Curmi & Partners

No Bank for your buck!

By David Curmi

As a collector of deposits and a provider of credit, commercial banks are often viewed as bellwethers of the economy they operate in.  Whilst this is usually the case, the current situation with the two largest banks locally appear to paint a different picture.

Driven primarily by domestic demand, the Maltese economy expanded at a brisk rate in 2018, with GDP growth estimated to have reached some 6.2%.  In 2019 growth is expected to moderate to 5.2% according to the European Commission forecasts with this growth continuing to reflect strong employment growth, increasing disposable income and buoyant private consumption.  Against this backdrop one would expect that the share prices of both HSBC and BOV are riding high.  Alas this is not so.  Both banks’ share prices are languishing at or close to the low for the last 5 years.  One reason for this is that the nature of the economic growth being witnessed is not driven by capital consumption but by personal consumption which does not require significant investment.  Hence, other than perhaps in the property development sector, companies are not investing in projects that require capital funding by the banks.  There are other reasons too.

On the 19th February HSBC reported its full year results with net income falling 7% to €28.7m.  The disappointment with these numbers came from a combination of a further deterioration of its core operations partially offset by some one-offs.  On the core business side, despite direction from the bank in 2018 that the de-risking process was largely over and focus would be on getting close to the customer, there was no evidence of this.  Management was however very upbeat that the pipeline of business that is being seen will manifest itself in the 2019 numbers.  Patience is required on this front.  HSBC has gone through a radical transformation over recent years, putting its clients through tough due diligence processes in order to weed out the unwanted business deemed to be too risky for the bank.  What is left is a much smaller book of higher quality clients which, the CEO assures is big enough to produce an attractive return on equity. 

The other disappointment emanates from the lower dividend distribution.  Having distributed a special dividend in 2018 the payout ratio was cut to 47.5%.  Very low by HSBC standards.  The main culprit for this was a new ECB regulation that requires banks to provide for delinquent loans if the bank has not been able to cash the security provided for the loan.  The reasoning used by the ECB is that banks should be able to crystallise their security in a timely manner.  Any inability to convert security into hard cash renders the collateral delinquent too and requires the bank to treat the loan as unsecured.  The unfortunate situation in Malta is that the legal system does not facilitate banks calling in on their security. This leads to an inefficient use of capital as this capital will need to be set aside to provide for the delinquent loan, rather than recycled back into the economy, even though the security may be perfectly valuable. 

It is a fact that HSBC today is an institution that carries low risk and operates a quality operation.  Whether it is able to convert this into a growing profit stream still remains to be seen.

BOV, on the other hand is expected to report its results after the Board of Directors meeting scheduled to be held on Friday 15th March.  The forces at play at BOV are diametrically opposite to those as HSBC.  This bank remains close to the heart beat of the local economy and when it reports its annual results, one would expect a strong performance at the operational level.  There is little doubt on this.  The challenges faced by BOV are very different however. The big elephant in the room remains the Deiulemar case being heard in the Italian courts where a precautionary warrant of seizure was issued to the tune of €363m, following preliminary procedures.   Reacting to this, the bank cut its dividend in 2018 and announced that it does not plan to pay a dividend in 2019. 

More recently the cyber breach experienced by the bank creates new challenges, and costs, for the bank to be able to deal with the aftermath of this situation.  It is not just an issue of the money that may have been stolen but more the wider damage to the bank’s reputation and the cost of fixing this. The mood and language used with the publication of the annual results will make for interesting analysis.

The bigger question in my mind lies not with what the banks are able to achieve whilst the local economy reaches new heights.  This is evident for all to see.  It is more what happens if and when the economic wheel turns.  I suspect it will be at that point that we discover to what extent the main local banks are real bellwethers of the local economy.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.