The Bank of Valletta Group reported operating profits for the first six months of the Financial Year 2009 (FY 2009) amounting to €10.1 million. This compares with an operating profit of €21.9 million for the equivalent period ended 31st March 2008. The final net profit for the period was reduced by the sum of €3.8 million, being BOV’s share of the results of its Middlesea group insurance associates (2008: profit of €3.1 million). The Board declared an interim dividend of €0.035 per share (gross).

Announcing the results, BOV Chairman Roderick Chalmers said that the period between mid-September 2008 and the end of February 2009 was “unquestionably, the toughest six month period in the history of modern banking and finance,” with major banks across both Europe and the United States that were hitherto pillars of the financial establishment having been either nationalised or obliged to seek very substantial financial assistance from governments by way of guarantees and/or additional capital.

The Chairman stated that a semblance of calm appeared to have been restored to the markets since the beginning of March, and that, although sentiment remained cautious and fragile, the hope was that the beginnings of what was likely to be a long drawn out period of recovery were being seen. He went on to say that, as was generally forecast, Malta’s wide open economy had not been immune to the global recession, although the impact to date has been relatively mild. However, Mr Chalmers opined that “a cautious expectation must be that the situation could become more challenging in the short to medium term.”

Roderick Chalmers observed that Bank of Valletta’s conservative funding, liquidity and capital ratio policies have, over the past 18 months, enabled it to “navigate through the unprecedented conditions experienced in the banking markets, whilst at the same time, continuing to provide credit and liquidity to the Maltese economy, and to BOV’s customers in the retail and business communities.” He emphasised that “in keeping with the pledge made last year, BOV, with its strong capital and liquidity positions, has and will continue to support Malta’s economy and business community in a pro-active and responsible manner.”

Review of Performance

The Chairman provided a detailed commentary on the results, explaining that these had been influenced by a number of factors including, (i) the strength and commitment of BOV’s core domestic retail and corporate banking business, (ii) the radical measures taken by the European Central Bank (ECB) in an effort to combat growing recessionary pressures, (iii) the disruptive impact of the global financial crisis on BOV’s Financial Markets (FM+I) book, and (iv), BOV’s share of the results of associates and jointly controlled entities.

Mr Chalmers explained that rapidly falling interest rates invariably had a negative effect on bank profitability, due to the delay in the re-pricing of time deposits and the compression of margin on lower cost liabilities. He noted that in the six month period under review the ECB, in its efforts to combat growing recessionary pressures, had lowered its reference rate five times from 4.25% to 1.5 %, with a further 0.25% reduction being announced on the 2nd of April. This extraordinarily rapid rate of decline in interest rates had, Mr Chalmers said, an adverse impact on bank profits estimated at €6 million.

Net commission and trading income for the six months was marginally above that earned in the previous period, and the Chairman regarded this as a “satisfactory result” given that the March 2008 numbers included €1.4 million of exchange income earned on Euro/Maltese lira transactions during the period prior to euro adoption. He explained that commission income on investment products remained “soft,” but that income from cards and foreign trade business has been ’strong.’ Management had implemented cost control measures, with the result that “overhead costs for the six months have been maintained at fractionally below 2008 levels.”

The net operating profit from core banking operations for the six months was reported at €42.1 million (2008: €47.9 million), with the reduction in profits being largely attributed to the compression in net interest margin. Mr Chalmers said that the Board expects “a gradual improvement in the net interest margin as deposits re-price, and as measures taken for the modest widening of certain select lending margins are implemented.” He explained that the Board had taken a policy decision not to pass on the last two ECB rate cuts totalling 0.75% (announced in March and April 2009) to either loans or deposits, and that the reasons for this decision were twofold; Firstly, it was felt necessary to maintain deposit rates paid to BOV customers in order to remain competitive, and secondly, the Board was “entirely satisfied” that current lending rates were already competitive, and compared very favourably with rates prevailing elsewhere in Europe.

