By Constantinos Psillides FITCH Ratings has upgraded Bank of Cyprus' (BoC) long-term issuer default ratings (IDR) to CC from RD and Hellenic Bank's (HB) to CCC from RD, according to a statement issued by the credit rating agency on Friday. The upgrade comes only a day after the BoC board unanimously agreed to seek investors for a potential capital increase of about €1b in a bid to expedite restructuring and further strengthen the group's financial position. Fitch has also upgraded the two banks' short-term IDR to C from RD. At the same time, the agency has affirmed BoC's Viability Rating (VR) at CC and HB's at CCC. While this is good news for the banks, the credit rating agency still has its reservations. A C rating indicates, according to Fitch's classification description, that there are still substantial risks. An RD rating indicates "an issuer that in Fitch Ratings' opinion has experienced an uncured payment default on a bond, loan or other material financial obligation but which has not entered into bankruptcy filings, administration, receivership, liquidation or other formal winding-up procedure, and which has not otherwise ceased operating." The agency said the upgrades follow the lifting of legal restrictions imposed by the Central Bank of Cyprus (CBC) on the free movement of capital within Cyprus on May 30. "Fitch's view is that although restrictions remain on cross-border outward capital flows, these banks are now substantively able to service all their obligations". Fitch believes that BoC's and HB's VRs are influenced by the recession in Cyprus, which continues to put at risk the two banks' very weak asset quality, as well as weak profitability and vulnerable capitalisation. The agency considers asset quality as one of the main concerns for Cypriot banks. In 1Q14 both banks' non-performing loans (NPLs) continued to increase, albeit at a lower rate than past quarters, reaching 55 per cent at BoC and 49 per cent at HB. Fitch expects loan quality to weaken further in the foreseeable future, although more moderately. "The two banks' most important challenge will be to improve NPL recoveries, for which banks have internally strengthened their recovery units. NPL coverage remained low in Fitch's view in a stress scenario at 35 per cent for BoC and 43 per cent for HB at end-1Q14," it added. Noting that customer funding in 2013 started to stabilise following large deposit outflows in 2012, Fitch points out that the two banks' deposit franchises remain and highly vulnerable to Cyprus' recession and could also be affected by the recent lifting of domestic capital controls and notably the anticipated gradual lifting of cross-border capital controls. The agency notes that in the absence of further liquidity shocks, BoC's depedency on central bank funding will decline further, albeit it will remain large in the foreseeable future, indicating material funding constraints. With regard to the two banks' Viability Rating, Fitch notes that while limited in the short-term, the VRs could be upgraded if pressure from unreserved NPLs ease and/or capital materially improves and further profitability improvements are evidenced. BoC's VR could also be upgraded if there is a significant reduction in central bank funding. An upgrade of the Cypriot sovereign rating (B-/Stable) would also put upward rating pressure on the banks, if this is associated with improved macro-economic fundamentals. Conversely, the VRs would be downgraded because of a weakening of the banks' asset quality and profitability, resulting in significant capital erosion, or if their funding profiles become more unstable and deteriorate. In Fitch's view, BoC remains more at risk of a VR downgrade than HB.
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