had included the following:-

(a) Notwithstanding considerable pressure to the contrary, there had been a drive to secure the gradual build up of BOV’s equity base, and to ensure that it was strongly capitalised at all times. Close to €100 million had been added to reserves over the four years to September 2008, and this led to BOV carrying a capital ratio of 11.5%, of which 10% is represented by Tier I capital, which compares very favourably with the levels prevailing at most other European banks.

(b) In spite of the satisfactory growth of the loan book, BOV had maintained a conservative loan to deposit ratio of below 70%. This meant that the Bank did not rely on the short-term inter-bank or commercial paper market for the funding of its lending business. Loan to deposit ratios in excess of 100% were not at all uncommon for a number of major banks in Europe, a factor that had caused these banks severe funding problems when the credit crunch caused the short term markets to contract very severely.

(c) Ensuring a strong liquidity position. Throughout 2008, BOV had maintained a liquidity ratio in excess of 50%, well above the prudential statutory minimum of 30%. A strong liquidity position has meant that at no time has BOV been a forced seller of its portfolio holdings, and is able to hold them through to redemption if so desired.

(d) The rigorous exclusion of sub-prime mortgages, Collateralised Debt Obligations (CDO’s), Asset Back Securities (ABS’) and other structured products from the Bank’s Financial Markets portfolio. Instead, the BOV portfolio was predominately deployed across a wide spread of multiple holdings across nearly 240 institutional names in quality, credit rated sovereign, supranational, corporate and financial institutions with a relatively short weighted average maturity of less than 3.5 years.

Mr Chalmers reaffirmed that, “The overall effect of these measures has been that BOV has been well capitalised and liquid throughout the crisis, and has maintained its discipline in terms of asset quality. The Bank has concentrated on securing strong capital and liquidity positions, whilst at the same time diversifying its investment book, and therefore its risk, across a wide range of quality credit rated holdings. This means that BOV has been, and remains, in a position to retain those holdings it chooses to through to redemption, and has not been obliged to dispose of these assets in the highly strained and distressed market conditions that have prevailed over the past year.”

Mr Chalmers went on to explain that notwithstanding the defensive posture adopted by BOV, it had not escaped the crisis totally unscathed, and that the earnings for FY 2008 had been adversely affected by two distinct factors, with almost 50% of the impact occurring in the last two weeks of the financial year. The first was a ‘direct hit’ as a result of the Lehman’s failure. Whereas initial indications were for recoveries on senior debt of between 40% and 60%, the complexity of winding up Lehman’s affairs has led to a downwards adjustment. Accordingly, at the year end, BOV has marked down its holding to 15% of nominal value, and this has impacted the FY 2008 results by €12.7 million. The second factor is that the credit spreads at 30th September 2008 had remained extremely elevated, and had had an impact on quoted bond prices in an almost frozen market. This caused further mark downs as a result of the mark to market accounting policy adopted by the Bank under IAS 39, with the consequent impact on FY 2008 earnings. The Chairman explained that excluding the Lehman’s position, unrealised fair value mark downs for FY 2008 amounted to €41 million, of which €14 million arose in the last two weeks of September alone. He observed that given the relatively short duration of most of the holdings, BOV would hope to claw back much of the mark downs on those securities it elected to hold through to redemption.

Mr Chalmers added that, “disappointing though the Lehman hit and the fair value mark downs have been, these should be viewed in the light of the extraordinary crisis that has engulfed the global banking sector – and in the context of the size of the average book of almost €2.6 billion managed by BOV’s Financial Markets team. Accordingly, the impact is equivalent to approximately 2% of the FM+I book.”

The results for Financial year 2008

Despite the increasingly competitive environment in which the Bank operated during FY 2008, a growth of 15.9% was registered in BOV’s net loan book coupled with a sustained improvement in the quality of the credit business. Loans and advances to customer reached €3.0 billion. “Concurrently, impaired lending as a percentage of our total book decreased from 4.8 % at September 2007 to 4.0 % as at the year end”, announced Mr. Chalmers.

FY 2008 has also seen a further consolidation of BOV’s position as the market leader in the Customer Deposit sector, as the Bank reacted to the changing market environment with the rollout of competitive products over the course of the year. “Total customer deposits have increased by €322 million from September 2007 to reach €4.6 billion as at the year end, and we have seen strong demand for both euro and foreign currency deposits,” said Mr. Chalmers.

