Moody’s: NPEs decline, a credit positive

Cypriot banks' nonperforming exposures decline 34% in September, is a credit positive, according to Moody’s rating agency.

In its weekly outlook, the rating agency states that on 11 January, the Central Bank of Cyprus released the system’s nonperforming exposures (NPEs) as of September 2018, which showed a €5.6 billion or 33.6% decline versus August 2018, a credit positive for the Cypriot banking system because it reduces asset quality risks and supports depositor confidence.

The NPE improvement primarily reflects the resolution of Cyprus Cooperative Bank Ltd. (CCB) and subsequent transfer of its €5.6 billion of NPEs, primarily related to household lending, to a non-bank asset management company, Cyprus Asset Management Company.

CCB's resolution and NPE transfer reduces the risk of higher losses for the Cypriot banking system. The CCB's remaining assets and deposits were transferred to Hellenic Bank Public Company Ltd. (Caa1 review for upgrade, caa21), which has supported overall depositor confidence in the system. Cyprus' percentage of NPEs dropped to 31.8% by 30 September 2018, which remains high relative to the region  but is down from 40.4% at the end of August 2018 and 43.7% at year-end 2017.

“We estimate that the majority of CCB’s NPEs (over 80%) were primarily mortgage loans. Therefore, the NPE ratio in the household sector (accounting for 40% of system gross loans as of September 2018) improved the most, declining to 38% as of September 2018, from 53% as of August”, it adds.

 Household loans have the lowest loan loss coverage ratio so their exclusion leads to an improvement in the system's overall coverage. Loan loss provision coverage increased to 51.9% as of 30 September, from 47.9% in August and 46.8% by year-end 2017, which is more in line with the euro-area average of around 50%.

However, the reduction in banking system NPEs does not reduce the debt burden on the economy because CCB’s NPEs will continue to be managed, albeit outside of the banking system, with the intention of being restructured, rescheduled and repaid.

Cypriot households continue to be highly indebted: household debt was 105% of Cyprus’ gross domestic product (GDP), and nonfinancial corporate debt accounted for an additional 122% of GDP as of March 2018. The transfer does not reduce these debt levels.

The €5.6 billion NPEs equal close to 30% of the country’s GDP and a resumption of loan repayments by households will likely still weigh on disposable income, spending and on economic growth.

In total, NPEs across Cypriot banks dropped by €10 billion during the first nine months of 2018 to €11 billion, almost half their amount as of year-end 2017. In addition to the recent €5.6 billion transfer, the other main driver of the recent reduction was roughly €3.2 billion of NPE sales and transfers by Bank of Cyprus Public Company Limited (Caa1 positive, caa1), Alpha Bank and Hellenic Bank primarily related to small and midsize enterprises.

Despite the reduction from these sales and transfers however, the pace of actual loan repayments has been very slow, despite economic recovery and growth since 2015. We expect loan repayments to be supported by the recent regulatory and legislative measures to improve the foreclosure and insolvency framework, and a government sponsored plan (Estia) targeting socially vulnerable borrowers that have defaulted on their mortgages. Estia in particular is expected to incentivize the resumption of repayment of around €1.4 billion of retail loans that remain in the banking system’s NPE balances.