Rating Agency Standard and Poor’s has upgraded Bank of Cyprus’ long-term issuer rating by one notch to BB+ (one notch below investment-grade status), assigning positive outlook.

BOC’s upgrade comes a few days after the upgrade of the Republic of Cyprus long-term rating to BBB+, also with a positive outlook. S&Ps cites Bank of Cyprus’ strengthened capital position and strong earnings generation capacity, combined with the broader reduction of financial risks in Cyprus.

“We upgraded BOC and BOC Holdings based on our view that the group's capitalization has strengthened,” the agency said in a press release issued yesterday, adding that “our ratings balance BOC's solid position as one of the leading banks in Cyprus and strong capitalization against our view of the elevated, albeit easing, risks for banks operating only in Cyprus.”

The agency added that “even as interest rate tailwinds slow, we expect BOC's net interest margins to remain resilient at 350 bps-400 bps in 2024 and 2025, more than 100 bps above the historical trend but below the peak of about 573 bps of 2023.”

It furthermore adds that tight cost control will further sustain earnings, with cost-to-income ratios moving toward 44%-46% by year-end 2026 in our base case from a low 33% as of March 31, 2024 (including the special levy), but still well below the 66% average in 2018-2022.

“We expect normalization of the cost of risk -including provisions on repossessed real estate assets- to lower than 80 bps from about 100 bps on average over 2021-2023. This should further shield earnings generation from a normalization of the interest rates. Overall, we forecast that the group will maintain a return on tangible equity higher than 16% in 2024, and 12%-13% in 2025-2026,” S&Ps added.

On the broader banking system in Cyprus, the agency pointed out that “Cypriot banks have absorbed most of the credit losses associated with the cleanup of their balance sheets.”

“After years of sizable sales of NPLs, securitizations, write-offs, and recoveries, Cyprus' banking sector has largely absorbed the hit to asset quality following the 2012 financial crisis. Despite remaining higher than peers, the sector's average NPL ratio continued to decline, reaching 7.3% as of March 31, 2024, from 11.0% at year-end 2021. At the same time, the loan loss reserves coverage ratio averaged 53.3%.”

The agency also pointed out that most of the NPLs are on the books of the smallest banks, which have struggled to offload them from their balance sheets through third-party transactions, “thus inflating the systemwide NPL metrics.”

“We believe the four largest banks, which represent about 90% of the market, have completed most of the cleanup of their balance sheets, showing an average NPL ratio of about 3.3% (excluding NPLs covered by the asset-protection scheme) as of year-end 2023,” the agency noted.

Moreover, the S&Ps said that as the burden of legacy problem assets fades and economic conditions remain supportive, banks will gradually expand their businesses. “Although loan deleveraging continued in 2023, we expect this trend to start reversing in 2024, with lending growth averaging 2.5% over 2024-2027,” the agency said.