03/07/2024 08:58
Fitch Ratings has upgraded Bank of Cyprus Public Company Limited's (BoC) Long-Term Issuer Default Rating (IDR) to 'BB+' from 'BB' and Viability Rating (VR) to 'bb+' from 'bb'. The Outlook on the Long-Term IDR is Positive.
According to the agency, the upgrade mainly reflects the upgrade of Cyprus's sovereign rating to 'BBB+'/Positive (see: Fitch Upgrades Cyprus to 'BBB+'; Outlook Positive dated 7 June 2024) and an improved assessment of the Cypriot operating environment. The former was underpinned by reduced private sector indebtedness and the expectation of continued economic growth, factors that we believe are supportive of Cypriot banks' long-term business model sustainability, as well as improved banking sector fundamentals.
The upgrade also reflects continued improvements to BoC's credit profile from stronger capitalisation and reduced exposure to legacy net problem assets.
The Positive Outlook reflects our expectation that BoC will continue to strengthen its capitalisation, helped by strong profitability, and to continue to gradually reduce its stock of legacy problem assets, ultimately resulting in a further decline of capital encumbrance by net problem assets and an improved risk profile.
Key rating drivers
Asset Quality, Capital Underpin Ratings: BoC's ratings reflect its strong competitive position as the largest domestic bank in the small Cypriot market and continued progress with deleveraging legacy problem assets (which include foreclosed real-estate properties and non-performing exposures (NPEs), i.e. Stage 3 loans and non-performing purchased and originated credit impaired). They also include sound profitability prospects and reduced capital encumbrance from net problem assets.
Leading Franchise in Cyprus: BoC is the largest bank in Cyprus. Its business model is centred on traditional retail and commercial banking, with some diversification in insurance and payments. The reducing stock of legacy problem assets and improved profitability support the long-term stability of its business profile. However, growth opportunities are limited by Cyprus's small size.
High, but Reducing, Problem Assets: BoC's problem assets ratio of about 10% at end-March 2024 is higher than peers. However, it is well below historical peaks, and we expect it to decline to about 7% in the next two years, mainly due to the organic reduction of legacy NPEs and continued disposals of foreclosed properties. Our assessment of BoC's asset quality also reflects that almost half of the bank's total assets are cash and high-quality debt securities, which are significantly lower risk than the loan book.
Profitability to Remain Adequate: BoC's profitability has significantly improved, driven by the higher interest rate environment and reduced impact from impairments on legacy problem assets. We expect the operating profit/risk-weighted assets (RWAs) ratio to reduce from unsustainably high levels in 2023, but to remain strong at above 4% in 2024 and above 3% in 2025. BoC's profitability is supported by good cost-efficiency, a benign economic environment and further development of the fee-generating business.
Adequate Capital Buffers, Falling Encumbrance: BoC's common equity Tier 1 (CET1) ratio of 17.6% (including unreviewed 1Q24 earnings net of 50% dividend accrual, hereafter referred to as 'pro-forma') at end-March 2024 had adequate buffers over regulatory requirements, and we expect it to strengthen further towards 20% by end-2026. Encumbrance of CET1 capital by net problem assets should also fall below 30% by end-2026 (end-March 2024: about 50%, pro-forma). At this level, it would still be higher than most southern European peers, but this is mitigated by the conservative valuation of foreclosed assets and the bank's consistent record of sales above book values.
Stable Deposit Base: BoC's funding is supported by a strong deposit franchise in Cyprus. As deposits are well in excess of loans, liquidity buffers are consistently strong. Most of the bank's deposits (about 60%) are from retail clients, and 58% are covered by the deposit guarantee scheme, contributing to funding stability. The bank has restored its access to unsecured wholesale funding. However, we believe that funding is more sensitive to investor confidence than at larger and higher-rated European peers.
Hellenic Bank
Fitch Ratings has also upgraded Hellenic Bank's Long-Term Issuer Default Rating (IDR) to 'BBB-' from 'BB+', with stable outlook and its Viability Rating (VR) to 'bbb-' from 'bb+'.
According to Fitch, the upgrade mainly reflects the upgrade of Cyprus's sovereign rating to 'BBB+'/Positive and improved assessment of the Cypriot operating environment. The former was underpinned by reduced private sector indebtedness and the expectation of continued economic growth, factors Fitch believes are supportive of Cypriot banks' long-term business model sustainability, as well as improved banking sector fundamentals.
The upgrade also reflects HB's continued record of healthy profitability resulting in capital accumulation, stable asset quality since the completion of the clean-up of legacy exposures and inexpensive deposit-based funding.
Fitch has also withdrawn HB's Government Support Rating (GSR) of 'no support' (ns) as it is no longer considered by Fitch to be relevant to the agency's coverage. This is because in June 2024 Athens-based Eurobank S.A. increased its stake in HB to 55.4% from 29.2%, becoming HB's most likely support provider. Fitch has consequently assigned a Shareholder Support Rating (SSR) of 'bb-'.
HB's Long-Term IDR is driven by its VR, which reflect its strong competitive position as the second-largest bank in the small Cypriot market, stable deposit-based funding and robust liquidity. It also reflects adequate profitability prospects in a positive interest rate environment, above-average regulatory capital ratios and manageable asset quality metrics.
Fitch notes that HB's business profile is characterised by traditional commercial banking activities. Diversification in fee-generating activities and insurance is limited, but will improve upon closing of the acquisition of CNP Assurances SA's Cypriot and Greek activities in 1Q25. HB has strong domestic market shares, especially towards households. However, Cyprus's small size limits growth opportunities.
Regarding HB's non-performing exposure ratio of 2.5% at end-March 2024 (excluding NPEs guaranteed by the asset protection scheme; APS) is well below historical peaks and the rating agency expects it to remain below HB's medium-term target of 3% in the next two years, a level in line with the southern European average.
Moreover, their assessment of HB's asset quality reflects that nearly two-thirds of the bank's assets are cash and high-quality debt securities, which are significantly lower-risk than the loan book.
A negative rating action could arise if the economic environment in Cyprus deteriorates sharply. This could be triggered by an unexpected domestic economic recession and a sharp rise in unemployment without prospects of a rebound in the short term, leading to a material deterioration of borrowers' creditworthiness and reduced business opportunities for banks.
"We could downgrade the ratings if we expected HB's problem asset ratio (which includes NPEs and foreclosed real estate assets, but excludes APS-guaranteed NPEs) to rise above 6% for a prolonged period and the CET1 ratio to fall below 15%, causing CET1 capital encumbrance by unreserved problem assets to significantly rise", they note.
On the other hand, Fitch says that a positive rating action is unlikely unless there are further improvements in the Cypriot operating environment. This would require business opportunities for bank to exceed our current expectations, by means of structurally stronger credit demand and penetration of wealth management and insurance products.
An upgrade would also require evidence of a stronger business profile, including in a lower interest rate environment. The problem asset ratio (excluding APS-guaranteed NPEs) would also have to fall below 3% and the CET1 ratio to remain above 15%. An upgrade would require a record of solid risk governance and well-managed risk concentrations, stable funding and continued compliance with MREL.