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Western EuropeApril 2 2012

Cyprus looks to break from Greek contagion

The exposure of Cypriot banks to the Greek economy has prompted rating downgrades for the country. But with some of the island's banks boasting high liquidity and interest from foreign investors, the long-term prospects look brighter.
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Cyprus looks to break from Greek contagion

The island of Cyprus is known for its close links to Greece, from the historic and cultural to the linguistic and economic. In the current environment, those links are looking a little less favourable. Despite going through a relatively shallow recession, the ratings agencies have downgraded Cyprus and its banks on several occasions over the past two years and their debt is now rated as speculative (although Fitch’s sovereign rating is still BBB-). The ties to Greece are largely responsible for these decisions.

Commercial banks in Cyprus have been heavily hit by their exposure to Greek government bonds (GGBs) and commercial loans. In its preliminary results for 2011, Cyprus’s largest bank, the Bank of Cyprus, made provisions during the year of €1.32bn on its holdings of GGBs and €217m on its Greek commercial loan portfolio. The figures for the country's second largest bank, Cyprus Popular Bank (until recently Marfin Popular Bank), were €1.97bn and €929m, respectively.

These losses have forced the Bank of Cyprus and Cyprus Popular Bank to put recapitalisation plans in place to meet the European Banking Authority’s (EBA’s) target of a core Tier 1 capital ratio of 9% by June 30 this year.

Cyprus Popular Bank has announced that it will seek to raise €1.35bn in new equity capital, the details of which are set to be announced at the bank’s extraordinary general meeting at the beginning of April. It has also announced a hybrid capital exchange and a deleveraging plan that has seen the bank divest itself of its Australian subsidiary, with the sale of its Estonian subsidiary pending.

Meanwhile, the Bank of Cyprus has raised €594m, of which €160m through a one for three rights issue and a further €434m of equity from a voluntary conversion of contingent convertible bonds.

Private capital available

Chris Nicolaou, senior credit analyst at ratings agency Capital Intelligence in Limassol, believes that the banks will be able to raise the necessary money. “We think the banks are fully capable of replenishing their capital, whether it is from private sector sources, which I think is the most likely or the most important source they could tap into, and if need be from the Cypriot government,” he says.

Yiannis Tirkides, economic research manager at Cyprus Popular Bank, says his bank has attracted a lot of interest from foreign investors looking to participate in the bank’s capital issue, and most of the concern that has been expressed relates to the bank’s Greek portfolio. “The only reason [private investment] may not go through – if it does not go through – is based on their assessment of the Greek risk,” he says.

It is the risk – described as ‘very material’ – that the Cypriot government may have to step in to prop up the banks that Moody’s cited in its latest downgrading of Cyprus’s sovereign debt in March. In the short term at least, the Bank of Cyprus capital raising has reduced the risk that the government will step in to help the bank meet the EBA target.

We believe Cyprus is a very good prospect in the medium to long term and has very strong growth engines. The country went through quite a soft patch with the Greek crisis but we can come out of it in the next couple of years and refocus on the island

Yiannis Tirkides

However, despite the country’s downgrading to non-investment grade, Cyprus has managed to secure its funding needs through bilateral agreements. Most of its needs for 2012 have been covered by a €2.5bn loan from Russia at 4.5% interest.

“I don’t expect the sovereign downgrade to have a significant effect on the economy because the Cypriot government has not been borrowing from the capital markets for some time because of the eurozone periphery prices,” says Constantinos Pittalis, head of investor relations at the Bank of Cyprus.

Bank of Cyprus optimism

Commenting on Moody’s March downgrade of the Bank of Cyprus from Ba2 to B1, Mr Pittalis points out that the Bank of Cyprus had high liquidity and a loan-to-deposit ratio of 92% at the end of 2011, and the bank has limited funding needs from the wholesale markets.

“We remain net lenders in the interbank market so we don’t have any funding which could be affected by the downgrade. It is a negative development but not something that could have a material impact,” says Mr Pittalis.

The high liquidity enjoyed by the Cypriot banking sector is in no small measure due to the level of deposits made by non-residents, mainly from outside the euro area. According to Central Bank of Cyprus data, foreign deposits held at Cypriot monetary financial institutions amounted to €26bn, or some 37% of a total of €70bn deposits at the end of 2011. The Greek crisis and poor credit rating of the Cypriot banks has done nothing to deter foreigners from keeping their deposits in Cyprus. At the end of 2008, the figure stood at €15.5bn, or 30% of total deposits.

Aside from its GGB travails, the Bank of Cyprus saw its banking operations return improved year-on-year results in 2011. There was a 12% improvement in net interest income to €1.17bn and pre-provision profits were up 11% to €805m. Profits after tax and provisions were up 2% to €312m, but the final result was a loss of €1.01bn after GGB impairment. Net interest margins improved from 2.66% to 2.98% and the bank's cost-to-income ratio was down to 48% from 50%.

Looking forward, Mr Pittalis says: “Given the current conditions, the main priorities of the group are to maintain healthy liquidity, strengthen the capital position, manage risks effectively and maintain organic profitability.”

Mr Pittalis anticipates most growth in 2012 to be in the Russian market. He anticipates low growth in lending in Cyprus and a slight reduction in Greece, reflecting market conditions.

“The group’s operations in Russia operate at one-third of capacity so there is lots of scope to grow the business. Having said that, loans in Russia are about 7% of group loans right now so even if they have a very big increase they will still account for a small percentage of the group’s position overall.”

