Moody’s says bank­ing sys­tem out­look still ‘neg­a­tive’

Financial Mirror (Cyprus) - - FRONT PAGE -

As the gov­ern­ment strug­gles to cope with fis­cal woes, labour un­rest and a stale­mate in talks with the Troika of in­ter­na­tional lenders, Moody’s is­sued a re­port say­ing that the out­look on the is­land’s bank­ing sys­tem re­mains ‘neg­a­tive’, due mainly to a per­sis­tently high rate of non-per­form­ing loans that could rise to beyond 50%.

One of the big­gest prob­lems is the high rate of NPLs, es­ti­mated at about 46% of all banks’ loan port­fo­lios, and their in­abil­ity to re­cover pay­ments or as­sets, pri­mar­ily be­cause of a stub­born par­lia­ment’s re­fusal to pass a law reg­u­lat­ing fore­clo­sures, an is­sue Moody’s does not re­flect upon in its re­port.

A con­tin­ued rise in prob­lem loans over the next 12-18 months will ex­ac­er­bate losses and erode banks’ cap­i­tal, the rat­ing agency said, adding that “the out­look also cap­tures the vul­ner­a­bil­ity of the banks’ fund­ing bases, owing to frag­ile de­pos­i­tor con­fi­dence after the res­o­lu­tion of the two largest banks in March 2013, lead­ing to de­pos­i­tor losses and con­tin­ued con­trols on cross-bor­der trans­fers.”

“As­set qual­ity de­te­ri­o­ra­tion will be driven by lower cor­po­rate earn­ings, re­duced net worth of house­holds, a high un­em­ploy­ment rate and fall­ing real es­tate prices,” said an­a­lyst Melina Sk­ouri­dou.

“Fol­low­ing a cu­mu­la­tive GDP con­trac­tion of 7.8% over the past two years, we ex­pect con­trac­tions of 4.1% in 2014 and 2.0% in 2015,” she said, adding that “fis­cal aus­ter­ity and re­duced business prospects have led to sig­nif­i­cant re­duc­tions in salaries, while de­clin­ing prop­erty prices and the bail-in of de­pos­i­tors have also eroded house­hold and cor­po­rate net worth.”

The Moody’s re­port said that lend­ing growth will re­main neg­a­tive as the prin­ci­pal do­mes­tic banks and Co-ops con­tinue to down­size close to the EU av­er­age of around 250% of GDP (from around 320% at March 2014) and as house­holds and busi­nesses con­tinue to delever­age. How­ever, bank reg­u­la­tion and su­per­vi­sion are be­ing en­hanced, which Moody’s says is “a pos­i­tive de­vel­op­ment.”


The acute as­set qual­ity de­te­ri­o­ra­tion is the main chal­lenge Cypriot banks face. As a re­sult of the dis­rup­tion from the bailin, the sub­se­quent con­trols and the eco­nomic con­trac­tion, prob­lem loan for­ma­tion ac­cel­er­ated sig­nif­i­cantly with NPLs ris­ing to 45.6% as of May 2014, from 24.7% in March 2013, rep­re­sent­ing over 1.5x the coun­try’s GDP, the rat­ing agency said.

“While we ex­pect NPLs to ex­ceed 50% over our out­look pe­riod, owing to the high do­mes­tic in­debt­ed­ness, fur­ther de­clines in real-es­tate prices and high un­em­ploy­ment (15.2% in June 2014), we ex­pect the pace of NPL for­ma­tion to de­cel­er­ate as the depth of the GDP con­trac­tion eases. At the same time, we con­sider that the banks’ loan loss re­serves (LLRs) against credit losses from th­ese ex­po­sures re­main low at 35% of NPLs as of March 2014 – par­tic­u­larly given our ex­pec­ta­tions of fur­ther de­clines in real es­tate col­lat­eral val­ues,” Sk­ouri­dou said in the re­port.

De­spite the size­able re­cap­i­tal­i­sa­tion in 2013, which raised Common Eq­uity Tier 1 (CET 1) ra­tio to an es­ti­mated 12.5% as of March 2014, Moody’s ex­pects that el­e­vated credit costs will lead to ad­di­tional cap­i­tal needs for the sys­tem. Fol­low­ing the EUR 1 bln cap­i­tal in­crease of the Bank of Cyprus in Au­gust, the rat­ing agency es­ti­mates the sec­tor’s cap­i­tal needs caused by losses on loans and Cyprus gov­ern­ment bonds to be around EUR 700 mln and an­tic­i­pate that the banks will be able to raise any ad­di­tional cap­i­tal through pri­vate re­sources.

