Cyprus Banks may need additional €1.5 billion, says Moody’s

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Rating agency Moody`s said on Thursday it maintained its outlook for Cyprus` banking system as negative, noting it estimates that the Cypriot banks will require additional capital of some €1.5 billion due to higher than estimated economic contraction and soaring loan-loss provisions.

Moody`s has maintained the Cyprus banking system as negative since May 2009.

"The financial crisis in Cyprus triggered a deep and prolonged economic recession that will further strain the already highly stressed operating environment. In this context the outlook reflects the formidable challenges facing the banks, namely acute asset-quality deterioration, continued concerns over their solvency, and intense funding and liquidity pressures," Moody`s said in report published today.

Moody`s estimates that the contraction of Cyprus GDP will reach 12% in 2013 and 6.4% in 2014 as opposed to the Troika projections for 8.7% and 3.9% in 2013 and 2014 respectively.

According to Moody`s, the stressed conditions will be characterised by a sharp drop in domestic consumption, reflecting the erosion of household incomes and wealth, compounded by surging unemployment (up to 17.3% in June 2013 from 13.8% as of end 2012); a further contraction of the real-estate sector; and reduced business volumes in financial services (which historically accounted for a large part of the economy), given the impairment of the banking system`s offshore business model.

Noting that the severe economic contraction will intensify already acute asset quality pressures, leading to exceptionally high loan-loss provisions, which will to over 35% by year-end 2013, Moody`s points out that "as a result of asset quality deterioration, the banks will likely require additional capital, above recent recapitalisations, to withstand potential credit losses from their loan books and/or their high exposure to Cypriot government bonds (Caa3 negative)."

"Under Moody`s central scenario, the Cypriot banks and cooperatives could face capital needs that exceed by some EUR1.5 billion the EUR2.5 billion of EU support funds earmarked for the banking sector," the report notes.

The agency also estimates that as a consequence of depositor losses, confidence in the banking system has been largely eroded, accelerating deposit outflows, adding that while current constraints on deposit withdrawals, which have been in place since the March bailout agreement, are preventing a full-blown capital flight, that deposits will continue to decline.

"Moody`s does not expect the constraints on cash withdrawals to be fully lifted unless confidence in the Bank of Cyprus` restructuring, and in the wider banking system, is restored," it adds.

Concluding the rating agency estimates that banks` reliance on central bank funding, which totaled €11.3 billion as of August 2013 (equal to approximately 22% of domestically owned rated bank assets and 70% of economic output), will rise further.

Cyprus and the Troika (EC, ECB and the IMF) agreed last March on a €10 billion bailout. The programme featured a conversion of uninsured deposits to capital in a bid to recaptalise the island`s largest lender, Bank of Cyprus, whereas Cyprus Popular Bank, the island`s second largest bank is to be wound down. The programme also featured a €1.5 billion capital injection to the island`s Cooperative Credit Institutions, whereas a further €1 billion is earmarked to cover possible capital requirements for the remaining Cypriot banks.