Curmi & Partners

Protecting your Rights

By David Curmi

BOV has announced a €150m rights issue to existing shareholders on a 1:4 basis. This comes on the back of the issue of €111.6m in 3.5% subordinated bonds. With all the problems in the banking sector around the world one would be justified in asking why the bank needs so much capital. 

Ironically, this is not capital that the bank needs to shore up its capital base. The fact, to my mind is that the bank does not need this capital in the traditional sense. It is very well capitalised. Its Common Equity Tier 1 (“CET1”) ratio, a measure used in the banking industry to assess the core strength of a bank is the highest it’s been, even before the rights issue. As at 30th September 2017 it was 14.1%, well ahead of the minimum of 4.5% and very much in line with European banks. Additionally BOV boasts a total loans-to-deposits ratio of 70% which is significantly below the European average. This indicates that BOV is able to fund its entire loan book, and more, from its customer deposits. No doubt this is an additional significant strength for the bank.  Even though there is a trend to using “on demand” deposits to a greater extent (rather than time deposits) the majority of these deposits are retail deposits that tend to be sticky in nature giving the bank peace of mind that they are unlikely to be withdrawn. BOV therefore clearly does not need extra cash. It already has too much of it. This is one of the key problems.

This stems from two aspects. The growth of the local economy continues to generate cash, some of which finds its way into BOV’s deposits. These grew 9.8% to €10.1bn as at 30th September 2017. On the other hand loan growth was sluggish at 4% as the Maltese economy is growing in areas that do not require significant capital. Other than home loan growth it is the services sector that is driving much of the growth. Yet this extra cash needs to find a home.  The natural home should be the ECB but here BOV suffers a negative interest rate (BOV will start charging customers with significant deposits from 1st January to offset this). The challenge for BOV deploying this cash in a way that provides a return with an acceptable level of risk. This is not easy and we are seeing this dynamic play out in the net interest income for the bank which fell 1.3% in the year ending 30th September 2017.

So why raise more cash in the form of a rights issue? The banking world as we knew it, changed dramatically post the 2008 crisis. Regulators are bent on ensuring that banks can absorb losses in all sorts of theoretical scenarios. This means that regulators are constantly assessing whether banks have the right capital levels for their business.  It also means that they have the right to dictate when more capital is needed, and importantly for shareholders, how much in dividends are paid out.  Dividend payout ratios are no longer a prerogative of a board of directors’ assessment of how much capital is needed in the business. They are increasingly a reflection of how much the regulator permits you to pay out. Given BOV’s importance in the local economy, and the nature and structure of the local economy with its high dependence on property, it is not a complete surprise that BOV should be required to increase its capital buffer levels.

Where does this leave shareholders?  Irrespective of the rights issue, the bank continues to perform reasonably well in the current challenging environment with respect to interest income generation.  Profitability growth is driven primarily by non interest income activities such as wealth management, bank assurance and the cards business. The bank will also be stronger as a result of the rights issue and though its return on equity will be diluted by the extra capital it has, the returns it is currently achieving are still very attractive, and above average at 12.4%. Furthermore, the extra capital should also give the bank breathing space to support some growth in its balance sheet and allow headroom for growth in dividends, which were already attractive at 5.8%. We also expect the pressure from the ECB’s loose monetary policy to abate as European economies continue to recover.

The rights issue price of €1.43, a discount to the then prevailing market price of 30% therefore looks attractive against this backdrop and should entice shareholders to protect their interest in the bank by taking up the rights.

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