“How­ever, we ex­pect the co­op­er­a­tives will tap the EUR 1 bln pro­gramme funds ear­marked for the bank­ing sys­tem, given their gov­ern­ment own­er­ship.”


Although the bank­ing sys­tem has made progress in terms of elim­i­nat­ing the do­mes­tic con­trols with­out ex­pe­ri­enc­ing large out­flows, cross-bor­der con­trols are still in place and de­pos­i­tor con­fi­dence re­mains frag­ile fol­low­ing last year’s bail-in. Ag­gre­gate de­posit bal­ances are sta­bil­is­ing but this is mainly the re­sult of mod­est growth in the more volatile non-res­i­dent de­posits.

“We ex­pect a sus­tained de­cline in the vol­ume of do­mes­tic de­posits as house­holds con­tinue to de­plete their sav­ings in or­der to main­tain liv­ing stan­dards or pay off debt. Although de­clin­ing, the sys­tem’s re­liance on Euro-sys­tem fund­ing will re­main sig­nif­i­cant, even beyond the 12-18 month out­look hori­zon,” the Moody’s re­port said.

The rat­ing agency ac­knowl­edges that Cypriot banks face fur­ther net losses in 2014, al­beit not of the same mag­ni­tude as 2012 and 2013, when the bank­ing sys­tem re­ported losses of EUR 4.5 bln and EUR 2.2 bln, re­spec­tively.

“High loan-loss charges and very lit­tle new business will gen­er­ate fur­ther losses over the next 12-18 months, which we ex­pect to be broadly sim­i­lar to last year’s EUR 687 mln loss from con­tin­u­ing op­er­a­tions. We ex­pect pre-pro­vi­sion prof­itabil­ity to sta­bilise to last year’s lev­els, as pres­sure on net in­ter­est mar­gins (NIMs) will be broadly off­set by higher fees and com­mis­sions gen­er­ated by the banks’ in­ter­na­tional units,” Moody’s said. The rat­ing agency added that while banks have made con­sid­er­able ef­fi­ciency gains by re­duc­ing head­count and cut­ting ex­penses, ad­di­tional cost-cut­ting will be dif­fi­cult to achieve.


“We do not in­cor­po­rate any rat­ing up­lift from sys­temic support in the banks’ rat­ings. This takes into ac­count the re­cent bail-in im­ple­mented in Cyprus and the EU Par­lia­ment’s vote to adopt the Bank Re­cov­ery and Res­o­lu­tion Di­rec­tive (BRRD) and the Sin­gle Res­o­lu­tion Mech­a­nism (SRM) Reg­u­la­tion,” the Moody’s re­port said.

The new frame­work es­tab­lishes a re­gion-wide res­o­lu­tion tool with a clear ex­pec­ta­tion that un­se­cured cred­i­tors will par­tic­i­pate in the re­cap­i­tal­i­sa­tion of banks if needed. Ac­cord­ingly, even if the gov­ern­ment’s ca­pac­ity (which is cur­rently limited, as in­di­cated by its Caa3 rat­ing) to support banks im­proves, po­ten­tial up­lift could be con­strained by the re­duced will­ing­ness to support sig­nalled by the adop­tion of the BRRD and SRM.

An­a­lyst Melina Sk­ouri­dou con­cluded that “our neg­a­tive out­look on the bank­ing sys­tem fo­cuses on the un­der­ly­ing credit con­di­tions and the weak op­er­at­ing en­vi­ron­ment. We main­tain sta­ble out­looks on the rat­ings of two banks and on Septem­ber 2 we ini­ti­ated a re­view for up­grade on the rat­ings of the Bank of Cyprus, fol­low­ing its re­cent cap­i­tal rais­ing. The dif­fer­ence be­tween the sys­tem out­look and those of the banks re­flect the very low rat­ings cur­rently as­signed to the three rated banks (Bank of Cyprus, Hel­lenic Bank, Rus­sian Com­mer­cial Bank), which are near to the bot­tom of Moody’s rat­ing scale.”

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