Fitch Ratings has affirmed Bank of Cyprus’(BoC) and Hellenic Bank’s long-Term Issuer Default Rating (IDR) at `RD` (restricted default), upgrading at the same time, the banks` Viability Ratings (VR) to `cc` and `ccc`, respectively, from `f”`.

However Fitch views BoC, and to a lesser extent HB, at risk of a VR downgrade, that would mainly come from a deterioration of the capital base as asset quality pressures continue, and/or if funding and liquidity deteriorates further, for example, because of the lifting of capital controls in Cyprus.

The upgrades of the VRs follow Fitch`s review of the two banks` standalone creditworthiness after the completion of their recapitalisation and public details of BoC`s restructuring plan, which were key milestones in restoring the banks` solvency.

The upgrades of VRs reflect the banks` recapitalisations, which resulted in Fitch eligible capital (FEC) ratios of 9.7% for BoC and pro-forma of around 16% for HB at end-3Q13. However, the highly speculative VRs of the two banks continue to reflect high asset quality and profitability risks, which if not contained could renew capital concerns, as well as banks` sensitivity to potentially further deposit outflows.

Fitch views BoC`s VR as more at risk than HB`s due to its thinner loss-absorption capacity and greater funding vulnerabilities, as evidenced by a deposit franchise that was heavily impaired by the depositors` bail-ins and high central bank funding dependence. BoC also faces the challenge of integrating the acquired operations of Cyprus Popular Bank Public Company Ltd.

While fragile, Fitch considers HB has a larger capital buffer than BoC to cope with potentially higher credit losses under Fitch`s assumed recessionary period.

“We expect the Cypriot economy to contract by 7.1% in 2013, 5.1% in 2014 and 1.5% in 2015. In Fitch`s view, to protect its viability BoC is therefore more likely to have to seek ways to improve capital levels to absorb continued credit losses”, notes the agency.

Fitch regards additional rapid loan quality deterioration as one of the main risks for Cypriot banks. Non-performing loans (NPLs) escalated further during 2013 and alongside loan contraction, led to high NPL ratios (53% for BoC at end-2013 and 44% for HB at end-3Q13 under the Central Bank of Cyprus` new definition).

Fitch views little upside potential for the two banks` VRs in the foreseeable future as they remain highly vulnerable to Cypriot economic developments and investor/depositor confidence issues. (CNA)