Turning to the Fair Value charge of €32 million (2008: €26 million), the Chairman observed that these were due to distinct elements. He explained that over 60% of the charge arose from “hedge ineffectiveness” on BOV’s Interest Rate Swaps (IRS). Mr Chalmers explained that the IRS hedged interest rate risk on all fixed rate holdings that extend beyond a defined duration, and reflected BOV’s conservative risk management approach in the conduct of the FM+I portfolio. “In the current disrupted and dislocated market conditions, degrees of temporary hedge ineffectiveness have emerged,” but, Mr Chalmers assured, “the Board is confident that this ineffectiveness (much of which relates to holdings of Malta Government or other sovereign holdings) will reverse over the duration of the holding, and that the technical and unrealised fair value adjustment made under IAS 39 will be reversed, with the bond redeeming at par and the IRS expiring at nil value.”

Roderick Chalmers noted that the balance of the fair value markdowns included the impact on values resulting from the widening of bond spreads as a result of the recent market turmoil. “In the current market environment, investors are demanding higher returns on holdings of credit instruments. Higher yields or spreads translate into lower capital values, and these lower values in BOV’s FM+I portfolio are reflected in the above fair value adjustment” he explained. The Chairman emphasised that BOV’s FM+I portfolio remains deployed across “a wide spread of holdings of moderate duration debt securities issued by quality, credit rated, sovereign, supranational, corporate and financial institutions”, and that the Board’s expectation is that “much, but not all, of the fair value markdowns of €84 million incurred in FY 2008 and the first half of FY 2009, will be clawed back over time, as the credit instruments involved are held through to redemption.”

The Chairman explained that the Board’s view is “reinforced” by BOV’s experience since the beginning of the financial crisis to date. Mr Chalmers said that over this period “the vast majority of holdings have paid interest and been redeemed at par on due date, with defaults experienced being limited to a very small number of holdings.” The Chairman said that “between July 2007 and March 2009, over €700 million of bonds (excluding sovereign holdings) had redeemed at par, whilst defaults to date of interest or redemption have been limited to holdings with a nominal value of €23 million (including Lehmans).” Finally, the Chairman noted that Fair Value gains for the period on investment holdings classified under accounting standards as “Available for Sale” amounted to €5 million before taxation (2008: €7.4 million), and were taken directly to reserves.

The share of losses of jointly controlled and associated entities relate to BOV’s share of losses incurred by the Middlesea Group in the six months ended 31st December 2008. Whereas Middlesea Valletta Life has remained profitable, notwithstanding exceedingly difficult capital markets conditions, the Middlesea general insurance businesses have reported a significant loss for the year. Mr Chalmers commented that “as was described more fully in Middlesea’s recent press release issued in connection with its annual results announcement, this has, in the main, been caused by unsatisfactory results arising from Progress Assicurazioni, the Middlesea subsidiary company operating in Italy.”

Review of Balance Sheet position

The Chairman referred to the undertaking set out in BOV’s 2008 Annual Report, and said that the Bank had continued to manage its balance sheet in a “prudent and conservative manner.” Liquidity has remained “strong” at 49.8%, and the core Tier I capital ratio remained “well above” European and US banking sector norms at 10.5%, as did BOV’s total capital ratio of 12.0%. The Chairman said that the Loan to Deposit ratio remained “comfortable” at 66.7%, and noted that the Bank “continues to be in the position whereby our loan book is wholly funded by retail liabilities, with no dependence on the short term inter-bank or commercial paper market.”

Total assets at the end of March 2009 stood at €6.0 billion (September 2008: €6.2 billion), while shareholders equity amounted to €392.6 million. Advances, net of impairment allowances, stood at €3.1 billion, an increase of €78 million, or 2.6%, since 30th September 2008. The Chairman said that credit quality remained “good”, with Non Performing Loans standing at 4.1% of gross advances (September 2008: 4.0%; March 2008: 4.3%). Customer Deposits have “continued to grow in a satisfactory manner”, with an increase of €51 million over the six months, to stand at €4.7 billion as at 31st March, 2009. Mr Chalmers noted that the increase in Customer Deposits over the 12 months from March 2008 amounted to close to €160 million.

Supporting the economy and BOV’s customers

Mr Chalmers reminded the press conference that BOV had pledged that it would support the Maltese economy and the business community in a responsible manner through the current economic downturn. “This we have done, and we will continue to ensure that credit is available to both the corporate and personal sectors” he said.

