Fitch affirms BOCY covered bonds at ‘CCC’

Fitch rating agency affirmed at ‘CCC’ the rating of the Bank of Cyprus outstanding residential mortgage covered bonds of EUR 1 bln.

The rating action follows the upgrade of the bank’s longterm issuer default rating (IDR) to ‘CC’ from ‘RD’ (Restricted Default) last Friday, after the lifting of local capital controls. As a result, Fitch said it no longer makes an exception to its covered bonds rating criteria and uses the LT IDR, instead of the viability rating VR, as a starting point for its credit risk analysis.

Fitch has not assigned an outlook to the covered bonds in line with its rating definition, under which outlooks are applied selectively to ratings in the ‘CCC’, ‘CC’ and ‘C’ categories.

“All else being equal, the covered bonds ‘CCC’ rating would be sensitive to movements of BOC’s IDR. The covered bonds’ rating would also be vulnerable to a deterioration of the performance of the residential mortgage portfolio of more severe magnitude than currently foreseen,” Fitch added. On Friday, Fitch upgraded the ratings of the Bank of Cyprus and Hellenic Bank, but warned that the island’s biggest lender still faces a high risk of capital erosion because of weakening asset quality and profitability.

It also affirmed BOCY’s viability rating (VR) at HB’s VR one notch higher at ‘ccc’.

“Although restrictions remain on cross-border outward capital flows, these banks are now substantively able to service all their obligations,” Fitch pointed out, adding however, that the remaining capital controls, especially

‘cc’, and outward “is unlikely to be fully implemented before the end of 2014.”

Fitch believes that BOCY’s and HB’s VRs are influenced by the recession in Cyprus, which continues to put at risk the two banks’ very weak asset quality, as well as weak profitability and vulnerable capitalisation.

The agency considers asset quality as one of the main concerns for Cypriot banks. In 1Q14 both banks’ nonperforming loans (NPLs) continued to increase, albeit at a lower rate than past quarters, reaching 55% at BOCY and 49% at HB of gross loans and Fitch expects loan quality to weaken further in the near future, although more moderately.

“The two banks’ most important challenge will be to improve NPL recoveries, for which banks have internally strengthened their recovery units. NPL coverage remained low in Fitch’s view in a stress scenario at 35% for BOCY and 43% for HB at end-1Q14,” it added.

The agency notes that in the absence of further liquidity shocks, Bank of Cyprus’ dependency on central bank funding will decline further, but will remain large in the foreseeable future, indicating material funding constraints.

With regard to the two banks’ viability rating, Fitch noted that while limited in the short-term, the VRs could be upgraded if pressure from unreserved NPLs ease and/or capital materially improves and further profitability improvements are evidenced.

In Fitch’s view, BOCY remains more downgrade than HB.

The upgrade is a “positive and important development” in

at

risk

of

a VR the course of stabilising the economy, Finance Minister Harris Georgides said, adding that decisive steps must be taken to ease the problem of NPLs in the banking system.

He added that all these moves should continue because the ultimate aim is to fully restore the international confidence to the Cypriot economy.

Invited to comment on Fitch’s observation that NPLs is the main challenge facing the Cypriot banks, Georgiades said this “is a serious side effect, or a residue of the unsustainable credit expansion and the excessive indebtedness of the previous years, which has left an oversized problem today.”

He said this upgrade would “undoubtedly” assist Bank of Cyprus’ efforts to raise fresh capital. No one would trust neither an economy, nor invest in a bank that would be downgraded or would not enjoy confidence, the minister added.