TEXT-Fitch cuts Cypriot banks following sovereign downgrade

Fri Nov 23, 2012 8:04am EST

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(The following statement was released by the rating agency)

Nov 23 - Fitch Ratings has downgraded Bank of Cyprus' (BOC), Cyprus Popular Bank's (CPB) and Hellenic Bank's (HB) Long-term Issuer Default Ratings (IDR) and Support Rating Floors (SRF) to 'BB-' from 'BB' following the downgrade of Cyprus' sovereign rating (see "Fitch Downgrades Cyprus to 'BB-'; Outlook Negative" dated 21 November 2012 on www.fitchratings.com). The Outlooks on the banks' Long-term IDRs are Negative in line with that of the sovereign. All three banks' Short-term IDRs and Support Ratings have been affirmed at 'B' and '3', respectively.

At the same time, BOC and CPB's Viability Ratings (VR) have been downgraded to 'c' from 'ccc' and 'cc', respectively reflecting the agency's belief that failure of the two banks is imminent. Fitch expects that BOC and CPB will require sizeable capital injections and that these will be provided by Cypriot and/or international authorities.

HB's VR has also been downgraded to 'cc' from 'ccc' to reflect that failure of the bank appears probable. Fitch questions the capacity of the bank to continue to operate without support as it is highly vulnerable to further deterioration in its credit risk profile and market conditions. However, extraordinary capital support could also be provided to HB if needed. A full list of rating actions is at the end of this comment.

RATING DRIVERS AND SENSITIVITIES - IDRs, SUPORT RATINGS AND SRFs

The downgrade of BOC, CPB and HB's Long-term IDRs, which remain at their SRFs, is based on Fitch's assessment that the state's ability to support its major banks has reduced, as reflected by Cyprus's sovereign downgrade, which is largely driven by a materially weaker macroeconomic outlook and the continued high level of uncertainty over the costs associated with the overall banking system's recapitalisation.

However, Fitch continues to incorporate in its assessment of support the fact that i) the propensity of the sovereign to support the three major Cypriot banks remains strong given their systemic importance in the domestic economy (combined assets totalled EUR77.2bn -430% of GDP - at end-H112) and ii) support from the IMF/EU/ECB (Troika) in respect of Cypriot banks' recapitalisation is being discussed in the context of Cyprus's formal request in June 2012 for financial assistance. Precedence in other troubled eurozone countries indicates that bank senior creditors would be fully covered in a support package.

The equalisation of the three banks' Long-term IDRs and SRFs with that of the sovereign rating reflects Fitch's view that sovereign and bank risks are closely interconnected in Cyprus. A lack of progress in negotiations with Troika puts the receipt of a support programme to address Cyprus' sovereign issues and Cypriot banks' recapitalisation at risk.

The affirmation of the Support Ratings at '3' indicates Fitch's opinion of continued moderate probability of support to the three Cypriot banks.

The Negative Outlook indicates that any further downgrade of Cyprus's sovereign rating and/or any change that reduced the likelihood of international support could lead to a further downgrade of the banks' Long-term IDRs, SRFs and Support Ratings.

RATING DRIVERS AND SENSITIVITIES - SENIOR DEBT

The rating of senior unsecured debt issued by BOC and CPB has been downgraded to 'BB-' from 'BB' in line with the banks' Long-term IDRs. Fitch expects support to be extended to senior unsecured creditors based on precedent observed in other EU countries. Debt ratings are sensitive to any change in banks' Long-term IDR and/or Fitch's assumptions around the level of support available to the banks.

RATING DRIVERS AND SENSITIVITIES - VRs

The downgrade of BOC's and CPB's VRs reflect Fitch's expectation that both banks will require sizeable capital injections to restore capital levels and confidence. Capital shortfalls will arise from net losses expected for FY2012 as a result of continued asset quality deterioration in Greece and Cyprus and further capital needs resulting from an independent loan stress test carried out by Troika and Cypriot authorities as a pre-requisite for the bail-out package for Cyprus.

With private capital-raising limited for most of the banks, Fitch believes that support will have to be provided by the government, which itself will need assistance from international authorities to do this.

At end-H112, both CPB and BOC reported core capital ratios below the minimum 8% required by the Central Bank of Cyprus (4.4% and 5.1%, respectively, at end-H112). In addition to the EUR1.8bn injection into CPB by the government in July which now holds 84% of the bank's shares, Fitch assesses that the three major Cypriot banks are likely to need further capital injections of at least around EUR4bn under a base case scenario which requires a Fitch core capital ratio (FCC) of 9%. Capital needs are largely concentrated at CPB and to a lesser extent BOC. BOC has already requested EUR730m, up from EUR500m estimated in June 2012 due to worse-than-expected deterioration in asset quality from Q112 to Q212.

Additional capital shortfalls for the three banks could increase to at least about EUR6bn resulting from Fitch's adverse stress test, which requires a FCC of 6%. Fitch acknowledges that its estimates of the potential losses and capital needs of Cypriot banks are subject to considerable uncertainty and are sensitive to changes in assumptions.

Capital shortfalls largely stem from banks' sizeable loan exposure to Greece but also from their deteriorating domestic loan portfolios due to worse than expected economic prospects in Cyprus. CPB is the most exposed to Greek loans (47% of total loans at end-H112, including international shipping loans booked in Greece), followed by BOC (34%) and HB (17%). Exposure to Greek government debt has substantially declined after impairments in 2011 and H112 and ranged between EUR8m at HB and EUR279m at CPB at end-H112.

The VRs of BOC and CPB are likely to go to 'f' reflecting banks' failure under Fitch's definitions once capital needs are identified at each bank and extraordinary capital support is committed. After recapitalisation, the agency will re-assess both banks' VRs and upgrade them to a level commensurate with their post-support credit profile.

The downgrade of HB's VR reflects Fitch's concern that the bank may be in need of further capital injections in view of Cyprus' weaker economic prospects and the independent loan stress test carried out by Troika and Cypriot authorities. At end-H112, its core capital ratio was 8.3% including the rights issue in July 2012. Fitch judges that its ability to raise further capital from private means is uncertain. HB's VR would be subject to further downward rating pressure depending on the extent and nature of potential further extraordinary support required. Improved capitalisation, a stabilisation of the risk profile and deposits could be rating positive.

The ratings actions are as follows:

BOC

Long-term IDR downgraded to 'BB-' from 'BB'; Negative Outlook

Short-term IDR affirmed at 'B'

Viability Rating downgraded to 'c' from 'ccc'

Support Rating affirmed at '3'

Support Rating Floor revised to 'BB-' from 'BB'

Senior notes downgraded to 'BB-' from 'BB'

Commercial paper affirmed at 'B'

CPB

Long-term IDR downgraded to 'BB-' from 'BB'; Negative Outlook

Short-term IDR affirmed at 'B'

Viability Rating downgraded to 'c' from 'cc'

Support Rating affirmed at '3'

Support Rating Floor revised to 'BB-' from 'BB'

Senior notes downgraded to 'BB-' from 'BB'

HB

Long-term IDR downgraded to 'BB-' from 'BB'; Negative Outlook

Short-term IDR affirmed at 'B'

Viability Rating downgraded to 'cc' from 'ccc'

Support Rating affirmed at '3'

Support Rating Floor revised to 'BB-' from 'BB'

The rating impact, if any, from the above rating actions on the banks' covered bonds will be detailed in a separate comment.

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