Fitch upgrades Hellenic Bank to 'BB+' with a stable outlook

Fitch Ratings has upgraded Hellenic Bank Public Company Limited's (HB) Long-Term Issuer Default Rating (IDR) to 'BB+' from 'BB-', and Viability Rating (VR) to 'bb+' from 'bb-'.

It added that the Outlook on the Long-Term IDR is Stable.

The upgrade reflects the combination of Fitch's improved assessment of the Cypriot operating environment and continued improvements in HB's credit profile, it said. “Cyprus' operating environment benefits from our expectation of continued domestic economic growth, improved banking sector fundamentals and reducing, albeit still above-average, private sector indebtedness,” Fitch said. “The upgrade also reflects HB's strengthened capitalisation, reduced stock of legacy problem assets (including non-performing exposures (NPEs) and net foreclosed real estate assets), structurally improved profitability and strong deposit franchise, which translates into a large low-cost deposit base.”

Key rating drivers

Franchise, capital underpin ratings: HB's ratings reflect its strong competitive position as the second-largest bank in the small Cypriot market, supporting its business prospects, stable deposit-based funding and robust liquidity. They also reflect structurally improved profitability prospects in the higher interest rate environment, above-average regulatory capital ratios and manageable asset quality metrics.

Strong market position, limited diversification: HB's business profile is characterised by traditional commercial banking activities, with limited diversification in fee-generating activities and insurance. The bank operates almost exclusively domestically with strong market shares, especially towards households. However, growth opportunities are limited, given Cyprus' small size and still above-average private-sector indebtedness.

Prudent underwriting, above-average concentrations: “We believe that HB's underwriting standards are prudent and adapt quickly to changing circumstances, and that risk controls and tools are adequate for the bank's complexity,” said Fitch. HB remains exposed to higher single-name and industry concentrations than larger peers, due to its small size and the composition of the local economy, which is skewed towards tourism, trade and services.

Average NPE ratio: HB's NPE ratio of 3.3% at end-June 2023 (excluding NPEs guaranteed by the Asset Protection Scheme; APS) is well below historical peaks and broadly in line with southern European averages, said Fitch. Inflation and higher interest rates could put pressure on some borrowers, it added, “but we expect the bank to remain below its medium-term target NPE ratio of 3% (excluding APS-guaranteed NPEs) in the next two years”.

High-quality non-loan assets: “Our assessment of HB's asset quality also reflects that nearly two-thirds of the bank's total assets are cash and high-quality debt securities, which are significantly lower-risk than the loan book,” said Fitch.

Strong profitability on high rates: HB's operating profit/risk-weighted assets (RWAs) rose to 5.7% in 1H23 (1H22: 2.1%) mainly due to strong net interest income expansion from the repricing of the bank's cash holdings and securities. The bank also benefited from structurally reduced staff costs and loan impairment releases amid benign asset quality dynamics.

Resilient profitability prospects: “We deem HB's profitability to be at a cyclical peak as interest rates are expected to fall while deposit remuneration, which lags market rates, is likely to modestly rise,” the rating agency said. “We also expect loan impairment charges to pick up but remain manageable.” Nonetheless, it added, profitability should settle at structurally higher levels than the past decade if interest rates remain clearly positive, the Cypriot economy continues to grow and the bank develops fee-income business.

Adequate capital buffers, manageable encumbrance: HB's common equity Tier 1 (CET1) ratio of 20.8% at end-June 2023 represents a significant buffer over regulatory requirements and is above most southern European peers. Capital encumbrance by unreserved problem assets is also manageable at below 20% of CET1 capital.

Deposit-Based Funding, Sound Liquidity: HB's loans/deposits ratio fell below 40% due to continued deposits growth, NPE disposals and prudent new loan origination. HB's deposit base is stable and highly granular. As deposits exceed loans, liquidity buffers have been consistently strong. HB completed two wholesale unsecured debt issuances over the past 18 months, but funding diversification remains limited and market access less certain than at more frequent and higher-rated issuers.

The Short-Term IDR of 'B' is the only option that corresponds to the bank's Long-Term IDR of 'BB+'.

Factors that could, individually or collectively, lead to negative rating action/downgrade

Negative rating action could arise if the economic environment in Cyprus deteriorates sharply. This could be triggered by an unexpected domestic economic recession and a sharp rise in unemployment without prospects of a rebound in the short term, leading to a material deterioration of borrowers' creditworthiness and reduced business opportunities for banks.

“We could downgrade the ratings if we expected HB's problem asset ratio (including NPEs and net foreclosed assets, but excluding APS-guaranteed NPEs) to rise above 7% on a sustained basis, or if the CET1 ratio falls below 14%, causing CET1 capital encumbrance by unreserved problem assets to significantly rise,” said Fitch.

A decline of the operating profit/ RWAs ratio below 1.5% due to structural weaknesses in HB's business model, or evidence of funding instability, could also be rating negative, it said.

