Moody's Investors Service on Monday upgraded Bank of Cyprus's long-term deposit ratings to Caa3 from the Ca it issued just six weeks ago with stable outlook "to reflect the bank's strengthened capital buffers as well as the reduction, to some extent, of its reliance on central bank funding."
The rating agency also upgraded the provisional senior unsecured programme rating to (P)Caa3 from (P)Ca -- and adjusted upwards its standalone baseline credit assessment (BCA) to caa3 from ca.
Despite the upgrade, the bank's ratings continue to be positioned at the lower end of Moody's rating scale, "reflecting the immense challenges the bank still faces, mainly in terms of addressing very high volumes of non-performing loans," the rating agency said.
Following a successful capital increase in August, Bank of Cyprus's fully loaded Common Equity Tier 1 (CET1) ratio increased to 15.1% from 11.3% as of June, enhancing the bank's capacity to absorb asset quality pressures and enabling it to pass the European Central Bank's comprehensive assessment (stress tests).
The upgrade also takes into account the partial reduction in Euro-system funding (primarily Emergency Liquidity Assistance) to a still high 29% of the bank's assets as of September, according to the rating agency's estimates, from 37% as of March this year.
However, Moody's said that the bank still faces significant challenges, underpinning the continued positioning of its ratings near the lower end of its rating scale. Non-performing loans stood at 58% as of June, while 90+ days due and impaired loans (a more globally comparable ratio) were at 49.8%. The rating agency said it expects some further increase in the NPL ratios, given the continued contraction in economic activity and that NPLs will peak towards the end of 2015 before starting to fall.
Importantly, while the rating agency expects that recent amendments to the legislative framework will improve the bank's recovery prospects as they allow for the execution of collateral within a reasonable timeframe (18 months), potential losses on real estate collateral (which covers the shortfall between the bank's cash provisions and the full scope of NPLs) are difficult to quantify, given the limited transactions in the domestic real-estate market and the lack of performance history under the new framework. As a result, the rating agency considers the 33% cash provisions against losses from NPLs (39% against impaired and 90 days past due) as low.
Upward pressure could develop on the ratings following further improvements in financial performance, a reduction in NPLs and a material decrease in central bank funding, combined with the elimination of existing capital controls.
On October 5, Moody's announced that it had placed the Bank of Cyprus 'Ca' deposit ratings on review for an upgrade, following the successful EUR 1 bln capital increase that strengthened capital buffers, bolstering the bank's loss-absorbing capacity and a positive step towards the bank's regeneration.
It added that the "already high level" of non performing loans could even rise beyond the current 58% of the bank's loanbook.
"But the extent to which these developments will lead to a sustained improvement in the bank's financial performance remains unclear, given the acute asset quality pressures the bank faces and its low provisioning against losses from problematic exposures," Melina Skouridou, Moody's lead analyst for Bank of Cyprus had explained at the time.
The analyst added that the repayment of euro-stem funding "is a vital first step in restoring fragile depositor confidence, which could help stem further erosion of its deposit base. In addition, following the capital increase, the bank's ownership structure is more concentrated with the participation of high-profile investors, such as the European Bank for Reconstruction and Development (EBRD), which will likely improve decision-making and corporate governance."
Skouridou added that the bank still faces acute challenges.
"The Cypriot economy continues to contract, unemployment is high and property prices are falling. As a result, we expect the share of non-performing loans (NPLs) in the bank's loan portfolio to continue to rise from already high levels (58% of total loans as of June). We consider the loan-loss provisions (covering only 33% of NPLs) inadequate to cover future losses from troubled exposures," she said.
"Although real-estate collateral provides some extra coverage, property prices are still declining and more provisions will have to be set aside, causing losses that will erode capital. Moreover, the bank's ability to collect the value of collateral depends on amendments to laws governing the foreclosure process in Cyprus. These amendments are in progress and their conclusion is as yet unknown."
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