Yesterday marked a significant day in the life of a Bank of Valletta plc equity investor, as the bank for the first time since 1991 has announced that it will not be declaring either interim or final dividends. This was triggered by a provision against litigation losses of €75 million which has impacted its’ 2018 interim financial statements significantly.

As a re-cap, BOV is party to legal proceedings with respect to its involvement in three separate cases, the most significant of which is its involvement with the Deiulemar Trust, whereby in a worst case scenario the bank is exposed to claims of up to €363 million. Despite the bank not declaring the breakdown of its €75million provision with respect to the three cases due to strategic reasons, the bank indicated that the vast majority of it is in relation to the Deiulemar case.

With respect to the merits of the Deiulemar case itself, the bank is insistent that it is in a strong legal position to win the case, on the basis of the fact that the events which caused the default of Deiulemar occurred before the bank became the Trustee of the Deiulemar Trust. More recently, on 19th July 2018, the bank lost its appeal against the precautionary warrant of seizure, however it is important to note that the hearing of the case hasn’t yet initiated. One of the pertinent issues the bank is facing is the location where the case is being heard, being the Tribunal of Torre Annunziata in Italy, which according to bank officials, could be biased due to the majority of the creditors originating from this relatively small provincial town. The bank is in fact in the process of attempting to get the case heard in Naples to mitigate a potential unfair judgement.

This turmoil comes at a time when the normalised financial performance of the bank is very encouraging. In the interim results for the first six months of 2018 published yesterday, operating income increased significantly to €128 million compared to €116 million of H1 2017, boosted by gains in both net interest income and net fee and commission income. Costs were contained, with the cost/income ratio improving as a consequence. The bank benefitted from a sharp increase in net impairment reversals of €20 million compared to €6 million in the first half of 2017, as a result of a realigning its impairment model in relation to IFRS 9, which deals with the impairment of financial assets. According to bank officials, this is in line with the de-risking of the bank’s model, however the magnitude of this gain isn’t expected to be repeated in future financial periods, thus should be interpreted with caution. Normalising profit before tax, excluding litigation provisions and impairment reversals, the bank’s performance improved from €62 million to €68 million, or a 9.7% improvement year-on-year.

Unfortunately this improved performance has been overshadowed by the legal headwinds that the bank is facing. Assuming that the majority of the €75 million provision is dedicated to the Deiulemar case, this would cover around 20% of the total outlay the bank would be required to disburse in a worst case scenario of the case being found against them. If there are further developments against the bank, it could lead to further provisions in the coming months/years until the case is fully resolved. Furthermore, due to the systemic importance of BOV in the Maltese economy, I have great doubts about the bank’s willingness and ability from a regulatory point of view to distribute dividends until the legal exposures are fully provided for.

Unfortunately the legal woes aren’t going to be resolved in the short term, and my best guesstimate is that it will take at least three to four years before the matter is fully resolved. In the meantime, the share price of the bank has understandably come under pressure and I suspect will remain so, due to the increased risk profile of the bank, the suspension of the dividend and the insecurity surrounding the future events which the bank is exposed to.

The profile of the equity investment in the bank has, almost overnight, changed from a stable dividend paying stock to a speculative one, whereby the share price of the bank will rally strongly on the back of positive news surrounding the Deiulemar case and be impacted negatively in an eventual negative consequence, possibly forcing the bank into a rights issue to sure up its capital reserves. As to the probability of winning/losing the case I will leave that up to the legal experts, however it is definitely keeping investors on edge as they revaluate their exposure to the bank from a portfolio perspective.