Fitch Ratings has downgraded Bank of Cyprus (BOC)’s long-term rating to A- from A, together with its short-term rating, to F2 from F1, and its Individual rating to C/D from C. BOC's support rating was affirmed at 2. The long-term, short-term and individual ratings have been removed from Rating Watch Negative and a Stable Outlook is in place.
The rating action reflects concerns over BOC's high costs, its asset quality indicators and loan loss reserve coverage levels as well as uncertainty regarding the economic outlook. Fitch expects BOC to report reduced net income in 2002 due to a combination of the economic slowdown in Cyprus, further falls in the domestic stock market, and a narrowing of margins following the interest rate cuts in 2001.
Loan loss provisions are also likely to rise, as the bank looks to strengthen its weak loan loss reserve coverage of non-performing loans. At end-June 2002, BOC's gross non-performing loans represented a substantial 7.3 percent of total lending as reported to the Central Bank of Cyprus.
BOC's Cypriot operations are heavily unionized and wages are indexed to a cost of living adjustment, which, together with the costs of expanding in Greece, creates pressure for the bank to maintain strong revenue growth. BOC is confident it can achieve future revenue growth targets by expanding its loan book and increasing mark-up spreads and thus its net interest margin.
It also intends to boost productivity by upgrading its IT systems, transferring staff within the group and implementing a hiring freeze in Cyprus. However, because tourism and financial services are the main drivers of its economic growth the Cypriot economy is sensitive to external factors and it is therefore likely that BOC's profitability will continue to be subdued in 2003. This in turn will make it more difficult for the bank to build up its loan loss reserve coverage, which is substantially lower than international best practice, despite the collateral backing.
In Greece, the bank is funding an expansion program aimed at increasing and diversifying revenues. Its Greek operations have performed well to date and, despite bearing the additional costs of several new branch openings, are expected to contribute around a third of the group's pre-provision operating profit in 2002. The bank has sound risk management controls in place, although Fitch notes that the young loan portfolio in Greece has yet to be tested in an economic downturn.
The fall in the Cyprus Stock Exchange following its peak in late 1999 has caused BOC's fee income to stagnate, resulting in realized and unrealized losses on its securities portfolio. The bank also has a large shortfall in its defined benefit company pension scheme of €60 million at end-June 2002, the cost of which Fitch understands will be spread over 20 years. BOC has some sensitivity to a fall in interest rates, owing to a mismatch between its short-term assets and one-year maturity fixed rate customer deposits, although it is gradually addressing the imbalance.
Fitch considers BOC's Tier 1 capital ratio of 8.1 percent at end-June 2002 to be reasonable, which includes a deduction for the company pension scheme shortfall. Nonetheless, the bank's capital adequacy may come under pressure, as the expansion program in Greece continues and BOC will need to make additional provisions to build up loan loss reserves thus limiting internal capital generation.
BOC is the oldest bank in Cyprus and, with 40 percent of retail deposits, has by far the largest market share on the island. BOC complements its core retail banking business with a full range of peripheral financial services including life and general insurance. It operated a network of 188 branches and had 3,459 staff in Cyprus at end-June 2002.
The bank expects to have 75 branches open in Greece by end-2002, offering services similar to those in Cyprus. Its national market share is growing but remains small at around three percent of loans. BOC also has a subsidiary in the UK and a small subsidiary in Australia.
Fitch's Individual ratings assess how a bank would be viewed if it were entirely independent and could not rely on external support. Its support ratings deal with the question of whether a bank would receive support from its owners or from the state if it were to get into difficulty. These ratings are not debt ratings but rather, respectively, an assessment of the intrinsic strength of a bank and of any level of outside support that may, or may not, be available to it. — (menareport.com)
© 2003 Mena Report (www.menareport.com)
