Moody’s warns of added credit risks for Maltese banks
Charlot Zahra
In its Banking System Rating (BSR) outlook on Malta, international credit rating agency Moody’s has rated the credit outlook for the Maltese banking system during the next 12 to 18 months as “negative”.
Moody’s said its negative outlook on the Maltese banking system reflected “a weakening domestic and global operating environment and expectations that it will have a more severe impact on the banks’ financial fundamentals, mainly profitability, asset quality and capital levels, going forward.
“Overall, we expect a slowdown in Malta’s economic growth mostly driven by weaker export demand, reduced tourism activity and gradually declining private consumption levels which is likely to impact borrowers’ ability to meet repayment obligations,” Moody’s said in its report published on 20 March 2009.
The credit rating agency warned that the negative outlook captured “growing concerns over asset quality deterioration of the Maltese banks due to their high exposure to the property sector as there are indications of a continuing drop in demand in the real estate market leading to a gradual reduction in property prices”.
So far, Moody’s explained, “the impact of the global financial crisis has been mostly felt on the sector’s profitability levels mainly due to write-downs in some banks’ securities portfolios resulting from fair valuation adjustments.
“In our view, a prolonged period of the international financial distress is likely to have a more severe impact on the Maltese banks’ profitability levels as it is likely to lead to higher valuation losses from the mark-to-market accounting method,” the international credit agency warned.
Moreover, the negative outlook also captured “our expectations that the Maltese banks will witness a further reduction in their profitability levels mostly due to a declining growth in business volumes and squeezed interest rate margins – a reflection of increased domestic competition to attract customer deposits.
That said, the banking system was “currently adequately capitalised with good liquidity levels as banks remain primarily deposit-funded with low reliance on wholesale and inter-bank lending” Moody’s said in its BSR on Malta.
Meanwhile, in line with other EU Member states, the government had extended Malta’s deposit guarantee scheme in order to strengthen the confidence in the banking system.
“Going forward, we will monitor the conditions in the global and the domestic economy and assess whether there is a more severe impact on the banks’ profitability and asset quality levels that exerts downward pressure on the rating,” the international credit rating agency said in its report. “Management’s ability to protect capitalisation going forward, will be a key rating driver.”
Key issues
Moody’s said that the ongoing global economic crisis was likely to have “a more severe impact on the credit environment in Malta,” particularly as the performance of the real estate and the tourism sectors was expected to deteriorate, while export demand was likely to be reduced further. “Moreover, a prolonged period of the global distress is expected to impact further the Maltese banks’ profitability, leading to further marked-to-market valuation adjustments in their securities portfolios,” Moody’s warned.
Additionally, profitability levels could be reduced further “due to declining growth in business volumes and squeezed interest rate margins – a reflection of the increased domestic competition to attract customer deposits”.
Current liquidity levels in the Maltese banking system were adequate due to the system’s low reliance on inter-bank and wholesale funding while regulatory capital was satisfactory.
Impact on global financial crisis on Maltese economy
Following several years of adequate business growth of Maltese banks which was supported by a favourable macroeconomic environment in Malta and the rest of Europe, Moody’s anticipate “a slowdown in the Maltese banking system due to expectations of weakening operating conditions.
During the period between 2005 and 2007, average growth for the total banking system assets stood at a respectable 22 per cent, while during H1 2008 total assets rose by a modest 8 per cent.
“In our view, the global recession and the ongoing volatility in the international markets are likely to affect the credit activity in Malta as the performance of key economic segments is likely to deteriorate,” Moody’s said in its report on the Maltese banking system.
Export demand was expected to “decline further due to problems faced in Malta’s main exporting markets, while the performance of the tourism sector is also likely to deteriorate further.
“More importantly, a prolonged period of the financial distress in other large European markets such as the UK would lead to a further deterioration in the property sector in Malta, given the large number of second-home buyers from this market,” the international credit rating agency warned.
Moody’s explained that “the declining trend of property prices in residential property prices in Malta since the beginning of 2008 reinforces our concerns.
“Private consumption is also likely to gradually decline leading to subdued credit demand in the retail sector,” the BSR on the Maltese banking system warned.
Structure of the Maltese Banking System
International Banking Institutions (IBI) operating in Malta accounted for around 67 per cent of the aggregate banking system, but did not compete in the domestic market.
“Hence the two largest domestically oriented banks continue to dominate the local banking system, which is small and highly concentrated, with the two largest domestically oriented banks – BoV and HSBC Bank Malta (HBM) – dominating the native banking sector, jointly controlling approximately 75 per cent of the domestic banking assets,” Moody’s explained.
