Cyprus banking outlook remains negative due to exposure to Greece

The outlook for the Cypriot banking system is negative, reflecting the challenging operating conditions and the rated banks' direct and sizeable exposure to the Greek economy, Moody's Investors Service said in a new Banking System Outlook.
"Asset quality and earnings for the rated Cypriot banks will remain under pressure in the near to medium term, given the muted economic growth in Cyprus and the anticipated economic contraction in Greece stemming from the Greek government's austerity measures," explained Christos Theofilou, Moody's analyst and author of the report.
The Moody's-rated Cypriot banks have direct and sizeable exposures in Greece through branches or subsidiaries, accounting for 41% of total loans as of June. The Greek exposures are affected by weak corporate earnings (due to the economic contraction) and reduced household disposable income (due to rising unemployment rates, additional tax measures and enforcement, and salary cuts). These factors will likely lead to substantially higher non-performing loans in Cypriot banks' loan books.
Moody's also expects non-performing loans to continue to rise in Cyprus, where economic activity is expected to remain weak in 2011. The country's real-estate market — which is a significant component of the banks' loan books and represents the majority of collateral for loans — remains a risk area with weak demand and unclear growth prospects.
"Bottom-line profitability for Cypriot banks will likely remain modest, slightly below 2009 levels, as it continues to be negatively affected by the weak macro-economic conditions in Cyprus and Greece, with elevated loan-loss provisions over the next 12 to 18 months. The contribution to overall profitability from Greece will likely remain minimal or negative due to high provisioning needs, high funding costs and low new business volume," added Theofilou.