Fitch downgrades Bank of Valletta rating, bank moves to increase capital levels

Fitch downgrades Bank of Valletta’s rating to BBB, citing increasing regulatory pressure and says Malta’s implementation regulatory framework is less thorough than in EU countries with stringent frameworks

Fitch: BoV's risk controls continue to lack the depth required for the risks it faces
Fitch: BoV's risk controls continue to lack the depth required for the risks it faces

The pressure from increasing regulatory requirements on Bank of Valletta’s capitalisation and the fact that the bank’s capital ratios do not fully reflect operational and market risks, have led Fitch Ratings to downgrade BOV’s Long-Term Issuer Default Rating (IDR) and Viability Rating to ‘BBB’ from ‘BBB+’ and to ‘bbb’ from ‘bbb+’, respectively.

The rating agency said on Thursday that although BOV was considering strengthening its capital through a new share offer, this would not be sufficient to meet future requirements and maintain its viability rating at ‘bbb+’.

“Although the bank has put in place a series of measures to reduce risks, we believe its risk controls continue to lack the depth required for the risks it faces in its operating environment,” Fitch said.

Fitch considered the strong franchise of BOV in Malta, where it has leading market shares, as well as a lack of geographical and business diversification.

But the bank’s operations, it concluded, focused largely on commercial and retail businesses, which in turn have resulted in some concentrations towards government exposures and the real estate sector.

The bank said it intends to reduce such concentrations but given the domestic operating environment, alternatives are limited, according to Fitch, placing pressure on the bank’s risk appetite and underwriting standards.

“Furthermore, risk controls in the non-credit-risk division have not evolved in line with the growth of certain businesses,” it said. “While the Maltese regulatory framework has improved over the past few years, its implementation is less thorough than in EU countries with the most stringent framework.”

Fitch said that by writing off a portion of its impaired loans in its 2016 financial year, the bank had demonstrated a proactive attitude to reduce the stock of its impaired loans on its balance sheet, which fell to 5.1% of gross loans (from 6.7% at end-FY15).

“This figure, however, remains higher than average in similar operating environments,” it said. “Coverage of impaired loans of 87% compares well internationally.”

The agency said that BOV’s profitability benefited from sound core revenues generated from commercial business activities, sound operating efficiency, and contained loan impairment charges.

BOV’s Short-Term IDR, which is the higher of the two ratings mapped to ‘BBB’, continued to reflect the bank’s robust funding and liquidity. BOV’s deposit base was robust, underpinned by a leading domestic franchise, an improving loan/deposit ratio (which reached a comfortable 44% at end-FY16), while unencumbered liquid assets remain stable at a high 16% of total assets, Fitch noted.

Bank of Valletta’s reaction

Reacting to Fitch Rating’s announcement, Bank of Valletta CEO Mario Mallia said that the downgrade in the long-term rating was driven by Fitch’s view that the bank needed to increase its capital levels, in an environment of rising regulatory requirements. 

“The Bank has, in fact, already made public its intention to strengthen its capital buffers, through a combination of fresh capital issues, restrained dividend payouts and the review of the business model,” he said.

Mallia reaffirmed BOV’s commitment to strengthening its levels of capital, as well as its risk management framework. 

“We have started by beefing up our subordinated debt capital, and are now addressing core equity,” he said. “We are also putting into place a robust Risk Appetite Framework, and building up from scratch a strong and well-resourced Anti-Financial Crime function.”

Mallia said that, at the same time, the bank was withdrawing from traditional businesses which lay outside its current risk appetite and that was also addressing legacy issues that involved the bank in undue legal and reputation risk.

Government statement on Fitch Ratings' decision

In a statement, the government said that although Fitch rating had revised its rating for BoV, the agency had assigned the highest of the two rating in the ‘BBB’ level.

It noted that Fitch had also concluded that “BOV's short term rating, which has been assigned at the higher of the two options available for banks rated 'BBB', continues  to reflect its robust funding and liquidity”.

The government said that Fitch had also acknowledged that BOV’s profitability benefited from “sound core revenues generated from its commercial business activities, good operating efficiency and contained loan impairment charges”.

The agency was thus not casting any doubt on the bank’s stability or profitability, the government said, so much so that although BoV had been downgraded in 2011, it had recorded continued growth and increase in profits since then.

The government said it was true that changes in the regulatory framework were resulting in major banks like Bov to have greater capital, particularly in the form of new shares.

This was especially due to European Union regulation introduced in recent years and which led Fitch Ratings to downgrade a third of European banks last year.

This year alone, the agency had amended the ratings of 65 banks worldwide, leading Fitch’s managing director to state in August that this was “one of the most volatile six-month periods in recent years”.

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