Bank of Valletta CEO Mario Mallia spoke to Anthony Manduca soon after a rating downgrade following the bank’s announcement that it had allocated €75 million for possible litigation costs and would not be paying out dividends this year.

News that Bank of Valletta had put aside €75 million for any potential losses it might incur as a result of three separate litigation cases created shockwaves at the Malta Stock Exchange. For the first time in years, shareholders will not be getting any dividends despite the bank registering higher profits.

BOV is involved in litigation in Italy relating to the Deiulemar case; in Malta with the appeal against the Financial Services Arbiter’s decision on the Property Fund; and it is in discussion with the Swedish Pensions Agency with regard to the Falcon Funds.

What would the cost be of these litigations in the worst-case scenario?

“Litigation always involves inherent risks,” said CEO Mario Mallia.

“The worst-case scenario in any dispute that is to be adjudicated is that the full claim made against you is upheld in court and subsequently confirmed on appeal.”

Of the three cases, he said, the Deiulemar one has yet to start being heard in the Italian court on its merits, since so far the debate has centred around preliminary issues. The Property Fund case been decided upon a number of pleas raised before the Arbiter for Financial Services, against which the bank has lodged an appeal. And the third case (Swedish Pension Agency) is not yet the subject of a lawsuit.

“The bank is determined to pursue all the available avenues for redress. In particular, in the Deiulemar case, it will leave no stone unturned to ensure that it is given a fair and impartial hearing.”

Bank will leave no stone unturned to ensure that it is given a fair and impartial hearing

Mr Mallia stressed that the largest case, that concerning Deiulemar, revolves around a Trust relationship which began in 2009.

“Both this case and the Property Fund saga are legacy cases, dating back several years. Since these cases originated, the bank’s risk appetite and its internal controls have evolved, and the bank – indeed banking in general – is today a much more regulated and safer place.”

Read: BOV shares plummet 9% as bank sets aside €75m for litigation costs

In keeping all these major cases under constant review, Mr Mallia said, the BOV board takes actions that include a review of its legal defence strategy as well as the recognition of accounting provisions if and when deemed appropriate in terms of financial reporting standards.

“The board has deemed it appropriate at this point to set aside the sum of €75 million against these litigation cases. This is obviously a judgement call, an estimate of possible eventual losses made in the present circumstances and given the present state of knowledge. The situation is being monitored continuously.”

Risk appetite

Asked to explain the rationale for the bank to hold a trust having a net worth of €6,000 only, Mr Mallia said replying to such a question today would be simple: the bank would not take on trust any asset today, whatever the value.

“The view today is that the trust business is no longer aligned to the bank's risk appetite. Back in 2009 the strategy was different, and included actively pursuing the generation of income from the trusts business.

“The trusts in question consisted of shares, with a total nominal value of €6,000, in a holding company. This company was itself the parent of another holding company, which was itself the parent of the Deiulemar group. The transactions complained of took place at this latter level, that is two levels below the level where the bank was involved merely as a trustee holding shares.

“The bank only ever held these shares in trust. No funds or any other physical assets were ever held,” he points out.

Re-assessment

The litigation has been ongoing since 2015 and the bank never deemed it necessary to take on provisions until this year. What triggered this change? To what extent was this decision influenced by the ECB?

Up to last year, Mr Mallia said, the bank did not deem it appropriate to provide against this case, in view of the legal advice that it had – namely that it has a very strong case. From a purely legal analysis, that advice remains unchanged.

“However, the board is also advised that there are other circumstances, extraordinary though they may be, and which have surfaced over the course of the sequestro conservativo, that have caused the bank to re-assess the overall situation and to recognise accounting provisions – not just on Deiulemar, but on all the major cases.”

BOV will emerge from this situation as a stronger institution

One such development was the issue of a sequestro conservativo against the bank, and the court’s subsequent decision to turn down the bank’s appeal against the sequestro. Other factors, such as the hostility of the environment at Torre Annunziata, have contributed significantly to the re-assessment of the board’s position.

Drop in the ocean?

Both the bank’s chairman and its CEO were recently quoted in the media as saying that this whole issue was a “drop in the ocean”. Doesn’t this contrast sharply with the surprising decision to suspend cash distributions for the current financial year ending December 31, 2018, Mr Mallia was asked. Was this decision imposed by the regulators?

“If that is the case, I have been misquoted. When I, and not the chairman, remarked that the claim was akin to a ‘drop in a bucket’, I was comparing the amount of €363 million blocked under the sequestro to the €12 billion in assets held by the bank.

“Dividend payout is a different thing altogether. The impact of a dividend payout on liquidity is insignificant but can be quite material on capital. The non-payment of a dividend is a capital conservation measure, and not a liquidity conservation matter.”

Asked when he expected the bank to be in a position to reinstitute dividends and whether a payout ratio of around 45 per cent was achievable going forward amid this uncertainty, Mr Mallia clarified that the bank never had a dividend payout ratio of 45 per cent, but of 25 per cent.

“The board will consider the payment of dividends at every reporting date and will take into account a number of factors such as profit recorded, contingent claims and regulatory capital requirements, and based on all those facts will then arrive at a decision.”

“One can therefore never comment in advance on the likelihood and the amount of future dividend distributions, irrespective of legal claims. We must also keep in mind that dividends – unlike interest – are never guaranteed.”

Stress test

Like other banks supervised by the European Central Bank, BOV will be subjected to a stress test in the coming months. What is the likely outcome of these tests for BOV especially in view of the concern expressed by credit rating agency S&P?

Mr Mallia said that stress tests, as their name implied, attempt to measure the strength of banks by observing how their financial situation would behave in an extreme negative scenario. Should a bank fail an ECB stress test, it would be required to boost its capital within a determined time period.

“In our case, should the stress scenario imposed on BOV cause us to fail the test, we would need to ‘bridge the gap’ between our result and the ‘pass mark’. This means that we would need to take the necessary measures to improve our capital position to reach the minimum capital ratio acceptable to the stress test. Like other banks, we too have a capital plan that would be activated in such circumstances.”

Regarding Standard & Poor’s concerns about BOV, Mr Mallia said the agency’s rating action last week was not taken on the inherent creditworthiness of the bank, nor in the light of the published interim financials, but rather due to the agency’s perception that the risk of the entire Maltese banking sector has increased.

“Indeed, BOV was downgraded on the basis of ‘industry risk’, and not on the basis of a credit assessment of the bank. We have, however, taken note of the S&P report, and I shall be evaluating it in detail with my executive team over the coming weeks.”

Capital increase

Did the bank have plans to increase its capital and how would such new capital be sold considering that no dividend would be paid at least for this year?

“Your question seems to assume that the market would only buy BOV shares because of its dividend payout. The bank is strong both in terms of its balance sheet and profitability, and its overall franchise. Equity investors tend to be long-term investors and will typically look at the overall picture, beyond any short-term dip.”

BOV, he said, was working on a contingency capital plan that could be activated to meet any short-term capital requirements. The plan encompasses the options which the bank could resort to, ranging from an actual rights issue to issuing hybrid capital (a debt instrument having many of the characteristics of equity), to managing the balance sheet in such a way as to shift from higher-risk to lower-risk assets.

“The riskier the asset, the higher the amount of capital required to support it. So moving towards lower-risk assets would reduce the capital that the bank requires.” He emphasised that there were a number of tools available in the management of capital. All were under consideration and none were being excluded outright.

“It is probable that the bank will opt to use a combination of options.”

When the bank made its last rights issue in November, it promised to deploy these funds into profitable business. “Seven or eight months down the road, we are looking at a half-year profit, before litigation provision, of €88.5 million, which is 30 per cent above last year’s result. So I do believe that we have kept our word and delivered record profits to our stakeholders.”

We have kept our word and delivered record profits

De-risking

Asked to define which areas will be affected by the bank’s ‘de-risking strategy’ and what sectors of the Maltese economy were likely to be affected if BOV decided to withdraw from certain business activities, he said this strategy was aimed at downsizing or exiting businesses or relationships which lay outside of the board’s risk appetite, or where the risk being assumed was not justified by the return being made.

“Most of the de-risking will involve non-core activities. I would compare de-risking to pruning a tree – a process whereby we will be trimming certain high-risk activities to give strength to the core. Pruning – if done properly – will give you a stronger tree. And that is indeed our aim – by reducing a number of peripheral activities, most of which are not even profitable, we will make BOV a more robust bank for the future.

“Since the exercise is focusing on non-core business, the wider economic impact is manageable.”

Asked if any cost-cutting measures would affect staff numbers or the number of branches, ATMs or overseas offices, Mr Mallia said he could firmly guarantee that no BOV employees will be laid off.

The bank continues to recruit people – especially in IT, compliance and anti-financial crime – and we have increased headcount over the past months by over 100 new recruits

“Indeed, the bank continues to recruit people – especially in IT, compliance and anti-financial crime – and we have increased headcount over the past months by over 100 new recruits.”

The board and management always gave top priority to cost management and this was not simply concerned with spending less, but with “optimising our expenditure, and ensuring that we get the best possible return on our investment”.

The bank’s entire operations and infrastructure, including the branch network and all physical and virtual delivery channels, were always under examination, Mr Mallia said.

“Sometimes, strategic cost management involves more spending in the short term, with the benefits to be reaped over the longer term. For example, our ongoing Core Banking Transformation programme is a vast change programme which is costing us millions of euros in the immediate term, but will ensure more efficient, and less expensive, processes in future.”

Long-term stability

Asked if he would like to pass on a message to shareholders and depositors who may be concerned about the likely effects of the current litigation in which BOV is involved, Mr Mallia said:

“BOV is a strong institution, with a strong franchise in Malta, deep roots in the local economy and a resilient, profitable business model. It is highly liquid, well-capitalised and supervised jointly by the European Central Bank and the MFSA.

“These are all factors that should provide ample comfort to shareholders and depositors alike. Although nobody knows the outcome of these litigation cases, we are confident of the long term stability and sustainability of the bank. BOV will emerge from this situation as a stronger institution, with the support of all its various stakeholders.”