Interim directors' report
The directors present their interim financial statements of MeDirect Bank (Malta) plc and its principal subsidiary, MeDirect Bank S.A. for the six-month period ended 30 September.
Principal activities
The principal activities of the Group comprise lending to international corporates and the provision of banking services primarily to the mass affluent sector in Malta and Belgium, focusing primarily on saving products and wealth management, as well as local corporate banking in Malta.
Throughout the financial period, management was tasked with executing on a series of initiatives that will diversify the Group's business lines from its historic core competencies and grow the Group's financial position. These being the Dutch mortgages and the related management of securitisation structures business lines.
Business development
At the moment the Group is looking at broadening its asset base internationally to diversify both its risk and its income. The Group entered into new asset classes and a new jurisdiction in thoughtful and well-planned ways, building on the Group's track record of both organic and inorganic growth.
New Dutch state-guaranteed mortgages business line
On 3 June 2019, the Governing Council of the European Central Bank consented to the strategic decision of MeDirect Belgium to enter into a new business line, namely the origination of Dutch state guaranteed mortgages ('Nationale Hypotheek Garantie') under Article 77 of the Belgian Banking Law.
These mortgages are prime Dutch mortgages that benefit from a guarantee from a private non-profit fund and indirectly from a government guarantee. The launch of this new business line as from September is part of the Group's strategic objective to diversify its business model.
MeDirect Belgium is doing this via an established third party mortgage originator in the Netherlands that after origination transfers the mortgages to MeDirect Belgium through a silent assignment.
Reclassification of a portion of the hold to collect lending portfolio and the set up and management of a securitisation structure
Throughout the financial period the Group changed its intention in relation to a specific sub-portfolio of their international lending portfolio, classified as hold to collect. The reasons for this change in business model were driven by the Group's intention to set up a securitisation structure as part of a new strategy, through which part of the international lending portfolio with a total carrying amount of €296.9 million were sold by the Group to this structured entity and derecognised from the Group's statement of financial position, subsequent to which structured notes were issued by the structured entity to the Group and third party investors.
A gain equivalent to €0.5 million was registered by the Group as a result of this transfer of loans to the structured entity. However, the Group's change in intention was not deemed to constitute a reclassification event, since the Group's remaining hold to collect portfolio retained its classification and the above mentioned sale from the international lending portfolio for the purpose of setting up a securitisation structure was classified as an isolated non-recurring event.
MeDirect Malta acquired a 5% vertical slice in each of the structured note tranches for risk retention purposes, for the amount of €20.3 million. MeDirect Belgium acquired a 35% share of the tranche with the highest credit rating for an amount of €87 million.
In view of the Group's projected exposure to the total variability of the structured entity's returns, taking into account of its maximum exposure as a collateral manager (i.e. incorporating all cash flows, including management and incentive fees) and its exposure to variability of returns from the 5% vertical slice together with other holdings of the structured notes, a significant share of the exposure to variable returns was transferred to other tranche holders and therefore the Group does not consolidate the structured entity.
During the financial period ended 30 September 2019, the Group continued to implement its business plan with the aim of sustaining the Group's long-term profitability by building a diversified asset base and its deposit customer base in the mass affluent market both in Malta and Belgium and also with select corporates in Malta.
The Group continues to fund its portfolios through deposits and through the international wholesale financial markets. The growth of the Group's deposit base in Belgium, especially with the introduction of the regulated savings product, has strengthened and made more robust the Group's funding platform.
Access to the Eurex repo platform continues to provide efficient funding for the Group. The Group's core deposit offering is a range of fixed-term and other saving products. As at 30 September, the Group's deposit base reached €2.4 billion (31 March: €2.2 billion).
The growth of the Group's deposit base also provides cross selling opportunities for investment and wealth management products. The Group's Lending Portfolio primarily consists of senior secured loans and revolving credit facilities to corporate borrowers domiciled in Western Europe.
Substantially all loans and revolving credit facilities in the portfolio are denominated in euro or pound sterling and substantially all of the loans are floating rate instruments (some have interest rate floors embedded within the contracts) and would not be adversely affected by material changes in interest rates.
The Dutch mortgages portfolio is expected to increase significantly over the coming months following the introduction of this new business line in September 2019. As part of the Group's funding strategy, MeDirect Malta had set up Grand Harbour I B.V., a controlled special purpose entity which has been consolidated since MeDirect Malta retained all the risks and rewards of the structure.
GH I was funded through two intragroup loan facilities subscribed to by MeDirect Malta and MeDirect Belgium. MeDirect Belgium and MeDirect Malta invested in GH I on a 74% - 26% basis with the tranche bought by MeDirect Belgium (the "Senior Loan") having a senior ranking vis-àvis the facility taken up by MeDirect Malta (the "Junior Loan").
The Group also continues to make significant investments in technology to enhance its retail online banking capabilities with the introduction of the new public website, the pilot phase of the new digital on-boarding process and the development of the mobile app for retail clients aimed for launch in 2020.
Significant investment went into the systems supporting the new business lines and there is ongoing investment to enhance the Group's anti-money laundering and financial crime controls along with the strengthening of the cyber security posture.
The MDB Group (the "Regulatory Group"), which comprises MDB Group Limited and its subsidiaries, the MeDirect Malta Group, remains committed to operating with strong regulatory ratios and a robust liquidity position. The Regulatory Group, that is also considered a core domestic bank by the Central Bank of Malta, will continue to ensure that appropriate capital levels are maintained reflecting the economic environment and the challenges that the Regulatory Group is faced with.
