CYPRUS: Moody’s upgrades Bank of Cyprus, Hellenic deposit ratings, positive outlook

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Moody's Investors Service has upgraded Bank of Cyprus and Hellenic Bank's long-term deposit ratings from Caa1 to B3, and their long-term Counterparty Risk Ratings (CRRs) to B1 from B2, with the outlook on both banks' long-term deposit ratings as ‘positive’.

The upgrade follows efforts by both banks to strengthen their capital base and improve their asset quality, through capital raise and reduction of their non-performing loans.

The rating agency said that Hellenic Bank's baseline credit assessment (BCA) and adjusted BCA were upgraded to caa1 from caa2, and its long-term Counterparty Risk Assessment (CRA) to B1(cr) from B2(cr), concluding the review for upgrade that was initiated on July 13, 2018.

The Bank of Cyprus upgrade is driven by changes in the bank's liability structure. In particular, the issuance of EUR 220 mln of Additional Tier 1 (AT1) securities in December 2018, enhances the buffers that are available to protect depositors and non-debt counterparty financial liabilities captured by the CRR, Moody’s said.

The upgrade of Hellenic Bank captures its strengthened franchise, asset quality and capital following the integration of EUR 9.3 bln of predominantly performing assets and liabilities, mainly deposits, acquired in the summer from the now resolved Cyprus Cooperative Bank, and a capital increase of EUR 150 mln, for which the bank has already received binding commitments and which will be completed in the first quarter of 2019. Hellenic Bank's deposit ratings continue to benefit from one notch of rating uplift following the acquisition of, predominantly, retail deposits and the application of Moody's advanced Loss Given Failure (LGF) analysis, the rating agency added.

For both banks, the positive outlook reflects Moody's expectations of further improvements in the banks' financial fundamentals, mainly asset quality over the next 12-18 months, in the context of an improved operating environment in Cyprus.

The rating agency expects strong growth trends with a 3.7% growth in real GDP for 2019, a rate significantly above the average forecast for euro area countries of 1.8%, and a continued decline in unemployment that stood at 9.2% as of November 2018.

The positive outlook on Bank of Cyprus acknowledges recent improvement in its financial fundamentals. Nonperforming exposures (NPEs) declined to 37% of gross loans as of September 2018, from 47% in December 2017, following the securitisation of a portfolio of NPEs in August 2018 that will likely be completed in the first quarter of 2019. The bank's capital is also strengthening, following the bank's issuance of AT1 securities in December 2018 and contingent on the regulator's approval of a reduction in its risk-weighted assets, following the NPE securitisation. The bank's Common Equity Tier 1 (CET1) ratio will strengthen to 13.2%, from 11.9% as of the end of September 2018, while its Total Capital Adequacy ratio will strengthen to 16.2%, from 13.4% as of September.

Moody’s said that Hellenic Bank's acquisition of the CCB’s “good assets” has strengthened its franchise and asset quality. Following the integration, it has become the second-largest bank in Cyprus, with around 31% market share of system deposits and is now the largest retail and SME bank. Hellenic's deposit mix has shifted and the bank is now predominantly retail deposit funded, which supports the sustainability of its deposit franchise.

Hellenic Bank's asset quality has also improved on a relative basis, following the acquisition of primarily performing loans from CCB, with NPEs-to-gross loans improving to 31% as of the end of September 2018, from 52% as of June 2018. NPEs dropped to 25.6% of gross loans excluding EUR 441 mln of non-performing loans that are guaranteed by the government, while the provisioning coverage improves to 66%, from 62% as of June 2018.

In November, DBRS Ratings gave the Cyprus sovereign a double rating upgrade, pushing it up to investment grade, driven by the banks’ effective downscaling of non-performing loans, the ‘orderly’ liquidation of the Co-operative bank and solid performance of the island’s economy.

This was the third upgrade out of ‘junk’ and to investment grade from the ‘Big Four’ rating agencies, following similar actions by Standard & Poors and Fitch.

Meanwhile, in an earlier report, Moody’s had warned that among highly indebted European sovereigns, Cyprus was most exposed to credit risks related to high household debt because it has a small economy, weak banking sector, and very elevated public and private debt levels.

European countries that are more economically resilient are able to carry higher and rising household debt without it necessarily weighing on their sovereign credit profiles, it said in November.

"Cyprus' sovereign credit profile is the most exposed of all the highly indebted European sovereigns to risks linked to high household debt," said Sarah Carlson, a Moody's Senior Vice President and co-author of the report.

"Elsewhere in Europe, financial assets such as savings, insurance and pensions, as well as generous social safety nets, protect sovereigns against the risks stemming from high household debt."

The ratings agency said the island also has a “number of unique market characteristics” that heighten the risks posed by high debt.

“Consumer loans account for almost half of outstanding household debt; close to 100% of Cypriot mortgages are floating rate and the country has an already weak shock-absorption capacity.”

In addition, Cyprus' economy is smaller and less diversified, and its growth is much more volatile, said the report.