These banks had “similar market shares and significant pricing power, marginalising the ability of the smaller local players to tap any of the few good lending credits,” the BSR on the Maltese banking system said.
While competition was generally strong between the two banks, both institutions had “strong and defensible franchises, which for the case of the rated bank – BoV – underpin its ratings”.
However, the credit rating agency warned that the small scale of Malta’s operating environment “limits the domestic banks’ lending opportunities and exposes their loan portfolios to industry and concentration risk.
“Operating within the confines of Malta’s small and highly concentrated environment limits domestic banks’ lending opportunities while introducing an element of industry risk to their loan portfolios,” it added.
Moody’s warned that “much of the credit exposures are to the property sector, of which a high portion is residential mortgages, while another large contributor to the credit activity is the export finance, tourism and the manufacturing industry (see figure 1).”
The most recent available data suggested that retail loans “comprise a high 35 per cent of the total loan portfolio, of which 78 per cent is mortgage finance, accounting for a dominant 29 per cent of the total loan portfolio”.
Moreover, there was also “a gradual reduction in the system’s total loan portfolio growth during 2007 and H1 2008 to 9 per cent and 8 per cent, respectively – compared to 12 per cent witnessed in 2006.
The largest drop was evidenced in the real estate rental and business sector, following strong growth of 38 per cent during 2005 and 2006, and 18 per cent during 2007.
“Moreover, the construction industry also grew by a modest 4 per cent, subsequent to two consecutive years of strong growth of around 16 per cent in 2006 and 2007,” Moody’s said.
“Overall, we expect credit demand to continue to drop, reflecting the weakening global and domestic economic conditions,” the international credit rating agency warned.
Moody’s also warned about the “rising consumer indebtedness heightens concerns, particularly as operating conditions are expected to deteriorate in the foreseeable future.
“While the retail sector has historically exhibited low delinquency rates, we are increasingly concerned about the consistent accumulation of debt by individuals particularly as operating conditions in Malta are expected to deteriorate,” Moody’s insisted.
According to statistics published by the Central Bank of Malta (CBM), household debt to GDP stood at around 50 per cent at end-June 2008.
“While this is almost in line with the euro area average, the risks associated with debt accumulation are higher, given expectations for a deteriorating performance of key economic segments in Malta and concerns over future unemployment rates,” Moody’s warned.
The Maltese banking system’s elevated risk element
In its report, Moody’s highlighted the fact that the small size of the Maltese economy was responsible for the “high borrower concentration levels in the banks’ loan portfolios relative to equity which weighs negatively on the banks’ risk positioning assessment.
“Admittedly, such a situation is difficult to avoid in a country such as Malta where economic activity is dominated by a few major corporate groups that are engaged in key market segments of the economy,” the international credit rating agency added.
For the rated Maltese banks (BOV), the 20 largest exposures on-balance sheet accounted for “over 200 per cent of its shareholders’ equity levels”.
“The anticipated economic slowdown and the high credit risk assumed by Maltese banks, which remain vulnerable to the performance of a few borrowers and a few economic sectors, raise concerns for the system’s future asset quality metrics underpinning the negative credit outlook for the sector,” Moody’s warned in its BSR report on Malta.
Moreover, another concern is the banks’ heavy reliance on real estate collateral, particularly since there are indications of a drop in residential property prices for a second successive quarter.
Growth in the residential property prices peaked in Q1 2004 at an “extraordinary 35 per cent and since then has been on a declining trend, witnessing negative growth since the beginning of 2008.
A high 62 per cent of the banking system loans were collateralised by real estate, while provisioning coverage was particularly low as banks provided only for the portion of the loan that was not covered by collateral.
“However, we should mention that banks discount real estate values by 30 per cent as a mitigating factor, and that stress tests carried out by the CBM indicate that, for the capital adequacy of banks to fall below the regulatory minimum, a decline in house prices greater than 30 per cent would have to occur.
“That said, there is a strong likelihood that any stresses in the economy leading to a 30 per cent decline in real estate prices would be accompanied by other bank asset quality problems,” Moody’s warned.
“Consequently, a less than 30 per cent decline in housing prices might be sufficient to impact the system’s capitalisation levels,” the international credit rating agency’s report on the Maltese banking system warned.
Moreover, the report highlighted the fact that the speed of court decisions –“which, despite a slight improvement, remains less efficient than in other markets” – remains another concern.
