Cyprus: Significant Progress on Reducing NPEs, But Challenges Lie Ahead

This commentary provides an update on the substantial progress made by Cyprus (BBB (low), Stable) in cleaning up its banks' balance sheets; the challenges and uncertainties the pandemic poses to this process; and the main initiatives to address some of the long-standing challenges.

Key highlights include:
• Cypriot banks substantially accelerated the reduction of their legacy NPEs in 2020. The NPE ratio dropped by 10 percentage points throughout 2020. Furthermore, NPEs not provisioned for reached their minimum in several years. DBRS Morningstar expects the sales of bad loans to non-bank institutions to remain the main driver of NPE reduction.
• The battery of support measures have effectively reduced and deferred the potential impact on banks' asset quality during 2020. However, as the extraordinary support is withdrawn, credit losses could start to accumulate in the system.
• Non-performing assets and overall leverage remain high. DBRS Morningstar views positively some of the measures to continue addressing the challenges and will continue to monitor their implementation.

“DBRS Morningstar views positively the significant reduction in legacy NPEs in recent years. Nevertheless, the adverse impact of the COVID-19 crisis on economic activity will inevitably lead to new flows of NPEs. Early indications after the expiry of the moratoria suggest limited impact thus far, although more time needs to elapse to assess the final impact.” said Javier Rouillet, Vice President at DBRS Morningstar. “The relative exposure of the Cypriot banking system to sectors heavily affected by the pandemic, such as hospitality, entertainment, trade, and transport is the highest in the EU, closely followed by Greece. Loans to these sectors represented close to 50% of the non-financial company (NFC) loan portfolio, making the tourism sector a key factor for the outlook of the Cypriot economy”, said Spyridoula Tzima, Assistant Vice President at DBRS Morningstar. “Given the increasing importance of non-performing assets outside the banking system, enhancing the operational environment for credit acquirers and credit servicers as well as strengthening the foreclosure framework will remain crucial for their timely resolution” added Javier Rouillet.