Fitch Ratings has affirmed Bank of Valletta p.l.c.'s (BoV) Long-Term Issuer Default Rating (IDR) at 'BBB' and Viability Rating (VR) at 'bbb'. The Outl
Fitch Ratings has affirmed Bank of Valletta p.l.c.’s (BoV) Long-Term Issuer Default Rating (IDR) at ‘BBB’ and Viability Rating (VR) at ‘bbb’. The Outlook on the Long-Term IDR is Negative.
A full list of rating actions is detailed below.
The affirmation reflects the strength of BoV’s capitalisation, which underpins the ratings. The affirmation also factors in BoV’s progress in de-risking its business model, which encompasses the unwinding of its trust business, the termination of relationships with clients that no longer fit within its revised risk appetite (eg. international clients with no connection with the Maltese economy), the file review of retail customer base and the revision of the customer on-boarding policy.
The Negative Outlook reflects the risk that capital could suddenly weaken in the event of a negative resolution of the Deiulemar litigation. This could result in the ratings being downgraded, since it would add to our expectations that asset quality will deteriorate due to the COVID-19 pandemic and earnings weaken due to a combination of economic slowdown, tight margins, reduced business and higher costs.
KEY RATING DRIVERS
IDRS AND VR
BoV’s ratings reflect its systemic role and leading franchise in Malta, its adequate capitalisation and stable funding and liquidity. Overall asset quality is satisfactory and has benefited from the positive momentum of the Maltese economy, but the bank’s impaired loan ratio remains above the European industry average and is likely to deteriorate due to the economic fallout.
In 2020 the bank has continued to progress on its de-risking, which also includes the reduction of contingent liabilities related to legacy litigations. In early September, the bank settled the dispute with Swedish Pension Agency related to Falcon Fund Sicav, while the Deiulemar case remains pending for a potential liability of EUR363 million. Fitch believes that the settlement of Deiulemar could be a major turning point in the bank’s de-risking strategy and could significantly reduce reputational risks. BoV has an ESG Relevance Score of 4 for governance structure to reflect the risks of such a large litigation and still weak, albeit improving, risk control framework.
BoV’s average operating profitability of 2.9% of risk-weighted assets (RWA) over the past four years still compares well with other European banks. However, in 1H20 it deteriorated significantly as a result of reduced business due to the economic downturn and its de-risking strategy, growing margin pressure due to competition and the higher costs needed from the implementation of the de-risking plan. Additionally, the bank’s profitability remains highly exposed to the domestic economic environment and constrained by the small size of the Maltese economy, which introduces risk concentration.
We expect the bank’s profitability to remain under pressure in the next few years, including from higher loan impairment charges, and to start recover gradually from 2023 although at structurally lower levels than in the past. However, we expect that the bank will try to compensate this by increasing the revenue from non-interest activities like wealth management.
Asset quality improved recently, with the impaired loan ratio decreasing to 4.6% at end-1H20 from 5.5% at end-2018. Fitch believes that the economic downturn will inevitably result in an uptick of the impaired loan ratio, which should nonetheless be manageable. Our assessment of asset quality takes into account that loans represented only 37% of total assets at end-1H20 and that most of the balance sheet is represented by cash holdings at the central bank and highly-rated securities.
BoV’s regulatory common equity Tier 1 (CET1) ratio of 19.8% at end-1H20 (excluding suspended dividends for 2019), has ample buffers over the bank’s CET1 Supervisory Review and Evaluation Process requirement of 13.4%. BoV has one of the highest Pillar 2 Requirements among European banks, reflecting the ECB’s view of the need to strengthen the risk framework further and high vulnerability to legal risk. The bank has adequate capital buffers to absorb the potential Deiulemar claim and the resulting capital shortfall would be manageable when considering current provisions and a EUR50 million insurance indemnity. However, a negative ruling of the case would likely result in a lower assessment of the bank’s capitalisation since its CET1 ratio would reduce significantly. CET1 capital encumbrance by unreserved impaired loans is modest at about 11.6% at end-1H20 and we expect it to increase only slightly as a result of asset quality deterioration.
Funding and liquidity are a relative rating strength for the bank, supported by BoV’s dominant deposit franchise domestically and a deposit base that significantly exceeds lending. Access to the wholesale markets is largely untested but not necessary in the near term. Liquidity is ample, with cash and liquid government bonds accounting for over half of total assets.
BoV’s ‘F2’ Short-Term IDR is the higher of the two options that map to a ‘BBB’ Long-Term IDR, reflecting our ‘bbb+’ assessment of the bank’s funding and liquidity profile.
SUPPORT RATING AND SUPPORT RATING FLOOR
The Support Rating of ‘5’ and Support Rating Floor of ‘No Floor’ reflect Fitch’s view that although external support is possible, it cannot be relied upon. 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 of 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 would be downgraded if the bank’s profitability and asset quality deteriorate well beyond our current expectations, which already encompass a moderate deterioration in the impaired loan ratio and an operating profit/RWAs level after the de-risking that is nearly half of the past four years’ average. The ratings could also be downgraded in the event of an adverse judgment in the Deiulemar case leading to a material deterioration of the bank’s CET1 ratio. Downward pressure on the ratings would also arise if BoV fails to strengthen its risk governance or if progress in implementing planned strategic initiatives is not sufficient to reduce and manage operational risk effectively.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Fitch would revise the Outlook to Stable if the bank continues to strengthen its risk controls and to implement its transformation plan, while limiting cost inflation, or if the Deiulemar dispute is closed with a limited impact on the bank’s capital. A revision of the Outlook would also need pressures from the coronavirus pandemic on profitability and asset quality to ease. Fitch believes that rating upside remains limited by the small economy in which the bank operates and the resulting risk concentration levels, and would require a track record of solid risk governance and resilient financial performance through the cycle.
SUPPORT RATING AND SUPPORT RATING FLOOR
An upgrade of the Support Rating and upward revision of the Support Rating Floor 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.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
Bank of Valletta p.l.c: Governance Structure: 4
BoV has an ESG Relevance Score of ‘4’ for governance structure reflecting concerns about the bank’s effectiveness in managing compliance risks. The score also considers the uncertainty surrounding the timing and resolution of the Deiulemar litigation that would have a negative impact on BoV’s credit profile, notably its capitalisation, and have a moderate influence on its VR in conjunction with other factors.
Source : https://www.fitchratings.com/
