Moody’s ratings agency has changed its outlook on the Cypriot banking system to positive from stable, reflecting its view that the country’s economic recovery will restore banks to profitability and improve their weak asset quality.
The outlook expresses Moody’s expectation of how bank creditworthiness will evolve in Cyprus over the next 12-18 months, the agency said.
“After five years of losses, we expect banks in Cyprus to be profitable in 2016 and foresee a modest 0.3 per cent – 0.5 per cent return on assets,” said Melina Skouridou, an Assistant Vice President at Moody’s and author of the report. “Cyprus’ accelerating economic recovery, driven by a revival of tourism, the strengthening business services sector and increased consumer spending, will support momentum in banks’ loan restructurings and generate some new business for the banks.”
Moody’s expects asset quality to improve as a result of these strengthening operating conditions, with the ratio of problem to gross loans continuing to decline to 43 per cent-45 per cent by year-end 2016, still high but below their peak of 55 per cent in September 2015.
The agency said the process of balance sheet rehabilitation will be long given the long cure periods for restructured loans before they are reclassified as performing, the sizeable amounts of distressed debt banks must tackle, and the relatively limited volumes of real estate transactions.
With an aggregate Common Equity Tier 1 ratio of 14.03 per cent for the main domestic banks, capital cushions are adequate under the rating agency’s baseline scenario.
However, bank solvency remains vulnerable due to persistent low loan-loss reserves against the large stock of problem loans – non-performing loans stood at 141 per cent of equity and balance sheet provisions of the domestic banks at the end of December 2015.
Moody’s expects funding conditions for Cypriot banks to improve.
Domestic deposits will continue to grow, reflecting the improved economic conditions. Creditor confidence has strengthened in recent quarters, allowing the Bank of Cyprus, the only bank relying on emergency liquidity assistance (ELA) funding from the central bank, to reduce its use of ELA to €2.0bln as of July 2016, down €9.4bln from its peak in April 2013.
“We expect Bank of Cyprus to fully repay ELA during 2017,” Skouridou said.
Nevertheless, depositor confidence remains sensitive to the banks’ solvency, the agency added.