Fitch: Bank of Cyprus on negative watch; downgrades Marfin, covered bonds

Fitch has placed Bank of Cyprus on negative watch and downgraded Marfin Popular Bank's Long-term Issuer Default Rating to BBB- from BBB – placing its individual rating on negative watch.
The rating agency has also downgraded Marfin Popular’s covered bonds to BBB from BBB+ and maintained them on Rating Watch Negative (RWN).
Fitch said the ratings indicate the agency’s expectation of further pressure on the banks' credit risk profiles, profitability and capital due to the challenging operating environment in Greece. It affirmed Hellenic Bank's BBB- rating.
On Tuesday, Fitch cut the sovereign rating for Cyprus by three notches to A-, saying it was concerned about the banks' exposure to Greek debt and the impact this could have on the island's finances.
Marfin Popular’s downgrade reflects its larger exposure to the Greek economy and sovereign and weaker funding profile with a higher reliance on ECB funding, the agency said.
Despite the risks, Fitch credited the Cypriot banks' strong domestic franchises, good funding base supported by large domestic and, to a lesser extent foreign, deposit bases which have proved stable to date.
Marfin's covered bonds total EUR 2 bln of rated debt and are secured by Greek residential mortgage loans. The programme is governed by a dedicated covered bonds legal framework, recently enacted in Cyprus.
The RWN on the covered bonds is expected to be resolved in the short term, following Greece's sovereign rating review, Fitch said.
The outlook on Cyprus was negative, the agency said. Its sharp downgrade, from AA-, makes it the third agency to cut the ratings because of the banking exposure to Greece. This is in line with Standard and Poor's rating and one notch below Moody's A2 rating.
Fitch said that it believed Cypriot banks were "relatively well placed" to absorb the impact of an assumed 50% haircut on Greek bonds, but that worse-case scenarios could have a knock-on effect on Cyprus's own debt profile. In that scenario the cost of recapitalising the banks to a tier 1 ratio of 10% would be 2 bln euros, or 11% of Cyprus's GDP.
But in a more severe stress test where a Greek default was associated with significant deterioration in asset quality, the cost could rise to 25% of GDP — placing strain on Cyprus's debt profile.
Fitch said the exposure to Greek government bonds by Cypriot and Greek banks which had subsidiaries based on the island totalled 14 bln euros. Bank of Cyprus held 1.8 bln, Marfin Popular 3.1 bln and Hellenic Bank 110 mln, officials told Reuters.
The Central Bank of Cyprus disagreed on Tuesday with the Fitch analysis. "The Central Bank is adopting stringent supervision which demands, among others, the maintenance of high liquidity and capital ratios to cover any possible risks which may be assumed," it said.
To allay concerns of ratings agencies healthy public finances were also required, the bank said.
The island itself, one of the smallest economies in the euro zone, is struggling to keep a lid on its public deficit, a high public payroll and anaemic growth which has sapped tax revenues.