Moody’s raises banking system outlook to ‘stable’ from ‘negative’

Moody’s Investors Service has changed its outlook for the Cypriot banking system to stable from negative, reflecting the modest economic recovery, which will bring an end to five years of acute asset quality deterioration.

“Although Cypriot banks’ massive stocks of problem loans will remain high and provision buffers low, we expect these stocks to begin to ease towards the end of 2016,” said Melina Skouridou, an analyst at Moody’s.

The stabilisation of asset quality metrics will be underpinned by a declining rate of new borrower defaults as household income and business cash flows rise in line with growing economic activity.

The rating agency anticipates 1.2% real GDP growth in 2015 and 1.4% in 2016, improving restructuring conditions for banks in Cyprus. At between 50%-54% for the core domestic banks, banks’ problem loan ratios will remain amongst the highest of any banking system Moody’s rates globally, while banks’ provisioning buffers will remain low.

“Cleaning up the balance sheet will take time, given the large volumes of problem loans the banks have to deal with and the fragile realestate market that will not support a high volume of foreclosed asset sales,” explained Skouridou.

As for the banks’ capital, Moody’s expects the rated banks’ capital cushions to decline under its baseline scenario, though they will remain above the regulatory minimum. The rating agency expects the ratio of tangible common equity to risk weighted asset declining by 140 basis points to 11.5% over the outlook horizon, as banks increase their provisions against non-performing loans.

Funding conditions for Cypriot banks will gradually improve, with depositor confidence — albeit still fragile — increasing in recent quarters. In addition, banks in Cyprus will finally return to profit in 2016, following five years of losses. For 2015, Moody’s expects a negative return on assets of around 2%, despite being marginally profitable in the first nine months of the year, as banks enhance their provision reserves.

Finally, while Moody’s rated Cypriot banks are identified by the authorities as domestically systemically important institutions, the rating agency’s deposit ratings continue to not incorporate any government support uplift due to, among other factors, the historic absence of support in Cyprus where senior bank creditors, including depositors, were bailed-in during the country’s financial crisis in 2013.