Meltdown

The Times of Malta



What has happened to the value of local equity securities since the beginning of the year is nothing but a value meltdown. The question which everybody is asking but few have the courage to answer,` is why is this happening, why is it happening now and could it have been avoided at all.

I seek to answer these questions in a non technical straightforward manner which I can corroborate with more detailed technical workings as necessary.

The most obvious question is, why is this happening` Some people who ought to know better have termed this as an unavoidable and overdue market correction.` I challenge this assertion most emphatically. Some background to this is necessary. The market had exploded in 1999 and a lot of hidden value which had accumulated over several years was exposed in the calendar year 1999 sparked firstly by the buy-back proposal of Mid-Med Bank and eventually by the takeover of Mid-Med by HSBC.

As often happens in such matters the price explosion was overdone and many people who entered the market in the year 2000 were disappointed by the end of last year that they suffered a loss rather than the growth they hoped for.` This was indeed a healthy and much needed market correction taking place in an orderly manner and teaching a salutary lesson to novice investors that share investment is not a guaranteed one `way road to riches.

So why has an orderly price correction taking place throughout most of the year 2000 suddenly turned into a meltdown in the first weeks of 2001` Why is this happening now`

I can trace two main reasons for this sudden melt-down and they both originate from our Ministry of Finance with the tacit collaboration of the Council of the Malta Stock Exchange.

The first relates to an offer which the Gvovernment made to shareholders of Mid-Med Bank on the register on 5thApril 1999 to buy some 860,000 shares of Middle Sea Insurance which the government bought from Mid-Med Bank in June 1999 prior to its take-over by HSBC.` These shares were offered at Lm2.28 when the traded market price of` shares on the Exchange was at the time of announcement Lm4.06 having come down in an orderly market correction from a high price of Lm5.

The inevitable here happened. No equity can be sold in the market at two different prices. The Malta Stock Exchange should never have allowed this no matter how much the government would turn red in the face by not honouring a pledge made in June 1999. Timing is essential and if the government wanted to offer these shares it should have done so immediately upon acquisition in June 1999 in order to avoid these monstrous market distortions.

The result was all too obvious to forsee. Middle Sea shares have stumbled some 36% from Lm4.06 it was trading at on announcement day and will stabilise at a price not far above the Lm2.28 with which the government has distorted the market.

In a small and unsophisticated market like ours confusion in one equity is contagious and quickly rubs onto other equities even without a valid reason.` But if there is a valid reason it rubs on far quicker. And there is certainly a valid reason.

Without much explanation the government announced in the Budget that it will extend the withholding tax concept applicable on bank deposits onto investment funds. Now this question of withholding tax on investment funds is still being considered by the EU for implementation in 2003. It is much more complicated that the fairly easy to administer tax at source on interest on bank deposits and its complication is compounded when the declared intention is to maintain capital gains exemption of equities and funds dealing in equities.

The problem is that many collective investment schemes do not deal only in equities. They invest in a mixture of debt and equity securities and applying the withholding tax concept on such fund is quite complicated. The confusion created by the Middle Sea saga was compounded by this uncertainty at a time when exchange control limit for foreign investment was increased on 1st January 2001 to Lm30,000.` As soon as a new annual quota for foreign investment came due on the first day of the real new millenium the melt-down began and` has seemingly become unstoppable.

Investors rushed out of funds for fear of being hit with the withholding tax and forced fund managers to dump equities on a dull illiquid market. The result is there for all to see.

Could it have been avoided` Most definitely.` Indeed it should have never happened.` The Middle Sea affair is a disgusting case of mismanagement by the Ministry of Finance and inertia by the Malta Stock Exchange. It would not have happened on any other seriously regulated market. The withholding tax extension to investment funds is a half-baked measure which has been announced without much fore-thought and which has created uncertainty and confusion. Attempts to clarify have only complicated matters further.

How is normality to be restored to the market` Normality is necessary and fastly so if the private sector is to be given a fair chance to tap the capital markets and government`s own privatisation plans are to proceed without hitches. If confusion has caused this problem lifting of the confusion is the cure to this mess. The Middle Sea saga will soon unwind itself as the motivation to make a quick buck by takers of government low price offer is nullified by the falling equity price.` But the withholding tax decision needs either full and total explanation or postponement in line with tempos being considered by the EU. The EU has delayed implementation until 2003 as they want Switzerland and other small European tax havens to participate with equivalent measures in order to avoid flight of capital from the EU. How we expect to be able to do it unilaterally whilst lifting restriction on capital exports is simply muddled thinking of confused minds.

What is the net profit & loss to government of all this. From the Middle Sea saga it has lost a potential one and half million liri if all potential offers have been taken. From the melt down I estimate that since the budget day government`s holding in Maltacom, Bank of Valletta, and Middle Sea have suffered a loss in market value of` about Lm52 million and still falling as I write. And this for an expected return of Lm3 million per annum from the new Withholding Tax on Collective Investment Schemes.

What a complete mess of managing the nation`s finances! The only good thing about this is that equity values have now fallen enough to enter again the bargain territory. Prime candidate among these is Bank of Valletta`s equity which with a PE ratio of 13 has clearly fallen much more than it deserves. May this help to restore order on the market.

Alfred Mifsud