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Fitch warns of Cyprus banks risk

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Fitch rating agency reaffirmed Cypriot banks’ negative outlook noting the general environment poses threats to their balance sheets.

In a report on the Cyprus banks, the agency notes that while they are offloading their toxic non-performing exposure, banks are still sensitive to possible obstacles to the economic recovery and investor sentiment.

Fitch said the small Cypriot economy and the private sector have a lot of leverage (private debt was 210% of GDP end of 2020), making the economy more vulnerable to external shocks.

The weak financial position of banks limits business opportunities and new viable lending options in a small and highly leveraged economy.

However, as Fitch notes, the country’s economy “has shown flexibility for a speedy recovery in previous crises, as reflected in an average growth of 4.6% in the five years before the pandemic”.

“We expect the recovery of the economy will support the further reduction of risk in Cyprus’ balance sheet and will offer stability in the operating environment over time.

“Nevertheless, the lack of structural solutions throughout the sector in Cyprus limits the speed with which banks can reduce risk in a weaker-than-expected economic recovery scenario.”

It said Cyprus’ ESTIA scheme, the homeowner rescue scheme backed by the Ministry of Finance to help loan repayments, had “disappointing” participation.

It noted the most promising solution for the issue of home-backed non-performing loans is the one under discussion for the conversion of the remainder of the Cooperative Bank into a bad loan buyer, a fact that could help accelerate the liquidation of quality assets.

Cypriot banks have successfully reduced the non-performing loan ratio from historically high levels over the last five years (63% at the Bank of Cyprus in 2014 and 60% in Hellenic Bank in September 2015), taking advantage of strong economic development dynamics.

Reducing the stock of NPLs was a difficult task during the pandemic.

However, banks continued to write off some loans and sell loans, a tactic carried out successfully, especially by the Bank of Cyprus.

Hellenic’s toxic assets ratio fell to 19% at the end of March 2021 from 27% at the end of 2019, while BOC reduced the ratio to 25% from 38% at the end of 2019.

Fitch said Cypriot banks have not benefited from structural solutions to clear their balance sheets in 2020-2021.

Banks relied heavily on write-offs and sales to process their stock of impaired loans during the pandemic.

BOC & HB’s direct exposure to the accommodation, food, and trade industries accounts for around 20% and 16% of gross loans by the end of 2020, respectively, making them vulnerable to resurgences of COVID-19 or international travel restrictions.

BOC and HB unveiled new targets regarding the reduction of NPLs in 2020 as part of their new strategic plans.

Bank of Cyprus targets its ratio to be less than 10% by the end of 2022 and about 5% in the medium term.

Similarly, HB plans to reduce its index to single digits in the medium term.

“In our view, these targets are ambitious but realistic and reflect the confidence of banks in their ability to absorb MES inflows from areas severely affected by the pandemic, such as tourism.”

Fitch noted that banks’ plans would depend on their ability to complete large loan transactions, which depend on the economic environment and investors’ appetite for Cypriot assets.

Fitch notes that the banks’ capitalisation capability is another key criterion.

“Reducing the stock of toxic assets and therefore reducing the capital burden is in our view the most likely scenario that will reverse the negative trend in the rating of the capitalisation of the two banks.”