Fitch Ratings has downgraded Bank of Valletta p.l.c.'s (BOV) Long-Term Issuer Default Rating (IDR) to 'BBB-' from 'BBB' and Viability Rating (VR) to 'bbb-' from 'bbb', and removed them from Under Criteria Observation (UCO). The Outlook on the Long-Term IDR is Stable.
The rating action follows the placement of BOV's ratings on UCO on 16 November 2021 after the publication of Fitch's updated Bank Rating Criteria on 12 November 2021. The updated criteria introduced a fixed weighting scheme to derive an implied VR from banks' key rating driver scores. The VR of BOV has been downgraded by one notch to align it with its implied VR, as our assessments of the bank's business profile and risk profile do not currently justify applying a positive adjustment to the implied VR.
Fitch has withdrawn BOV's Support Rating of '5' and Support Rating Floor of 'No Floor' as they are no longer relevant to the agency's coverage following the publication of the updated Bank Rating Criteria. In line with the updated criteria, we have assigned BOV a Government Support Rating (GSR) of 'no support' (ns).
Key rating drivers
Dominant Bank in Small Country: BOV's IDRs and VR continue to reflect its systemic role and leading franchise in Malta, its ample capital buffers relative to regulatory minimum requirements, stable funding and robust liquidity. They also reflect stable asset quality despite the pandemic, and satisfactory profitability that remains under pressure from its reliance on net interest income and cost inflation.
De-Risking Continues: BOV has been strengthening its risk framework after regulators identified several shortcomings. While we acknowledge the significant progress so far, we believe that some weaknesses remain, as changes take time to become fully effective and Malta remains a jurisdiction with aBOVe-average exposure to operational and reputational risks. Lending standards and securities investment guidelines are prudent and in line with global industry practices.
Stable Asset Quality: BOV's impaired loan ratio improved slightly to 4.1% at end-2021 from 4.7% at end-2020 despite the pandemic due to a strong rebound of the Maltese economy and government measures supporting borrowers' creditworthiness. BOV also benefitted from healthy impaired loan recoveries and cures. BOV has increased provisions on long-standing impaired loans and pandemic-hit borrowers, resulting in an adequate impaired loan coverage of 74%. We expect asset quality to remain broadly stable, but sensitive to developments in the operating environment.
Profitability Below Historical Levels: BOV's profitability in 2021 rebounded from pandemic lows but remained below historical levels, as the bank suffered from low interest rates due to its fairly undiversified business model, large securities portfolio and excess liquidity. Costs have also increased consistently, as the bank invested in risk management, compliance and IT.
Vulnerable to Macroeconomic Developments: We expect revenue growth to outpace cost increase as BOV should benefit from continued economic growth in Malta and stronger placements of fee-generating products. However, macroeconomic uncertainty from the potential permanence of Malta being on Financial Action Task Force's (FATF) grey list and inflation might lead to weaker revenue growth, higher loan impairment charges and, ultimately, subdued profitability.
Capitalisation a Relative Rating Strength: Capitalisation is scored at 'bbb' to reflect that BOV's common equity Tier 1 (CET1) ratio of 21.9% at end-2021 was well in excess of regulatory minimum requirements and capital encumbrance by unreserved impaired loans was low at 6%. We expect capital ratios to remain broadly stable, as internal capital generation should largely match risk-weighted asset (RWA) growth.
Concentration, Legal Risks: Our assessment of capitalisation is constrained by concentration risk arising from BOV's almost exclusively domestic lending book. Capitalisation is also exposed to legal risks arising from the Deiulemar case, as reflected in an ESG Relevance Score of '4' for governance structure, although we expect the bank's capital buffers to remain adequate even in the most adverse scenario.
Strong Deposit Base, Ample Liquidity: Funding and liquidity are rating strengths, supported by BOV's dominant deposit franchise domestically and a deposit base that significantly exceeds lending. Liquidity is ample and conservatively managed, with cash and liquid government bonds accounting for over half of total assets.
Untested Market Access: BOV historically had no need to raise unsecured debt on the wholesale market given its ample deposit base, resulting in limited funding diversification. However, we expect the bank to issue senior debt in the coming quarters to comply with minimum requirements for own funds and eligible liabilities (MREL) by end-2023. We believe that market access may be unreliable or expensive at times of heightened volatility, as it is still untested.
No Support: BOV's GSR of 'ns' reflects Fitch's view that although external extraordinary sovereign support is possible, it cannot be relied on. Senior creditors can no longer expect to receive full extraordinary support from the sovereign if the bank becomes non-viable. The EU's Bank Recovery and Resolution Directive and the Single Resolution Mechanism for eurozone banks provide a framework for the resolution of banks that requires senior creditors to participate in losses, if necessary, instead or ahead of a bank receiving sovereign support.
Rating sensitivities
Factors that could, individually or collectively, lead to negative rating action/downgrade:
BOV's ratings could be downgraded if the impaired loan ratio increases to aBOVe 6% for a prolonged period, operating profitability deteriorates structurally below 1.5% of RWAs or the CET1 ratio falls below 15%, for example due to an adverse judgment in the Deiulemar litigation, extraordinary capital distributions, large operational losses, or a combination of these.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
BOV's small size and concentration in the domestic market mean that we see limited rating upside, unless BOV generates significantly higher and more diversified revenue and improves operating profitability above 2.5% of RWAs.
An upgrade would also require an impaired loan ratio structurally of around 4%, the maintenance of the CET1 ratio aBOVe 15% and a record of solid risk governance. Rating upside could also arise if our assessment of the operating environment improves materially, for example if Malta is removed from the FATF's grey list and continues to grow above the European average, providing good business prospects with no change to the bank's risk appetite.
An upward revision of the GSR would be contingent on a positive change in the sovereign's propensity to support the bank. In Fitch's view, this is highly unlikely, although not impossible.
VR Adjustments
The business profile score of 'bbb-' is aBOVe the 'bb' category implied score due to the following adjustment reason(s): market position (positive).
The asset quality score of 'bbb-' is aBOVe the 'bb' category implied score due to the following adjustment reason(s): non-loan exposure (positive).
The capitalisation & leverage score of 'bbb' is below the 'a' category implied score due to the following adjustment reason(s): risk profile and business model (negative).
The funding & liquidity score of 'bbb' is below the 'a' category implied score due to the following adjustment reason(s): non-deposit funding (negative).