Factors that could, individually or collectively, lead to positive rating action/upgrade

Positive rating action is contingent on improvements in the Cypriot operating environment, Fitch said. This would require an upgrade of the sovereign Long-Term IDR and the expectation of continued economic growth in Cyprus, as these improvements would likely translate into better business opportunities for domestic banks, reduced credit risk from the banks' large exposures to the sovereign and improved market access amid greater investor confidence.

An upgrade would also require evidence of a stronger business profile by means of an operating profit/RWAs settling sustainably above 2%, including in a lower interest rate environment. The problem asset ratio (excluding APS-guaranteed NPEs) would also have to fall below 4% and the CET1 ratio to remain above the bank's medium-term target of 14%, with low capital encumbrance by unreserved problem assets. An upgrade would also require no material deterioration in the bank's risk profile, stable funding and continued compliance with the minimum requirement for own funds and eligible liabilities (MREL).]

Other debt and issuer ratings: Key rating drivers

Deposits

HB's long-term deposit rating is one notch above its Long-Term IDR because of full depositor preference in Cyprus and our expectation that HB will comply with its final MREL, which will become binding by end-2025, said Fitch. HB's resolution debt buffer is moderate and we expect it to be maintained or slightly increased in line with the bank's MREL needs. Deposits will therefore benefit from protection offered by bank resolution buffers consisting of debt and equity, resulting in a lower probability of default.

The short-term deposit rating of 'F3' is the only option that corresponds to the bank's 'BBB-' long-term deposit rating, the rating agency said.

Senior preferred debt

HB's long-term senior preferred debt is rated in line with its Long-Term IDR, reflecting Fitch’s view that the default risk of the notes is equivalent to that of the bank as expressed by the IDR, and that senior preferred obligations have average recovery prospects. “This is based on our expectation that HB's resolution buffers will comprise both senior preferred and more junior debt instruments, as well as equity,” it said. The rating also reflects its expectation that the combined buffer of Additional Tier 1, Tier 2 and senior non-preferred debt is unlikely to exceed 10% of the bank's RWAs on a sustained basis.

Senior non-preferred debt

Senior non-preferred debt is rated one notch below the Long-Term IDR to reflect the risk of below-average recoveries arising from the use of more senior debt to meet resolution buffer requirements and the combined buffer of Additional Tier 1, Tier 2 and senior non-preferred debt being unlikely to exceed 10% of RWAs.

Subordinated debt

HB's subordinated debt is rated two notches below the VR to reflect poor recovery prospects in a non-viability event given its junior ranking. No notching is applied for incremental non-performance risk.

Government Support Rating (GSR)

HB's GSR of 'no support' (ns) reflects Fitch's view that senior creditors cannot expect to receive full extraordinary support from the sovereign if the bank becomes non-viable. This is due to the EU's Bank Recovery and Resolution Directive and the Single Resolution Mechanism for Eurozone banks provide a framework for the resolution of banks that requires senior creditors participating in losses, if necessary, instead of, or ahead of, a bank receiving sovereign support.

Other debt and issuer ratings: Rating sensitivities

The long-term deposit, senior preferred and senior non-preferred debt ratings are primarily sensitive to changes in the bank's Long-Term IDR, said Fitch.

“In addition, the senior preferred and senior non-preferred debt ratings could be upgraded by one notch if we expected HB to meet its resolution buffer requirements only with senior non-preferred and junior instruments, or if we expected the size of the combined buffer of senior non-preferred and junior debt to sustainably exceed 10% of RWAs,” it added. “Furthermore, the deposit ratings could be downgraded if we deemed HB unable to issue enough senior and junior resolution debt to achieve and maintain compliance with its final MREL.”

The subordinated debt rating is sensitive to changes in the bank's VR.

An upgrade of the GSR would be contingent on a positive change in the sovereign's propensity to support the bank. In Fitch's view, this is highly unlikely, although not impossible.

“We expect to withdraw HB's GSR if Eurobank S.A. (BB/Stable) completes the planned acquisition of a majority stake in HB,” it said. “At that point, we expect to assign to HB a Shareholder Support Rating, the level of which will depend on Eurobank's Long-Term IDR and our assessment of Eurobank's ability and propensity to support HB.”

VR adjustments

The operating environment score of 'bb+' has been assigned below the 'bbb' implied category score, due to the following adjustment reasons: size and structure of economy (negative), level and growth of credit (negative).

The asset quality score of 'bb+' has been assigned above the 'b & below' implied category score due to the following adjustment reason: collateral and reserves (positive).

The earnings and profitability score of 'bb' has been assigned above the 'b & below' implied category score due to the following adjustment reason: historical and future metrics (positive).

The funding & liquidity score of 'bb+' has been assigned below the 'bbb' implied category score, due to the following adjustment reason: non-deposit funding (negative).

ESG considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section, Fitch explained. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision.