Financial stability report of the banking system

Financial stability report of the banking system 2020

ABSTRACT

The purpose of this report is to address how the evolution and progress of the the banking industry after the recession of 2013 has contributed in a more resilient system with the beginning of the covid-19 global crisis. Some measures discussed below have made an effect on the improvement of banking practises over the recent years. However there is still more to be made especially for the reduction of nonperforming loans. A representation of their performance before covid-19 and after analyses the risks faced by the banks in some of their most important instruments, and the extra attention needed after the beginning of the pandemic. Economic uncertainty has forced the government to approve certain laws adopted by the banks, that will not be beneficial to them, and are only made to protect the public.

INTRODUCTION

After the recession of 2013 in Cyprus, the banking system has concentrated its function in a national level to be able to reform the banking system. The banking sector has managed to limit and focus on the prevalence of more sustainable practises. More specifically it has reduced the number of total assets by 2019 to 2.7% of GDP in contract to 6.3 % of GDP before the haircut of deposits in 2012. The equity and liquidity level (CET1) has increased from 15,7% in 2015 to 16,6% in 2019 and the loan to deposit ratio has been reduced from 136% to 69% at the end of 2019. At the end of 2019 excess reserves were 14.3% billion which corresponds to 300% instead of 100% which is the minimum amount required. Decisions made by the authorities to allow the use of capital stock or to delay capital increases have released 1.5 billion in capital.

GDP FELL TO -5.1 % IN 2020

In 2020, Cyprus has been significantly affected from the economic recession of the Covid-19 pandemic. The closure of many businesses from the mid of March, the ban of flights and the suspension of the operation of the tourist industry , stemmed from an abrupt contraction of demand and negative supply-side effects.. Taking support measures eased to a large extent the degree of economic impact from pandemic. The rapid and timely taking of supervisory, budgetary, and other measures, both in Cyprus and in the euro area, from the European Central Bank (ECB),Central Bank of Cyprus (KTK)contributed to mitigating the effects of the pandemic on the real economy and to some extent household income, supporting at the same time the companies affected. Compensatory fiscal measures received by the state in March 2020, took the form of subsidies, social spending and tax breaks. New support measures were taken and the second half of 2020 and early 2021, in the middle of the second wave of the pandemic.

RISKS FOR CREDIT INSTITUTIONS:

Banks are required to build their own capital that fully reflects their size and absorb any potential losses without government support. Potential reduction and delays in income may result in greater unemployment and therefore less profitability in the banking sector due to potential delays of loan instalments. Already exiting high number of NPLs and structural problems further affect the ability of the banks to provide new loans.

MEASURES BY THE GOVERNMENT: Suspension of loan instalments, including the interest rate. Interest rate subsidies offered on new mortgages and new business loans to boost spending.

MEASURES BY THE BANKS:

Association of all banks suspended the sales as an additional measure to tackle the pandemic. Some banks have outsourced the management of MEX to specialised companies in order to increase the efficiency of the NIS management.

MEASURES BY THE E.E:

ECB has allowed a temporary relief of capital and liquidity requirement which amounted to 1.4b 40 release of capital. PEPP program of the EE contributed to a significant decline of the Cypriot 10-year bond of 2.21% on March 18 2020 to 1.74% on March 19,302020,while after the application of PEPP, on January 31, 2021 it was at 0.28%. European Guarantee Fund of the European Investment Bank, the Government Guarantee 20 Scheme to the European Investment Bank for lending through credit institutions to small and medium-sized enterprises and for providing 10 liquidity to finance small and medium enterprises, through the Cyprus Entrepreneurship Fund. 0

2021

2023

2025

2027

2029

NON -PERFORMING LOANS After a significant decline of NPLs in 2018, progress was more limited in 2019, but moved at a faster rate in 2020 In 2020 the percentage of NPLs was less than 20% in contrast to 2019 which stood at 28.5% of gross loans. The coverage ratio of forecasts for precarious loans collected by the section of non-performing grants was reduced to 49% in November 2020 from 53,7 in 2019, but still remaining above the European average of 46,6 in September of 2020. Banks had planned large disposals of NPL sales by the mid of 2020 Hellenic bank launched a portfolio sale (project tide) Bank of Cyprus received binding bids for the helix 2 portfolio. Concentration in the construction and trade is higher. Real estate comes second. NPLs are driven both by the public and corporates. This shows that there is diversity in risks.