Hellenic's silver lining

Cypriot-owned Hellenic Bank, the third largest in the country, charged impairments of 70% of the nominal value of its GGBs, or €77m. This figure, however, was much less than the provisions made in the year against non-performing loans (NPLs), which amounted to €142m, bringing in the year’s results at a loss of €87m. Again, the silver lining was net income of €301m showing a 12% improvement on 2010, as well as costs being reduced by 6%. The Tier 1 capital ratio at year end was 10% and the capital adequacy ratio was 13%. Any plans Hellenic Bank may have for capital enhancement were not due to be announced until the end of March, after The Banker went to press.

“The 2011 financial results confirm Hellenic Bank Group’s ability to realise recurring profits, to maintain an adequate level of liquidity and a strong balance sheet, which enable it to effectively manage the negative economic developments and the high level of uncertainty surrounding credit developments in Europe and especially in Greece,” says Antonis Rouvas, the bank’s group chief financial officer. 

He indicates a conservative strategy for the bank, in view of the prevailing financial environment. “The strategic targets of the group continue to focus on effective management of credit risk, safeguarding and enhancement of the capital adequacy ratios, safeguarding of sound liquidity and cautious and rational growth,” he says.

Cyrpus loan market shares 2012

Popular's mixed bag

Cyprus Popular Bank also improved its revenues in 2011. Net interest income climbed 12% on 2010 figures to €799m, but total income was a more modest 1.5% to €1.04bn, and pre-provision profits were 3.2% higher at €388m. However, loan provisions of €1.15bn took the year’s results deep into the red, with the geographical analysis showing the loss being entirely due to operations in Greece, where the NPL ratio jumped from 8% to 19.5% in the year. GGB and other impairments of €2.17bn took the loss to €2.51bn, and to complete the picture a goodwill write-off of €820m resulted in an accounting loss of €3.33bn.

“Improvement in our net interest margin accounts for much of the gain in profit for the year,” says Mr Tirkides. He admits that this improvement has been slow and Greece, with a margin of 1.83%, still lags Cyprus at 2.53%. “Much lending was done in Greece on low interest margins and the conditions of the contracts were such that we couldn’t reprice those loans so we were stuck with a big chunk of the portfolio in Greece effectively underpriced,” he says.

The bank’s cost-to-income ratio improved slightly in 2011, from 63.2% to 62.6%, and Mr Tirkides sees further scope for cutting costs, especially in the bank’s Greek operations, which have a cost-to-income ratio of 86.5% compared with 42.6% on Cyprus. The main reason for this stems back to the 2006 triple merger that formed Cyprus Popular Bank and the lack of rationalisation of the Greek branch network the new bank inherited.

Given its problems in Greece, it is not surprising that Cyprus Popular Bank’s strategy is looking to concentrate on local Cypriot operations. “We believe Cyprus is a very good prospect in the medium to long term and has very strong growth engines. The country went through quite a soft patch with the Greek crisis but we can come out of it in the next couple of years and refocus on the island. That means we want to be part of this country’s future expansion and economic remake,” says Mr Tirkides.

Mr Nicolaou warns that asset quality remains an important current issue for Cypriot banking, as well as the immediate issue of recapitalisation, but believes that the long-term future of the sector is healthy. He expects profitability to be subdued because of provision charges and slow balance sheet growth. But he does not see signs of a full-blown Cypriot banking crisis or loss of confidence in the system.

“It’s not going to be an easy period but I think longer term we’re talking about a system with a very strong banking franchise, both domestically and it also has the benefit of the international business that has been serviced by the Cypriot banks for the past 20 years. That is a very strong element to the franchise so the banking system can revert to a much better situation because the business base is sound,” he says.

Home comforts

The three sectors that give the greatest causes for optimism in Cyprus are tourism, international business services and energy. The country has halved its dependence on tourism, to about 10% of gross domestic product (GDP). But even so, tourism in particular performed well in 2011, and Mr Tirkides says the early indications for 2012 are encouraging.

“Perhaps Cyprus’s entrance into the euro in 2008 caught tourism a bit off-guard as the pound-to-euro conversion rate was unfavourable for tourism. But the sector went through a number of years of restructuring and is now coming out stronger,” he says.

On the international business services sector, the number of Cyprus-registered companies rose by 7% in 2011. Bank of Cyprus has outperformed the market, seeing its client base in the sector rise by 16%.

“Customers appreciate the advantage of Cyprus being a member of the EU and the eurozone with a competitive tax regime, low costs compared with other jurisdictions in Europe and good infrastructure. Our legal system is based on English law so this is another characteristic that helps distinguish Cyprus from other jurisdictions in the EU and make the environment more business friendly,” says Mr Pittalis.

The energy sector has come to the fore with the announcement in late 2011 of 141 billion cubic metres to 226 billion cubic metres of natural gas discovered in Cypriot waters, worth an estimated $150bn. Mr Nicolaou says some results can be seen already.

“It takes time to develop these reserves and get a flow of income but the short-term effect is definitely beneficial in terms of changing the investment climate and attracting investment. That has had a positive effect and continues to do so,” he says.

Degree of optimism

As well as future prospects, Mr Nicolaou points out that the country's government has tackled some of the current problems affecting the Cypriot economy. The authorities were initially slow to announce budget cuts. However, pay reductions and other measures were introduced in 2011 to bring down the government deficit, and he believes the country is now over the worst of the crisis.

Commenting on Cyprus’s prospects for 2012, Mr Tirkides acknowledges that various bodies have made negative projections, such as the European Commission, which forecasts a GDP contraction of 0.5% this year. But he is more optimistic. “I think there will be positive growth. There might be another negative quarter year on year in the first quarter and that will be that, unless things take a turn for the worse, which I do not anticipate this year,” he says.

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