The Chairman elaborated further, “during the six months to 31st March 2009, the Bank approved €115 million of new home loans (of which €96 million gross were drawn down), whilst credit actually utilised by the business sector over the six months increased by €160 million (or 8.1%), net of two large identified facilities that were repaid in full during the current period. BOV’s Capital Markets team have also been active. Finally, the Bank remains the largest participant in the Malta Government Stock issuance and Treasury Bills market, thereby providing broad support and liquidity to the economy.”

Mr Chalmers concluded, “BOV is indeed living up to its pledge of being there for our customers, and fully supporting the Maltese economy and our business community in a responsible manner. We have also sought to balance the needs and requirements of depositors and borrowers in a judicious and even handed manner, and although this has required a modest widening of spreads on certain facilities, lending spreads and absolute borrowing rates remain extremely competitive by international standards. Home loans remain available from rates of 3.15%, and our average business lending rates compare well with rates prevailing elsewhere in Europe.

Interim Dividend

Turning to the payment of an interim dividend, the Chairman explained that the results for the period have been adversely affected by unrealised Fair Value mark downs arising over a compressed period of significant market stress. The Board resolved to declare an interim dividend of €0.035 per share (gross), which will result in a net distribution to shareholders totalling €3.6 million. This dividend compares with the 2008 interim dividend (as restated for bonus issue in January 2009) of €0.1125 per share. Mr Chalmers stated that the final dividend recommendation will “be determined by the Board later in the year, and will take into account the results for the year as a whole, as well as the conditions prevailing at that time.”

Outlook

Looking forward, Roderick Chalmers said that conditions have improved somewhat since early March, after a six month period of extreme stress in the global financial markets. He pointed out, however, that sentiment remained “fragile”, and that, in his view, any lasting recovery will inevitably be something of a gradual process, with set-backs occurring from time to time. He stated that BOV’s core retail and corporate banking businesses are soundly based, and are operating satisfactorily, and that the Board expected to see a gradual improvement of the net interest margin, with interest rates coming close to the bottom of the cycle.

“A cautious expectation must be that the impact of the global recession will increasingly influence the local economy – and this may be reflected in some deterioration in asset quality, something that is being watched with extreme vigilance” the Chairman said, going on to remark that ” BOV’s Financial Markets book remains of good quality and moderate duration, and whereas some losses will be incurred, the Board is confident that a significant proportion of the unrealised Fair Value markdowns booked to date will be recovered over time, as the investments concerned are held through to redemption.”

Roderick Chalmers reiterated that BOV would continue with its conservative funding, liquidity and capital ratio policies – policies which the Chairman said had enabled it over the past 18 months to “navigate through some of the toughest conditions experienced in the banking markets for many generations, whilst at the same time, continuing to provide credit and liquidity to the Maltese economy and to our customers in the retail and business communities.” He said that whereas the market conditions that had been experienced have inevitably had a short term impact on the profitability of the Bank, any stabilisation of conditions will be “quickly reflected in improved results.”

“We will continue to manage our balance sheet in a prudent and conservative manner, as always seeking to balance the demands and requirements of our depositors and borrowers alike, whilst at the same time being acutely aware of our responsibilities to our other stakeholders – shareholders, employees and the wider community,” said Mr Chalmers. “We will persist with our cautious approach, maintaining high liquidity and strong capital ratios. Our expectation is that the emerging regulatory regimes for banks will require increased levels of capital to be held, and that as announced in the autumn of 2008, in anticipation of this regulatory change, and in order to replace issues that mature in 2010, we intend to come to the market shortly with a subordinated bond issue, to further strengthen our capital ratios,” he concluded.

Conclusion

Mr Chalmers closed by saying that the Board of Directors wished to express sincere thanks to Tonio Depasquale, the Chief Executive, his senior management team and all the Bank’s staff for their hard work and unflinching commitment over a period of extreme pressure and stress in the financial services sector. “The Board is, as always, grateful to BOV’s many customers for the business they bring to the Bank, and for the great confidence and trust that they always demonstrate. BOV’s firm commitment to support our many customers and the economy as a whole through the current down-cycle has been clearly acknowledged and appreciated” Mr Chalmers observed. Finally, Mr Chalmers said that, that as would be expected, the prevailing international economic conditions and developments meant that BOV had maintained a regular and open dialogue with the regulatory authorities at the MFSA and the Central Bank, as well as with the Ministry of Finance, and he was grateful to them for their support, wise counsel and advice.