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Fitch: Negative outlook for cypriot banks

05/10/2020 09:08

Fitch Ratings has affirmed Bank of Cyprus Public Company Limited`s (BoC) Long-Term Issuer Default Rating (IDR) at `B-` and Viability Rating (VR) at `b-` and removed them from Rating Watch Negative (RWN).

The Outlook on the IDR is Negative.

According to Fitch, the affirmation reflects its updated view that BoC`s ratings are not immediately at risk from the impact of the economic downturn from the pandemic as the announced sale of non-performing exposure (NPE) provides the bank with additional headroom at this rating level to absorb the likely reduction in profitability, higher credit risks and higher capital encumbrance from unreserved problem assets due to the coronavirus crisis.

The Negative Outlook, it adds, "reflects our view that risks remain skewed to the downside in the medium term, especially if the recession proves deeper or the recovery weaker than our forecasts." In this case, BoC`s ratings "might come under pressure from higher-than-anticipated inflows of new impaired loans generating larger credit losses, weaker revenue generation, ultimately resulting in greater-than-expected capital erosion."

Furthermore, Fitch says that BoC`s ratings reflect weak asset quality, which results in very high capital encumbrance by unreserved problem assets (NPE and foreclosed assets), and weak profitability, which is still constrained by high loan impairment charges (LIC). The ratings also reflect BoC`s strong franchise and market position as the largest bank in Cyprus, which is a small market, and an acceptable funding profile.

It notes that BoC`s asset quality has been weak for a prolonged period of time. Despite continuous decrease since the peak (NPE ratio of 63% at end-2014), the NPE ratio was still high at 22% at end-June 2020, including the announced sale of EUR0.9 billion of NPE (Helix 2), down from 29% at end-March 2020.

Fitch says that completion of the deal is expected in 1H21 and is highly probable, in our view. The resulting decrease of the stock of NPE will give the bank additional headroom to absorb shocks.

Moreover, it notes that BoC`s asset quality remains under pressure as it is vulnerable to the fallout of the current recession, even if we do not expect a significant increase in NPE in 2020, due to the nine-month moratorium on payment of capital and interest for loans.

"Our view is supported by the high portion of loans under moratorium at end-June 2020, which accounted for about 66% of the performing loans portfolio. Our assessment of asset quality also considers the high problem assets ratio, which was slightly above 30% at end-June 2020."

Regarding its profitability, Fitch says that BoC`s profitability is weak and weighed down by a still large stock of problem assets, as LIC pose a threat to earnings.

"Profitability continued to be weak in 1H20, when the bank announced a EUR125 million loss before tax, as it has been significantly impacted by higher LIC (139bp in 1H20) and Helix 2 losses (EUR68 million including transaction costs). We expect profitability to remain under pressure in the next 18 months, from subdued new business volume and high LIC".

According to Fitch, the bank`s fully loaded common equity Tier 1 (CET1) ratio (including the full impact of IFRS 9) was 12.7% at end-June 2020, pro forma for the completion of the Helix 2 transaction. Capital remains highly vulnerable to the large proportion of unreserved problem assets.

It adds that encumbrance by unreserved problem assets was high at 1.7x fully-loaded CET1 capital at end-June 2020 (down from about 1.9x at end-March 2020).

"This makes capital sensitive to shocks and still not commensurate with risks. We expect asset quality to deteriorate and consequently capital encumbrance to increase. The bank`s capacity to generate capital internally is weakened by the current economic environment, making capital ratios vulnerable to potential losses generated by higher impairment charges".

Regarding funding, it says that BoC`s funding is supported by the bank`s deposit franchise in Cyprus adding that together with the deleveraging of the balance sheet, the gross loans/deposits ratio declined to about 70% at end-June 2020.

About 80% of BoC`s deposits are domestic retail deposits, almost all of which are covered by the deposit guarantee scheme, contributing to funding stability, it says.

Fitch notes that the liquidity buffer mitigates the potential volatility of deposits related to BoC`s non-resident transaction business.

The bank`s funding and liquidity profile remains sensitive to confidence shocks and access to unsecured wholesale funding at a reasonable cost in the current environment might prove challenging, Fitch concludes.

Fitch affirmed Hellenic Bank’s rating at B

Fitch Ratings has affirmed Hellenic Bank Public Company Limited`s (HB) Long-Term Issuer Default Rating (IDR) at `B` and Viability Rating (VR) at `b` and removed them from Rating Watch Negative (RWN). The Outlook on the Long-Term IDR is Negative.
 
The affirmation reflects the rating agency’s updated view that HB`s ratings are not immediately at risk from the impact of the economic downturn from the pandemic, as its current financial position provides the bank with some rating headroom to absorb the likely reduction in profitability, higher credit risks and higher capital encumbrance from unreserved non-performing exposure (NPE) due to the coronavirus crisis.
 
The Negative Outlook reflects Fitch’s view that risks remain skewed to the downside in the medium term, especially if the recession proves deeper or the recovery weaker than our forecasts. In this case, HB`s ratings would come under pressure from higher inflows of new impaired loans generating larger credit losses, weaker revenue generation, ultimately resulting in greater-than-expected capital erosion.
 
According to the report, HB`s ratings are constrained by weak asset quality by international standards and high capital encumbrance by unreserved problem assets (NPE and net foreclosed assets). They also reflect its strong franchise and market position as the second-largest bank in Cyprus, a small country and improved overall financial profile following the smooth integration of Cyprus Cooperative Bank LTD (CCB).
 
It also says that given the nature and size of the economy, HB is naturally exposed to currently volatile borrowers like small businesses, SMEs (around 35% of total gross loans at end-June 2020) or the tourism industry (about EUR430 million or close 10% of performing loans). The portion of loans under moratorium was high at end-June 2020, at about 55% of performing loans.
 
“The current economic situation will also delay the work-out of problem assets, as NPE trades will be difficult to achieve in 2020 and foreclosure of properties is more difficult. Consequently, we expect asset quality to deteriorate in 2021. However, we do not expect a significant increase in NPE in 2020, thanks to the nine-month moratorium on loan repayments until end-2020”, it is added.
 
Fitch also expects earnings to decrease over the next two years as a result of high loan impairment charges (LICs) and subdued business volumes.

It is added that capital remains highly vulnerable to the large proportion of unreserved problem assets (about 75% of fully-loaded CET1 if NPE guaranteed by APS are excluded), which makes it sensitive to asset quality shocks.