Fitch Upgrades Bank of Cyprus Covered Bond Programme to 'BB '
The rating action follows the revision of Fitch's residential mortgage assumptions for Cyprus after the programme's annual review.
KEY RATING DRIVERS
The three-notch upgrade reflects the lower expected loss of the broadly unchanged cover pool under Fitch revised residential asset assumptions.
Fitch reviewed assumptions for the base frequency of foreclosure (FF) matrix and the market value declines (MVDs). The 'B' base FF for a standard residential mortgage loan in Cyprus (i.e. 30% debt-to-income and 60%-70% original loan-to-value) has reduced to 28.3% from 40.5% and the MVD has been revised to 52.1% from 60% at the national level.
A detailed description of the rating drivers and the assumptions considered for t
he analysis of BoC's covered bonds can be found in the special report "Bank of Cyprus Public Company Ltd - Mortgage Covered Bonds - Rating Drivers and Assumptions", dated 12 April 2016 available at www.fitchratings.com.
When reviewing the assumptions for Cyprus, Fitch recognised that as at end-2015 the economy was recovering, despite the still fragile macroeconomic environment and the high unemployment rate - both of which are the primary drivers of FF. Indeed, GDP grew by 1.6% in 2015 yoy, which was better than expected. Fitch expects unemployment to decrease to the 14% range by 2017. Cypriot public finances improved while the banking sector made progress in restructuring with signs of stabilisation in bank deposits. The stock of consolidated sector non-performing loans has started to decline, from a peak of over 50% in November 2014, to 45% in December 2015. It remains one of the highest globally.
Fitch's 'BB+' breakeven overcollateralisation (OC) is 41.8% (equivalent to a 70.5% asset percentage). The main driver of the breakeven OC is the 34.8% credit loss (down from the previous 'B+' 37.3%) that results from a 'BB+' weighted average (WA) FF of 65.7% and a 'BB+' WA recovery rate of 60.7%.
The second largest contributor to the 'BB+' breakeven OC is the 9.9% asset disposal component, which primarily reflects the OC such that principal and interest revenues on assets are sufficient to cover interest payments on the covered bonds without triggering asset sales. It also takes into account the additional OC that the issuer puts aside to account for set-off that Fitch has factored in by projecting the amount for the next 12 months using the average marginal rate since September 2015, when the cover pool decreased along with the partial cancellation of the covered bonds from EUR1.0bn to EUR0.65bn.
A residual negative 0.2% OC derives from the cash flow valuation component, which reflects the interest rates composition of the cover assets and of the covered bonds. The breakeven OC considers whether timely payments are met in a 'B+' scenario and tests for recoveries given default on the covered bonds of at least 91% in a 'BB+' scenario.
The 'BB+' rating is based on BoC's Issuer Default Rating (IDR) of 'CCC', an unchanged IDR uplift of one, an unchanged Discontinuity Cap (D-Cap) of eight notches (minimal discontinuity risk), and the 47% committed OC that Fitch takes into account in its analysis, which provides more protection than the 41.8% 'BB+' breakeven OC.
The Stable Outlook on the covered bond rating reflects the slower pace of underlying asset quality deterioration and progress in economic recovery, albeit still fragile.
The unchanged D-Cap of eight is driven by the minimal discontinuity risk assessment of the liquidity gap and systemic risk component. The conditional pass-through structure together with the mandatory principal coverage and the six-month interest provisions mitigate the refinancing and liquidity risk in a scenario where the cover pool is enforced as a source of payments for the covered bondholders.
The unchanged IDR uplift of one reflects the bail-in exemption for fully collateralised covered bonds and the domestically systemic importance of the issuer so that Fitch believes resolution methods other than liquidation are more likely to preserve important banking operations, including covered bonds.
A negative rating action on the covered bonds issued by Bank of Cyprus Public Company Ltd (BoC) would be triggered by (i) a downward revision of the 'BB+' country ceiling (ii) a reduction in the total number of notches for the IDR uplift and the Discontinuity Cap to three or below; and (iii) a decrease in the programme overcollateralisation (OC) below the Fitch's 41.8% breakeven OC.
All else being equal, it is unlikely that the 'BB+' covered bond rating would be affected by a one- or a two-notch change to the IDR of BoC. An upward movement of the country ceiling would only lead to an upgrade of the rating of the programme if sufficient OC would be available to withstand assumptions for rating scenarios higher than 'BB+'.
The Fitch breakeven OC for the covered bond rating will be affected, among others, by the profile of the cover assets relative to outstanding covered bonds, which can change over time, even in the absence of new issuance. Therefore the breakeven OC to maintain the covered bond rating cannot be assumed to remain stable over time.
More details on the cover pool and Fitch's analysis are available in the full rating report, "Bank of Cyprus Public Company Ltd - Mortgage Covered Bonds", dated 12 April 2016 and available at www.fitchratings.com.