The Chairman described the domestic, corporate and retail activity as satisfactory, with areas of particular note being the Cards business and fund management. Valletta Fund Management performed well in a remarkably challenging environment, and Valletta Fund Services saw a growth of funds under administration to €1,040 million from € 850 million a year ago. Mr Chalmers went on to note that whereas the marked reduction in profits was largely attributed to Financial Markets activity, other factors had also affected earnings for the year under review. These included loss of foreign exchange earnings following the adoption of the euro, the impact on BOV’s stock-broking, bancassurance and asset management businesses resulting from the disruption in the financial markets and the consequent impact on investor behaviour and risk appetites, one-off costs associated with the adoption of the Euro and shrinking interest margins, as a result of greater competition both for deposits and for quality credits. Furthermore, the contributions to profits from associates and jointly controlled companies were also impacted by conditions in the global financial markets.

The impairment charge for the year showed an increase of €3.4 million over FY 2007, which is very modest in absolute terms, and the year on year increase was largely due to lower recoveries in FY 2008 than were experienced in 2007. Net interest for the year had been impacted by €3 million, resulting from lower recoveries of suspended interest on impaired loans compared to the previous year. Increases in costs, year on year, have come in at 5%, attributable principally to the impact of the new three-year Collective Agreement which became effective 1 January 2008.

Some of the year’s achievements

Outlining the major achievements of FY 2008, Mr. Chalmers said that Bank of Valletta has successfully leveraged its position as Official Partner Bank of the National Euro Changeover Committee and endeavoured to ensure a smooth transition for its customers. Over 52% of Euro changeover business was transacted by BOV, as a result of an innovative marketing campaign and bank-wide efforts to make the currency change as efficient as possible. “The Bank emerged as the lead player in this historic event, serving the Maltese community as a centre of reference for all euro changeover related matters. The changeover programme managed by the Bank, and the primary role it played as a key partner of participating national institutions, were instrumental in securing the smooth and seamless transition,” said Mr. Chalmers, who noted that Malta was being referred to as a case study for seamless currency transition planning and implementation.

During the year, rating agencies Fitch and Moodys confirmed all BOV’s credit ratings and outlook and reaffirmed the Bank’s position as the largest financial institution on the Islands. Once again, Bank of Valletta has been successful in being nominated for and winning prestigious industry awards.

Mr. Chalmers highlighted that throughout this year Bank of Valletta continued to be active in strengthening the relationship it has with the local community. Through its extensive Community Programme, the Bank redistributes a percentage of its previous-year’s profits to the community through initiatives related to culture, heritage, sports, the environment, education and social causes.

Looking ahead

Mr Chalmers then made observations about the future within the context of troubled financial markets, “Governments around the world have been taking extraordinary steps to stabilise the financial system – and have committed huge, indeed unprecedented, resources to this end. Notwithstanding this, international markets remain extremely nervous, and we can expect continuing volatility in the short to medium term, particularly given the redemption pressures being experienced and the sizeable de-leveraging that is currently taking place. The general belief is that the policy-makers’ radical but somewhat belated action will secure the global financial system, but will not prevent a widespread recession of uncertain duration. Increasingly, the markets will turn their attention and concerns to the likely impact of this recession on the wider economy, and this together with ongoing de-leveraging will continue to keep prices under pressure.” “With our open economy, it is likely that Malta will be affected by the wider downturn, and therefore the outlook for the next twelve months must be a very cautious one” said Mr Chalmers. He went on to confirm that the Bank is carefully considering the potential repercussions of an economic downturn, but will be doing all that is possible to continue to provide credit to the economy and ready support to its customers.

In conclusion, Mr Chalmers stated that, “the Bank of Valletta Group is well positioned and the fundamentals for the Group’s businesses remain strong, with a powerful balance sheet and very sound liquidity and capital positions. Our credit book remains of good quality, and our depositor base is stable and has been growing for a number of years. We will continue to manage our balance sheet in a conservative manner, adding to capital if and when required. We are wholly committed to supporting Malta’s economy and our business community in a responsible manner, and will continue to be assiduous in our care and attention of our corporate and retail customer base, building on our reputation as Malta’s caring Bank. Management, as always, will be watching costs very carefully. The Board, management and the entire BOV team are committed to working very hard to ensure that the Group will continue to extend outstanding customer service, and to report strong financial results in what promises to be a challenging environment.”

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