Implementation of policies to limit NPLs ESTIA SCHEME:

The project aimed to resolve the problem of non-performing loans with the condition of a mortgage on the borrower's first home. The ESTIA plan implies budgetary costs as the state undertakes the subsidisation of equal instalments of contribution from the borrower. But more broadly it aims to restore these loans to performing and deplete the stock of non-performing loans. Wealth, income and viability were the main criteria for proceeding with an application. Only 12% of the applications were successful.

LEGAL FRAMEWORK: Creating an auxiliary institutional framework to enhance efficiency and the management of non-performing loans and the treatment of strategic defaulters. Specifically In recent years, laws have been approved for the purchase and sale of loans, the sale of real estate, insolvency, and securitization of loans. The progress made in MEX is directly related to the use of the above-mentioned legal framework with the exception at this stage the securitization of loans, which has not been used. The loan for the restructuring of collateral was approved in the mid of 2020 and applications need to comply with the CBC'S restructuring code. Loans were applicable if the initial amount was up to 350.000 collateralized by the primary residence Banks and acquiring companies voluntarily suspended foreclosure proceedings between March- August 2020. In December 2020 enacted a law for freezing foreclosure proceedings until March 2021 for small business and residences up to 350k, which was extended until July 2021 for residences up to 500K, small business premises and farmland up to 250K.

KEDIPES:

source: Kedipes official website

KEY INFORMATION: Cumulative cash inflows for 2020 decrease by 23,6% compared with the previous year Cumulative operating expenses decreased by 9,3% compared to the previous year Under the Asset Protection Scheme, six claims have been filed to date by the Hellenic Bank. A Partial payment amounting to 55,6mln was made for the first two claims. An agreement has been made with Altamira Cyprus for the period of 20202027, consisting of a recovery plan. Project ‘Ledra’ for the potential sale of performing and restructured loans runs with some delay, with the perimeter of the first partial sale expected to be around €400-500mln (of 1.2bln) of contractual balances and the launch a competitive procedure expected to be in Q3 2021 Suspension of auctions, for a period of 6 months, for all the portfolio of KEDIPES Slow progress with the "ESTIA" scheme. Only 5% with contractual balance of 40mln have the final approval by the Ministry of Labour. KEDIPES, in coordination with the Ministry of Finance is developing a Mortgage to Rent scheme which aims to allow housing protection to people with low capability of repayment of their loan. The Board of Directors of KEDIPES decided a new cash payment of €80mln against State Aid in April 2021, increasing the total amount of repayment of State Aid in cash to €400mln from the beginning of KEDIPES operations in September 2018.

PROFITABILITY, CAPITALISATION AND LIQUIDITY

The pandemic has found the profitability of the banking sector under pressure due to the prolonged environment of many low interest rates, high level of NPLs and the structural problems that manifested through high operating costs relative to operating revenue of the sector. The profitability of the banking system remains a potential risk due to deteriorating macroeconomic conditions, of potentially increased forecasting needs and the limited prospects of new borrowing and low interest rates

PROFIT OR LOSS FOR THE YEAR €000

-1,5 return of funds

NET INTEREST MARGIN OUTSTANDING

NEW BUSINESS

CAPITAL ADEQUACY REMAINS AT PRE COVID LEVELS

Specifically the capital adequacy ratio of common shares of category 1 for all banking sector amounted to 17.38%, marking an increase from 16.55% recorded in September 2019 and remaining stable at the levels of December 2020. The overall capital adequacy ratio amounted to 20.06% on 30 September 2020, compared to 19,03% in September 2019 Even though regulatory funds were slightly higher from the minimum capital requirements, covid -19 duration will determine the effects of this tool. The conservation of regulatory funds at pre- covid levels irrespective of the regulatory requirements, reveals the uncertainty of the banks banks considering the direction of the pandemic.and it's consequences that may arise in the banking industry.

