Moody’s keeps Cyprus banking outlook ‘negative’; banks need more

The outlook for the Cyprus banking system remains negative, unchanged since May 2009, and the banks will continue to operate in a highly-stressed environment, with a 12% contraction of GDP expected in 2013 and 6.4% in 2014, Moody’s Investors Service in a new report on Thursday.
The rating agency said that “the financial crisis 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 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); further contraction of the real-estate sector; and reduced business volumes in financial services, given the impairment of the banking system's offshore business model.
The severe economic contraction “will intensify already acute asset quality pressures, leading to exceptionally high loan-loss provisions,” the report said, adding that while there is limited publicly available data, problem loans are estimated to have increased to around 26% of gross loans as of December 2012, six months before the bail-in, and will increase to over 35% by year-end 2013.
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 EUR 1.5 bln the EUR 2.5 bln of EU support funds earmarked for the banking sector.
As a consequence of depositor losses, confidence in the banking system has been largely eroded, accelerating deposit outflows. While current constraints on deposit withdrawals are preventing a full-blown capital flight, Moody's expects 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's restructuring, and in the wider banking system, is restored. The rating agency estimates that banks' reliance on central bank funding, which totalled EUR 11.3 bln as of August 2013 (equal to 22% of domestically owned rated bank assets and 70% of economic output), will rise further.