The Regulatory Group is under the Single Supervisory Mechanism and the direct supervision of the European Central Bank. The Regulatory Group is confident that it will continue to meet the high expectations of the ECB.
Financial performance
The Group reported a profit before tax of €10.5 million for the six months ended 30 September compared with €8.1 million for the same period last year. The Group registered gains on disposal of €4.5 million and was positively impacted by the release of the Stage 1 and Stage 2 allowances for Expected Credit Losses as a result of the sale of the loan portfolio in August 2019 to the securitisation structure set-up by the Group.
This was slightly reduced by the restructuring costs amounting to €3.1 million included within personnel expenses that were incurred throughout this financial period as a result of changes at a senior management level.
During the six-months ended 30 September, the Group registered net interest income of €31.5 million (Period ended 30 September 2018: €33.7 million). Total operating income amounted to €41.6 million (Period ended 30 September 2018: €37.6 million). Total operating expenses amounted to €30.2 million (Period ended 30 September 2018: €24.9 million).
As previously mentioned throughout this financial period the Group started diversifying its asset base. As a result of the sale of portfolio to the aforementioned securitisation structure setup by the Group, the traditional lending portfolio decreased to €1.4 billion, net of expected credit losses of €23.9 million (31 March 2019: €1.8 billion net of expected credit losses of €23.9 million) and as at 30 September the Group had a Dutch mortgages portfolio amounting to €0.4 million and holdings in securitisation structures, mainly having rating of AAA, amounting to €288.6 million.
In addition, the Group had commitments of €404.7 million under revolving credit facilities as at 30 September 2019 (31 March 2019: €448.1 million), other undrawn corporate credit facilities of €89.6 million (31 March 2019: €61.3 million) and commitments in relation to Dutch mortgages amounting to €49.4 million.
As at 30 September, the Group also had commitments to purchase facilities on term loans amounting to €60.7 million (31 March 2019: €60.8 million) of which €11 million were subject to a back-to-back sale agreement with a third party.
As at 30 September, the Group's investment portfolio, consisting of debt securities stood at €0.9 billion (31 March 2019: €0.7 billion).
Dividends and reserves
After adjusting the Reserve for General Banking Risks in accordance with the requirements of Banking Rule 09 - Measures addressing credit risk arising from the assessment of the quality of asset portfolios of credit institutions authorised under the Maltese Banking Act (Cap. 371), the retained earnings of the Group amounted to €65 million (31 March 2019: €56.1 million).
By virtue of a shareholders' resolution dated 30 May 2018 and 28 June 2019, MeDirect Bank (Malta) plc approved the repayment of the shareholder contribution equivalent to €7.23 million and €10 million respectively.
Outlook and future business developments
The ongoing robustness of capital and liquidity ratios provide a stable foundation from which to produce attractive and sustainable returns. Following the restructuring exercise that was announced at the beginning of this financial period and given the strategic evaluation process undertaken by the shareholder, the new management are focusing their efforts on the agreed commercial objectives and the accompanying growth opportunities that they bring, supported by the strong foundations that have been built over the recent past, in which the Group invested and will continue to invest heavily.
Stability in the international capital markets results in a positive effect on the Group's wealth management and investment services businesses since greater investor confidence leads to increased customer interest in the investment products offered by the Group.
The Eurozone macroeconomic environment remains challenging, especially with the uncertainty surrounding the UK Brexit, and that any reversal of the positive trends previously described could have a negative effect on the Group's asset portfolios and businesses. Despite these ongoing challenges, the Group remains confident that its underlying strategy will continue to result in profitable growth. Furthermore, the Group will continue to explore further new opportunities in order to diversify the Group's asset classes and the relative revenue streams.
The Group has recently been operating with a relatively stable leverage ratio and intends to continue to operate with a capital adequacy ratio in excess of the minimum capital requirements determined by Capital Requirements Directive IV and also in conformity with any other guidance issued by the Group's regulator, the ECB's Joint Supervisory Team.
The developments mentioned above enable the Board of Directors to look forward to the future with cautious optimism.
Related parties
There were no material changes in related party transactions from those detailed in the financial statements for the period ended 31 March 2019. During this period no further related party transactions materially affected the financial position or liquidity of the Group, other than the related party transactions disclosed in Note 6. Events after the reporting date Issue of 4% Subordinated Unsecured Bonds due 2024-2029 On 8 October 2019 MeDirect Malta announced the plan in relation to the issue and listing of €35 million 4% Subordinated Bonds denominated in Euro and Pound Sterling maturing on 5 November 2029 with a 5 November 2024 early redemption option held by MeDirect Malta. The proceeds were used: - to early redeem the €25 million Subordinated Unsecured Bonds bearing interest at 6% per annum and maturing on 28 November 2024 with a 28 November 2019 early redemption option held by MeDirect Malta; - for the purpose of part-financing the redemption of the 7.5% Subordinated Bonds of MeDirect Malta redeemable on 4 December 2019; and - in part for general corporate funding purposes of the Group. Change of the accounting reference period The Group changed its accounting reference period to 31 December 2019. Accordingly, the next Annual report and the related financial statements will cover a nine-month period from 1 April 2019 to 31 December 2019 with the comparative figures presented being the twelve-month period for the year ended 31 March 2019. There were no other events after the reporting date that would have a material effect on the financial statements.