BoV capital adequacy still under microscope despite turning profit

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Despite reporting a profit of €145.9m for the year to 30 September 2016 in its latest set of results, Bank of Valletta (BoV) has still been plagued by concerns about its risk levels and capital adequacy.

As at September 2016, BoV had a Tier One capital adequacy ratio of 12.82% – above the minimum requirement laid down by the Malta Financial Services Authority, but considered by commentators as low given Malta’s regulatory requirements in comparison to the stricter regime across the rest of Europe.

These problems with its capitalisation led to Fitch ratings downgrading BoV’s financial ratings from BBB+ to BBB in November 2016.

At the time of the downgrade, Fitch released a statement saying: “The downgrade of BoV reflects our view that its capitalisation is under pressure from increasing regulatory requirements and that its current capital ratios are not fully reflecting operational and market risks. We believe that although the bank is considering strengthening its capital through a new share offer, this would not be sufficient to meet all future requirements.

“Although the bank has put in place a series of measures to reduce risks, we believe its risk controls continue to lack the depth required for the risks it faces in its operating environment.

But former BoV chairman John Cassar White, who was replaced in his position by Taddeo Scerri in December 2016, said the bank was aware of the issues, and was already making strides to correct the issues.

“[Our] strategy gives priority to the long-term stability and sustainability of the business,” he wrote in the bank’s 2016 results. “While the Board understands the need for the Bank to deliver an adequate level of profitability and dividend payout year after year – in line with the legitimate expectations of shareholders – it must not allow itself to be distracted from its strategic vision.

“This may at times entail sacrificing immediate gains in the pursuit of longer term goals, and exiting from certain business lines that are at the periphery of the Bank’s risk appetite.”

“Our strategy for the medium term can be described as one of consolidation – that is, taking stock of the Bank’s situation in the current social, economic and regulatory environment, and ensuring that it is adequately resourced to meet the challenges and take up the opportunities that present themselves,” he added.

The steps being put in place by White include all dividend payouts being directly related to its capital adequacy ratio and an increased retention of earnings as reserves.

“[The need for greater capital levels] means the bank is giving primary importance to the conservation and generation of capital,” he said. “Its strategy here is twofold: to retain a greater proportion of earnings as reserves, by gradually easing down its dividend payout ratio over the past few years to levels that can be sustained over the long term; and to issue fresh equity and debt capital over the coming years.

“As from this year, the Bank’s dividend payout ratio is being determined with reference to a target [capital adequacy]  ratio. Sufficient earnings are retained to enable the Bank to reach its target ratio, with the remaining profit then being deemed eligible for distribution.”

And this approach to keeping increased funds within the bank has led to a steady growth in the bank’s assets, which have grown by 8.9% over the last financial year to €10.7bn, up from €9.9bn.

This more conservative approach to business will also see the bank re-align its business model to fit in with its new approach to capital reserving.

“The final cornerstone of the Bank’s consolidation strategy is the ongoing revision of the BoV business model,” White said. “The model is evolving from one based on growth to one with a focus on quality, with a lower risk profile and, correspondingly, potentially lower returns. The business strategy is therefore to de-risk a number of business areas where the risk-return balance is unfavourable, and, concurrently, to cultivate alternative sources of revenue to supplement profitability.

“The Bank is aware that de-risking, coupled with higher levels of capital, may result in a lower return on equity. This is consistent with the priority given by the Board to long-term stability and sustainability.”