Weak banking, NPLs, poor public finances hamper Cyprus sovereign

A weak banking sector and slow recovery of non-performing loans, risks related to public finances and poorer households continue to impair Cyprus’s sovereign creditworthiness, Moody’s Investor Service said in a market report issued on Wednesday.

Despite recent encouraging statements from all other rating agencies that the island’s near-bankrupt economy was on a path to recovery, Moody’s also does not see any “meaningful” recovery for another two years.

It said that the Caa3 rating with a positive outlook reflects the ongoing credit risks relating to the sustainability of the country’s public finances, as well as the resulting elevated risk of default in the medium-term.

Moody’s said that that the main challenge facing the Cypriot authorities is helping the banks deal with their high percentage of non-performing loans (NPLs), currently at 45% of all loan portfolios, one third of which represent household loans.

On the fiscal side, the primary deficit has narrowed from 3.2% of GDP in 2012 to 2.0% of GDP in 2013, which is below the target set under the Troika’s economic adjustment programme. In addition, the government recently improved its debt-amortisation profile by repaying early a bond due to mature in 2017, thanks to the proceeds raised from international markets.

However, Moody’s said that historically high indebtedness and decreasing incomes have stretched Cypriot households’ creditworthiness over the last few years, and whilst costcompetitiveness has improved, it has not translated into stronger export performance.

As a result, Moody’s considers it unlikely that there will be any meaningful economic recovery before 2016. While the 2013 economic contraction was more benign than expected, the recession could be more protracted in the context of high unemployment, reduction in wages, erosion of savings, and the restructuring of the banking sector.

The national authorities and the Troika are currently addressing the challenge of how the country can help deal with the high percentage of NPLs within Cyprus’s banking system.

Furthermore, Moody’s regards banking sector risk as “very high”, primarily because of the low baseline credit assessments assigned to rated banks in the system and also because of the significant size of the banking sector, as defined by total assets as a percentage of GDP, which stood at around 485% of GDP in May 2014.

Lastly, Moody’s noted that even though the restructuring process of the banking sector is under way, the actions that the authorities and the Troika have identified to lower the high NPL levels have not yet been fully implemented.