Last Tuesday, Bank of Valletta plc published its interim financial statements for the six-month financial period up to 30 June, 2018. The group reported a profit before tax of €13.5 million compared to €67.8 million for the corresponding period last year. The decrease in profitability was attributed to a litigation loss provision of €75 million. In fact, the group registered a very strong pre-tax profit before litigation provision of €88.5 million, and operating profit increased by an impressive 43% compared to the corresponding figures of the previous year.

On a positive note, the group has seen an improvement in all its revenue streams. Interest margin rose by 8% to €79 million, backed by strong growth in the loan book, particularly in home loans. Despite the positive performance, interest margin was still under pressure by the persisting low interest rates and a competitive environment.

Commission income grew by 21% to €40 million, mainly as a result of credit card issuing, acquiring fees and fees related to the provision of credit and investment services. These improvements are in line with the bank's strategy to diversify its revenue sources.

The group's expenses increased by 2%; this increase was driven by higher costs related to HR and IT as the group seeks to find ways to meet the more onerous regulatory demands, and to implement more efficient ways to do business.

In the company announcement, the bank stated that the €75 million litigation provision is being made in the context of changing circumstances with regard to three litigation cases which the bank is currently involved in, namely the Falcon Fund SICAV case, the La Valette Multi Manager Property Fund case, and the Deiulemar Trust case. As at December 2017, after seeking legal advice, the bank decided no provision was required due to its strong legal position in these cases.

The bank further stated that the Board of Directors keeps litigation cases under continuous review in order to assess the impact that any development might have on the group's position. In line with the prudency concept, the Board will take any necessary actions in the light of new information, such as making the appropriate provisions, if so required while keeping supervisory authorities and the market informed of any material developments.

The most material of the three cases is the Deiulemar case. The bank is being sued for €363 million in Torre Annunziata, Italy, for trusts which were on boarded by the bank in 2009. It is important to highlight that the only assets settled in trust with the bank were shares of the Deiulemar group with a nominal value of €6,000. Two years after the group went bankrupt in 2012, a lawsuit was filed against the bank as trustee by the curators of the bankruptcy.

During the first half of 2018, there were significant developments in this case. In March 2018, the court issued a precautionary warrant of €363 million against the bank. The bank appealed the decision, which was denied by the appellate court in July 2018.

Although the legal advice regarding the strength of the bank's legal defence remained unchanged, the higher probability of an eventual outflow of funds led the Board to prudently recognise a provision of €75 million, which represents the best estimate of potential losses in the current situation. This provision covers the three cases.

On its own initiative, the bank had already placed assets under custody with an independent bank with a value of over €363 million, to make good for the precautionary warrant. This did not have any impact on the bank's operations, due to the high levels of liquidity maintained by the bank.

As circumstances changed, the Board of Directors did well to provide for such potential losses which are in line with accounting standards, but also for potential investors and current shareholders to put a value on the changing circumstances.

The bank also announced that the Board of Directors had decided not to declare an interim dividend and also expressed its intent not to recommend a final cash dividend for the financial year 2018. This announcement was obviously not welcomed by investors. The bank said it has been in extensive discussions with the regulators on the matter, and it is evident that in today's world the distribution of a dividend is not only the prerogative of the directors. However, in the circumstances, it was appropriate for the directors to inform the market that a final dividend would not be paid.

Notwithstanding this provision, the bank remains highly liquid with cash and short-term funds amounting to €3.5 billion. Equity stands at €946 million, down by 1.7% when compared to December 2017. Capital ratios remain satisfactory, as the Capital Adequacy Ratio stood at 19.8%, while the Common Equity Tier 1 ratio stood at 16.8%, compared to 19.4% and 16.1% respectively that were registered in December 2017.

The bank reiterated that the Board's strategy is to keep focusing on the long-term feasibility and financial stability of the bank, by continuing to strengthen the Bank's capital position. The bank will also seek to improve its technological framework as well as its compliance structure, to enhance governance.

Market reaction

Once the announcement was made, the share price of Bank of Valletta plc fell by nine per cent on the day but recovered from a low of €1.50 to €1.54 on a trading volume of just over 100,000 shares. On Wednesday, the equity bounced back by five per cent back to the €1.62 price level, as 141,000 shares changed hands to partially erase the previous day's losses. BOV closed the week at the €1.60 price level, 5.9% lower on the week as 398,418 shares changed hands. As happens in these situations, some risk-averse investors sold their shares while risk-takers jumped at the opportunity and bought on the correction. Given the headlines, the equity seems to have weathered the storm despite losing some ground as investors took on board the strong results. It is positive to note that investors did not panic and are taking a long-term view on the equity as they should.

Mr Mizzi is managing director of Jesmond Mizzi Financial Advisors Limited. The article does not intend to give investment advice and the contents therein should not be construed as such. The company is sponsoring broker of Bank of Valletta plc and is licensed to conduct investment services by the MFSA and is a member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company and their clients are likely to have an interest in securities mentioned in this article. For further information contact Jesmond Mizzi Financial Advisors Limited at 67, Level 3, South Street, Valletta, or call 2122 4410, or email [email protected]