Capital Intelligence Ratings (CI Ratings or CI) today announced that it has affirmed the Long-Term Foreign Currency Rating (LT FCR) and Short-Term Foreign Currency Rating (ST FCR) of Hellenic Bank (HB) at ‘BB-’ and ‘B’, respectively. At the same time, CI Ratings has affirmed the Bank’s Bank Standalone Rating (BSR) of ‘bb-’. The Outlook for the LT FCR and BSR remains Stable.
The Bank’s BSR is derived from a Core Financial Strength (CFS) rating of ‘bb-’ and an Operating Environment Risk Anchor (OPERA) of ‘bb-’, the latter reflecting moderate economic and industry risks. The LT FCR is set at the same level as the BSR as it is uncertain whether extraordinary support would be forthcoming from the authorities in the event of financial distress. Our support assessment takes into account Cyprus’ implementation of the EU’s Bank Recovery Resolution Directive (BRRD), which makes it likely that senior creditors would be required to absorb losses prior to the Bank receiving any official support. It also factors in the moderate capacity of the government (‘BB+’/‘B’/ Stable) to provide timely and sufficient assistance to the Bank in the event of need.
The strongest credit strength supporting the CFS is funding and liquidity. The Bank enjoys a well diversified and stable retail customer deposit base and has very little reliance on wholesale funding of any type. Liquidity metrics continue to be strong. Less strong – although still a credit strength – is the capital position. Headline ratios are strong and capital quality is good. However, the ratio of unprovided non-performing exposures (NPEs) to equity remains high, albeit on a downward path. It should moreover be noted that part of the gross NPEs benefit from what is tantamount to a 90% government guarantee; this accounts for why HB can afford to hold lower loan loss reserves (LLR) than would otherwise be the case.
The large deposit base and relatively low proportion of loans in the balance sheet means that HB maintains a large share of its asset base in the form of investment securities. These are almost wholly made up of debt securities with a mix of Cyprus Government bonds, high quality bank debt and covered bonds. The holdings are very liquid. With net loans and investment securities holding roughly the same shares of total assets, the impact of NPEs on the overall asset quality of the asset base as a whole has lessened, particularly when the partial quasi-government guarantee on part of the NPE portfolio is factored in. Nonetheless, loan asset quality remains the most important credit challenge after Covid-19 itself, and one that will take an extended period of time to whittle away. Notwithstanding the partial government guarantee of part of the NPE portfolio, LLR coverage is still considered by CI to be below what would be seen as a satisfactory level. Although IFRS 9 requirements are fully met, the realisability of collateral and other security enhancements such as third-party guarantees carries a higher degree of uncertainty than might be the case in some other EU markets due to legal factors.
The other main credit challenge is weak profitability. At the net level, this reflects the high cost of credit and the large proportion of operating profit consumed by provisioning. However, profitability is also modest at the operating level. Net interest income is impacted by the carry cost of unprovided NPEs and by the lower yields on investment securities; despite this the share of operating income provided by non-interest income remains low. The main headwinds are however weak income generation overall coupled with a large cost base and the resulting high cost-income ratio. There are however opportunities going forward to increase fee and commission income by cross-selling non-credit products to the ex-CCB (Cooperative Central Bank) portion of the customer base as that predecessor bank had a very limited offering of insurance and investment products.
Two final credit challenges are the high exposure to the real estate market in the loan portfolio and the high exposure to Cyprus government risk. Real estate values impact HB in a number of ways – of which the impact on the real estate owned by the Bank portion is the least important. Almost half of all performing loans are to households, of which three quarters are in the form of residential mortgages. However, non-household lending is also heavily secured by real estate collateral. Adding in the exposure to the real estate collateral of NPEs as well, HB has a heavy contingent exposure to the health of the Cyprus real estate market.
In terms of exposure to government risk, there is not only a large portfolio of government bonds but also contingent exposure under the government-backed APS scheme, which protects against adverse effects from the loan portfolio taken on board with the CCB acquisition.
Rating Outlook
The Outlook for the ratings is Stable, indicating that the ratings are unlikely to change over the next 12 months. While most of the Bank’s financial metrics significantly improved following the acquisition of CCB (and continue to improve), the large stock of NPEs and the uncertainties related to the effects of Covid-19 on both asset quality and profitability are likely to continue to constrain the ratings.
Rating Dynamics: Upside Scenario
The Outlook could be revised to Positive if there was a substantial improvement in loan asset quality metrics, including the loss coverage ratio coupled with a sustainable increase in profitability.
Rating Dynamics: Downside Scenario
The Outlook could be revised to Negative or the ratings lowered if loan asset quality again worsens once the governmental Covid-19 support and forbearance measures end. A similar shift in the Outlook could be prompted by any changes to the law which further reduce the realisability of collateral – or excessively prolong the period required to achieve this.
