Curmi & Partners

BOV's Annunciation Day

By David Curmi

The news that the Italian Court of Torre Del Annunziata, a seaside resort 22km south of Naples, had ordered a precautionary warrant requesting €363m to be deposited as a guarantee by BOV came as a big surprise both to the market and, from the reaction of the bank, its board of directors too.  This was not expected.  Past statements from the bank sounded an upbeat bullish tone on the expected outcome.  Yet, first blood, of what will most likely be a long and drawn out fight, has been drawn by the liquidators of Deiulemar.  Conclusions must not be rushed however.  This is a marathon not a 100m sprint.

What we know of this case is still sketchy, and for the time being we are unlikely to get to know a lot more.  Given the nature of the case, and the fact that the case is not due to start until this October according to the Italian press, we are unlikely to get to know very much.  The nature and content of official communications by Bank of Valletta is going to be an important part of the risk assessment process that shareholders must undertake.

On the face of it, and according to all the BOV sources that I have come across, the bank has a very strong case.  I have no doubt that this is a fact.  The probability of a negative outcome, is seen as being remote.  The issue is that, whichever way you look at it, this could be a rather big elephant in a somewhat small room. Whilst the probability of a worst case outcome materialising may in fact be remote, its impact can be rather large.  This is why I do not concur to the chairman’s statement who was quoted in this newspaper as saying that “operations and shareholders' interests are not affected”.  It is a fact that BOV has an extremely strong balance sheet, and its capital ratios are indeed above the European average.  As at 31 Dec 2017 the bank held €2.9bn in cash at the ECB, earning negative interest rates and following the recent successful rights issue, its capital position was further strengthened, not in anticipation of a potential negative outcome in this case, but to further bolster its capital buffers to be able to lend more into the local economy and possibly have more elbow room on the dividend front.  Yet let us for a moment imagine the unimaginable, however remote, and assess what would be the position if the case is indeed lost and BOV are requested to make good to the tune of the €363m.  For a bank that has an equity base of €962m as at 31 Dec 2017, we could be faced with wiping out 38% of this.  Put another way, all the banks retained earnings as at this date would be lost. This is pretty substantial by any measure.

I accept that the above scenario is pretty remote and believe firmly in BOV’s case, however I also believe that the market is failing itself when pricing risk.  Not just with BOV but in many other cases, domestically, we see that investors have an almost happy go lucky approach to such events.  Perhaps believing it will be all right on the night.  Or perhaps not wanting to believe the alternative as it is too painful to fathom.  Yet the pricing of such risk is an important part of establishing the right risk reward ratio when considering a potential investment. By falling 2.7% on the day following the announcement, investors appear to  be comfortable pricing in a 1 in 13 chance that this event may indeed occur, assuming there would be no other impact on operations or the bank’s ability to pay larger dividends, as had been hoped following the rights issue.  In today’s highly regulated banking environment it is not a given that the ECB will treat this in such a lackadaisical approach

This is indeed an unfortunate incident for BOV.  The bank had only just reported a good set of numbers.  On an enlarged capital base, following the rights issue, the bank reported a post tax return on equity of 14.1%(for 15months).  This is not to be sniffed at. On average European banks only manage mid single digit numbers.   Investors were now looking forward to seeing more of these returns filter through to them in the form of dividends.  As a result of the Deiulemar case however, the wait might be much longer. Not quite the good news of the annunciation we are used to.

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.