Bank's role in mitigating the economic impact of COVID-19 The central bank stepped up their liquidity support to banks to promote lending to those mostly hit bad by the pandemic Bank supervisors provided temporary capital, liquidity and operational relief so that they can continue working in this challenging environment The state implemented government-backed loan guarantees or payment deferral schemes ( "moratoria"), which provide incentives for banks to continue lending and offer a relief to the financial pressure of households and businesses.

Overview of the two largest banks

Hellenic Bank Ongoing improvement in loan quality A 41% NPE reduction during FY20, with Net NPEs reduced to 2,8% of Total assets REOS account for only 1,3% of total assets Solid capital position Capital adequacy ratio consists of 22,3% The minimum requirement for CAR is 14,45% Deposit base Deposits increase despite the negative interest rates introduced in March 2020 Customer deposits totalled 14,2b in Dec 2020 Non-Cypriot deposits account only 15% Lending Increased by 28% compared to 2019 Most of it consisting of retail lending Growing and diversifying the securities portfolio Securities at 32% of total assets in Dec-20, compared to 28% in Dec-18 • 49% of the securities portfolio is CGBs, compared to 91% in Dec-1 PROFIT FY20 Profit for the period of €50,5 m, down by 53% yo-y, primarily due to the 82% increase in impairment losses reflecting the COVID-19 impact; FY20 RoTE of 4,8%, compared to 12% the year before

Bank of Cyprus Profit: Total income of 137mn Profit after tax of 4 mn Total operating expenses at 84mn for 3Q2020, up by 4% as more normal business operations have resumed post lockdown Total operating expenses of €249 mn for 9M2020, down 13% yoy CET1 RATIO: Total capital ratio of 18,2% Deposits at 16,4bn Significant surplus liquidity of 4,1bn (LCR 256%) NPE performance: Organic NPE reduction of €230 mn with pace returning to pre-lockdown levels €0.9 bn NPE sale (Helix 2) agreed in August 2020 NPEs reduced to €2.4 bn (€1.0 bn net)2 • Gross NPE ratio reduced to 21%2 (10% net ) and coverage maintained at 59% Moratorium scheme: ·Payment deferrals were granted to 25K customers affecting 5,9 billion gross loans Lending ·Retail housing up 43% qoq, supported by government interest rate subsidy scheme; pipeline of €148 mn by mid-November Non-interest income at 55mn ·Net fee and commission income increased to €35 mn as transactional volumes gradually recover post lockdown ·Net insurance income decreased to €13 mn in 3Q2020, impacted by lower claims in 2Q2020 due to the lockdown and lower management fee income from unit-linked funds reflecting the performance of the market ·REMU gains2 at €2 mn as sales gradually increasing post lockdown; REMU sales remain volatile ·Net FX and other income1 reduced to €5 mn in 3Q2020 impacted by €6 mn revaluation loss on financial instruments Digital transformation ·84% of total transactions2 are performed through digital channels (vs 77% in FY2019) ·74% of customers currently digitally engaged3 (vs 69% in FY2019)

MY OPINION The position of the banking sector has improved over the recent years after the economic crisis of 2013. However, there is still more progress to be made in order to remain resilient in the post – pandemic years. Even though there have been reductions in the NPLs, a transformation in digital technology and a reduction in operating and staff costs, challenges remain to a huge extend in place. Most specifically the ongoing NPL performance, still doesn’t allow the bank to create more loans and reduce further it’s operating costs. Holding a huge number of NPLs poses a huge risk to the company. Potential investors are interested in investing in companies with healthy books of accounts. Furthermore, if the percentage of NPLs is less favorable, the lender’s stock price may potentially decrease. This will result in lenders potentially suffering from less profitability if they don’t earn an income from their credit businesses. In Addition to this, the consequences of the pandemic are still uncertain. A prolonged crisis may result in higher unemployment and lower revenues due to customers enable to repay their loans. This will further reduce asset quality and potentially the profitability and liquidity of the banks. In most severe cases they can suffer from insolvency.

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