S&P raises Bank of Cyprus ratings on asset quality improvement

S&P Global Ratings raised its long-term issuer credit rating on Bank of Cyprus to BB- from B+, citing improvements in its asset quality and easing of economic risks.

The upgrade of the island’s largest lender follows the upgrade of Cyprus’ long-term sovereign ratings last week.

“The upgrade on BoC reflects the material improvements achieved in reducing its problem loans, placing the bank on a stronger footing to face a potentially more challenging environment,” S&P said.

It recalled that the bank managed a 96% cumulative reduction of its NPL stock of NPLs since its peak in 2014 through a mix of market sales and organic efforts.

“NPLs represented 5.7% of gross loans at end-June 2022, pro forma the latest NPL transaction—the so-called Helix 3, expected to be completed by the end of the year.

“This compares with 30% at end-2019.”

The agency noted that easing economic risks in Cyprus “support BoC’s adequate capitalisation and provides some buffer to accommodate growth.”

It estimates that lower economic risk will have a positive effect of 115 bps on BoC’s risk-adjusted capital (RAC) ratio, which stood at 8% at end-2021, pro forma Helix 3.

“Thus, we expect that BoC’s capitalisation will stay sustainably above 7% over the next 18 months, providing some cushion to moderately grow its loan book and accommodate potentially higher credit losses.

“The quality of capital will compare favourably to that of Greek peers, which, unlike BoC, hold large amounts of deferred tax credits on their books.”

The stable outlook on BoC over the next 12-18 months “balances its improved risk profile and capitalisation against the need to improve its efficiency and profitability.”

“We expect management will remain focused on keeping asset quality under control and translating recent voluntary staff reductions into cost savings.

“We forecast BoC’s cost-to-income ratio will reach about 63% by end-2023, compared with over 70% in 2021”.

Banking system

S&P said Cypriot banks have made substantial progress in cleaning problematic loans since 2018 and improved underwriting standards.

Following four years of NPL sales, debt-to-asset swaps, loan recoveries, and write-offs, systemwide legacy NPLs have reduced by more than EUR 7 bln or 71% since 2018.

“Banks’ risk profiles have so far proven resilient to the effects of COVID-19, with only 3% of loans that benefitted from the widely used moratoriums becoming nonperforming.” It also noted that banks are maintaining stricter underwriting standards, which should contribute to lower asset quality deterioration in coming quarters.

The average loan-to-value on new household mortgages stood at a comfortable 45.5% at the end-2021.

“The clean-up is not finished, though.

“NPLs remain high compared with the EU average, at 11.4% of gross loans for the system as of end-May 2022 (or about 16%-18% adding foreclosed assets).”

Moreover, the agency expects global protracted inflation, higher energy prices, and indirect effects from Russia being a relevant trade partner will impact Cypriot banks, “but within manageable levels.”

According to the agency, Cypriot banks remain “relatively more exposed to cyclical sectors and private sector leverage is higher than for EU peers.”

“Banks’ ability to reduce network operating costs and become more digital is key to improving their efficiency, which stood at 73% in 2021.

“Rising rates should provide tailwinds to banks’ net interest income because loan books are largely floating.”