Fitch Ratings has revised the outlook on Bank of Cyprus' (BoC) long-term issuer default rating (IDR) to positive from stable after its deal to offload mortgage-related toxic loans.
Fitch has also affirmed the bank's long-term IDR at B- and viability rating (VR) at b-, following BoC's agreement of securitising a portfolio of €2.8 billion of gross loans, including €2.7 billion of non-performing loans (NPLs), equivalent to about a third of the bank`s total NPLs.
Fitch said the NPLs sale "will be positive for BoC`s credit risk profile and will reduce capital encumbrance by unreserved problem assets" which include NPE and foreclosed assets.
The transaction is expected to be finalised by end-2018 or 1Q19.
“The execution risk on the transaction is small given the strong incentives for all involved parties to complete the deal."
Fitch’s positive outlook "also reflects the progress made by the bank in organically reducing volumes of problem assets, helped by the improving operating environment in Cyprus, and our expectation that this trend will continue in the next 18-24 months."
It said the bank`s IDRs reflect "its weak asset quality… which results in very high encumbrance of capital by unreserved problem assets and constrains profitability."
Once the NPLs sale is completed "the deal will improve the quality of the BoC`s loan book".
"We expect asset quality to continue to improve, given BoC`s track record in restructuring problem loans, the announced government scheme to support borrowers whose loans are backed by primary residences and changes to foreclosure laws that should speed up collateral repossession," Fitch said.
Fitch’s assessment of asset quality "also takes into the good quality of the bank`s other earning assets, in particular cash and balances with central banks, €4.2 billion or 18% of total assets at end-June 2018."
The NPLs sale (project Helix) is also seen as significantly reducing BoC`s exposure to unreserved problem assets, which is expected to fall to 2.5x of the bank`s IFRS9 fully loaded common equity Tier 1 (CET1).
BoC estimates that the transaction will add about 60bp, in net terms, to its CET1 capital ratio. A further 85bp will come from the sale of the UK subsidiary.
"Despite the improvement, we remain vigilant to the high vulnerability of the bank`s capital to stress in the Cypriot economy and property market," Fitch warns.
It said BoC`s funding profile has continued to benefit from the growth of the deposit base, which is up by 3% since-2017.
“With the loan book shrinking, the gross loans/deposits ratio improved from 105% at end-2017, to about 83% at end-June 2018, pro-forma for project Helix and the sale of BoC`s UK subsidiary.”
The bank`s liquidity buffer should be boosted by the proceeds from the transaction.
"As a result, we expect that about 22% of assets will be in the form of cash and central bank placements," Fitch said.
“The bank`s senior unsecured debt long-term and short-term ratings of B-/RR4 and B, respectively, are in line with the bank`s IDRs. The RR4 Recovery Rating reflects average recovery prospects.”
