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The completion of the recapitalisation and restructuring process for the Cypriot banks should improve confidence and contribute to funding stability in the system, Fitch Ratings says. However, the banks will remain vulnerable to funding and liquidity risks and exposed to intense asset quality and profitability pressures in the recession, so ratings are likely to stay deeply speculative-grade for some time.
We expect Cyprus' GDP to contract by 8.9% in 2013 and a further 4.9% in 2014. A much deeper and longer recession could aggravate already poor asset quality and profitability and renew pressures on capitalisation. This may put further pressure on funding and liquidity profiles. We see this as the major risk for Cypriot banks.
The banks' recapitalisations and restructurings, due to be completed by end-2013, are milestones on the roadmap for the full lifting of capital and deposit restrictions first introduced in March 2013. The completion should reactivate capital flows and help mitigate liquidity risks, especially at Bank of Cyprus (BoC) - the largest bank, which was exposed to the greatest losses.
Although the process has begun, individual banks are at different stages. The two largest banks - BoC and Hellenic Bank - have had Long-Term IDRs at 'RD' since March and April, respectively. We expect to upgrade the ratings of Hellenic Bank shortly after it is recapitalised. For BoC, which was recapitalised at end-July, ratings will be revised when the group's restructuring commitments and financial and credit profiles are disclosed, so we can complete our analysis.
We believe it is likely that the banks' revised Long-Term IDRs will be driven by their stand-alone intrinsic strength rather than sovereign support, as the Cypriot authorities have limited ability to support the banks. This is reflected in Cyprus' weak credit profile (Foreign Currency IDR 'B-') and the EUR10bn IMF/EU bail-out package it received.
Capital controls are likely to remain in place for some time, to help the stabilisation of the Cypriot economy and banking sector. But this will not prevent us from upgrading the banks' ratings.
BoC's pro forma core capital ratio stands at 11.8% following the recapitalisation, which forced losses onto junior and senior creditors, including a 47.5% deposit-to-equity conversion of uninsured deposits (exceeding EUR100,000). However, funding and liquidity remains affected by continuous deposit withdrawals. BoC remains reliant on central bank funding, largely through the Emergency Liquidity Assistance mechanism, despite regaining its counterparty status with the ECB. It has most to gain if confidence for the sector improves.
Hellenic Bank has until end-October to meet the regulatory minimum 9% core capital ratio by private means. If unsuccessful, the bank will receive state aid without forcing losses onto senior creditors. Its funding and liquidity may be more resilient. Despite the crisis, loans/deposits were close to 80% at end-H113, partly supported by the capital controls and the bank does not rely on ECB funding.
Finally, the credit cooperative banks, which represent the bulk of the remainder of the system, will be recapitalised with a EUR1.5bn capital injection directly from the Cypriot state under the IMF/EU support package. They will also be significantly restructured. Fitch
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