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DBRS: Banks slash toxic loan legacy

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DBRS Morningstar rating agency reports that Cypriot banks substantially accelerated the reduction of their legacy NPEs in 2020, dropping by 10 percentage points.

It noted that NPEs not provisioned for reached their minimum for several years.

DBRS Morningstar expects the sales of bad loans to non-bank institutions to be the main driver of NPE reduction.

“The battery of support measures have effectively reduced and deferred the potential impact on banks’ asset quality during 2020.

“However, as the extraordinary support is withdrawn, credit losses could start to accumulate in the system.”

It is also noted that non-performing assets and overall leverage remain high.

DBRS Morningstar positively views some of the measures to continue addressing the challenges and will continue to monitor their implementation.

It views the significant progress positively in cleaning up banking system balance sheets in recent years.

“Despite the unfavourable macroeconomic environment due to the COVID-19 crisis, efforts to reduce banks’ legacy non-performing exposures (NPEs) in Cyprus intensified in 2020.”

The NPE ratio stood at 17.7% in December 2020, falling by almost 10 percentage points from 28% in December 2019.

Asset Quality

It argues, despite the significant reduction in legacy NPEs, the adverse impact of the COVID-19 crisis on economic activity will inevitably lead to new flows of NPEs, especially as state support is withdrawn, posing additional challenges for Cypriot banks to improve their asset quality.

“The various support measures implemented by the government have softened the blow from the pandemic on households and corporations thus far, indirectly reducing and deferring the potential impact on banks’ asset quality.

“The extent of the damage remains unclear and will depend on the capacity of households and firms to adjust to the COVID-19 shock and still remain current on their debt obligations.”

However, DBRS believes the Cypriot banking system’s relatively strong capitalisation levels and liquidity provide the banks with room to absorb losses without impacting their lending capacity.

“The expiry of the loan repayment moratoria, imposed between March and December 2020, could bring some of the underlying damage afloat and result in new flows of NPEs, especially in the hardest-hit sectors of the economy.

“Repayment moratoria was widely used by households and businesses, with roughly €11.7 bln under moratoria (42 % of total loans or around 56% of GDP).”

Take-up of the second moratoria scheme that was introduced in January 2021 and expires in June 2021 was relatively low.

“The relative exposure of the Cypriot banking system to sectors heavily affected by the pandemic is the highest in the EU, closely followed by Greece.

“The recovery in these sectors is likely to be gradual and dependant on the vaccination rollout in Cyprus and its key tourism source markets.”

Only 5% of the loans exiting the moratoria have incurred arrears as of end-January.

“Overall, the customers’ ability to pay their loan obligations will depend on how swift the economic recovery will be after the withdrawal of the support measures.

“Given the importance of the tourism sector to the economy, the speed of the recovery in the sector will be a key in determining this.”

DBRS Morningstar expects offloading bad loans to non-bank institutions to remain the driver of NPEs reduction, as seen in recent years.

“The high level of NPEs outside the banking system, currently exceeding the level of NPEs in the Cypriot banking system, highlights the importance of enhancing data access for NPE management in credit acquiring and credit servicing companies.”

It said, preserving and strengthening the foreclosure framework will remain an important determinant of the success in resolving NPEs and improving borrower payment discipline.