Filenews 7 September 2022
S&P Global Ratings last night upgraded the Bank of Cyprus' long-term credit rating by one notch, to BB- from B+, assigning a stable outlook, citing the significant reduction in bad loans on its balance sheet, which put the bank in a stronger position to face a more difficult environment.
The upgrade of the Bank of Cyprus' rating followed the upgrade of the debt of the Republic of Cyprus last Friday.
"The bank of Cyprus' upgrade reflects the significant improvements that have been achieved in reducing distressed loans, putting the bank in a stronger position to face a potentially more challenging environment," S&P Global Ratings says.
According to the agency, since the peak of NPLs in 2014, the bank has achieved a cumulative reduction in NPLs by 96% through sales and organic efforts, recalling that at the end of June 2022 the bank's NPL ratio stood at 5.7% adjusted for the last NPL portfolio sale (Helix 3), which is expected to be completed at the end of the year while at the end of 2019 the NPL ratio stood at 30%.
S&Ps also reports that the stable outlook balances the improved risk profile and its capitalization against the need to improve efficiency and profitability. "We expect management to remain focused on keeping asset quality under control, creating savings from the recent voluntary exit plan," it says, adding that the cost-to-revenue ratio will fall by around 63% at the end of 2023 from over 70% in 2021.
It also notes that the decline in financial risks in Cyprus supports the bank's adequate capitalisation and provides room to support growth. In fact, it estimates that the lower financial risk will have a positive impact of 115 basis points on the bank's risk-adjusted capital (RAC) which at the end of 2021 and adjusted for the Helix 3 package stood at 8%.
"Therefore, we estimate that the capitalization of the Bank of Cyprus will remain in a sustainable manner above 7% over the next 18 months, providing some space for a mild growth of its loan portfolio and absorb potentially higher credit losses", the firm notes, adding that "we expect that the quality of capital will compare favourably with that of the corresponding Greek banks, which, unlike the Bank of Cyprus, hold large amounts of deferred taxation on their books."
More broadly for the banking system, S&Ps notes that Cypriot banks have made significant progress in cleaning up distressed loans since 2018 and have improved lending practices. After four years of NPL sales, debt-to-real estate swaps and NPLs for the entire banking system, they have fallen by more than €7 billion or by 71% since 2018. In addition, the credit profile of banks has proven resilient to the effects of the Covid-19 pandemic, with only 3% of the loans that benefited from the moratorium on instalments becoming non-performing, he adds.
It adds that banks have maintained stricter risk-taking standards, which will contribute to a smaller deterioration in asset quality in the coming quarters. It notes in this regard that the average loan ratio in terms of the value of the mortgage book stood at a "comfortable" 45% at the end of 2021.
"The clean-up is not over, however," the agency points out, adding that bad loans remain high compared to the EU average, i.e. 11.4% of total loans at the end of May 2022 or 16% to 18% of divested assets.
Noting that the NPL coverage ratio is 50%, the agency notes that a slowdown in the pace of NPL decline is expected in the future. "This is because loan sales will become more difficult and the majority of NPLs are household bad loans that are difficult to carry over," the agency explains.
It also estimates that the inflow of new NPLs will come mainly from stage 2 loans (of credit losses under IFRS 9), which account for around 15% of total gross loans in Cyprus, compared to the EU average of 9%. "We therefore expect the NPL ratio of the Cypriot banking system to be around 10% in the next 12 to 18 months," he adds.
The agency considers that prolonged inflationary pressures, high energy prices and indirect effects from Russia, Cyprus' trading partner, will affect Cypriot banks, but the impact will be at "manageable levels".
It estimates that the exposure of Cypriot banks to the professional and business sector related to Russia is less than 2% of the total loans of the banking system.
Moreover, S&P Global Ratings considers that banks in Cyprus are relatively more exposed to cyclical factors since private sector leverage is higher compared to other European banks. They are also under pressure to improve their profitability, while deposits from non-residents of Cyprus (17% of total deposits at the end of June 2022) create volatility in their financing.
According to the agency, the reduction of their operating costs and network and the increase of the digital transformation will be key to improving the efficiency of Cypriot banks, pointing out, however, that the increase in key interest rates has a favourable impact on net interest income, as banks' loan portfolios are mainly with floating interest rates.
