FINANCE: Bank of Cyprus capital via deferred tax credits bolstered after law change

Parliament approving the conversion of a certain type of deferred tax assets (DTAs) into deferred tax credits (DTCs) was good news for Cyprus’ largest bank, said ratings agency Moody’s.

Bank of Cyprus (B3 positive, caa11) is the main beneficiary of the amendment, and the conversion of eligible DTAs into government claims under certain conditions will strengthen its capital levels, said a Moody’s analysis.

The bank’s regulatory pro-forma Common Equity Tier 1 (CET1) ratio on a group basis will increase by 170 basis points to 15.4%, while we estimate that our ratio of tangible common equity (TCE) to risk-weighted assets will rise by 60 basis points to 11.2%, it added.

The law amendment addresses DTAs realized from tax losses transferred to a bank from its acquisition of another resolved bank. DTAs are a lower-quality asset and both Moody’s and bank regulators give them limited value in banks’ capital calculations.

It benefits banks because they can convert these DTAs into DTCs, or government claims, enabling direct reimbursement from the government when a bank reports a loss or enters liquidation.

This, in turn, will allow banks to fully include these DTCs as part of CET1 capital under the Basel III regulatory framework. We will also give them a higher credit as part of our TCE calculations, although we do not recognize them fully, said Moody’s.

Bank of Cyprus is the only bank that has taken on material tax losses from a resolved bank, Cyprus Popular Bank in March 2013.

The amendment will enable Bank of Cyprus’ regulatory capital ratio to improve by Euros 250 mln, which stems from the reversal of prior DTA impairments, the inclusion of DTCs in the regulatory CET1 capital calculation and through lower risk-weighted assets on a transitional basis.

As a result, the bank’s pro forma CET1 will rise to 15.4% from 13.7% as of the end of 2018.

This compares with a minimum regulatory capital ratio of 10.5% in 2019. The bank’s figures also include the potential sale of nonperforming exposures (NPEs) that awaits regulatory approval.

Because the realization of eligible DTCs could take up to 10 years in the case of Cyprus, we will still limit the benefit to our TCE ratios, which will nonetheless increase, said Moody’s.

IT added: We expect the bank’s TCE to improve by Euros 100 mln, increasing our adjusted ratio of TCE to risk-weighted assets by around 60 basis points to 11.2% from 10.6% as of September 2018. Our ratio excludes the NPE sale, which has the potential to further increase the ratio to nearly 13%.

The analysis argued that stronger capital levels enhance the buffers that the bank has available to absorb the full effect of International Financial Reporting Standard No. 9, which reduces CET1 by 190 basis points to 13.5%, and to support its NPE reduction strategies.

As of the end of 2018, group NPEs were one of the highest in our rated bank universe, with a ratio of NPEs to gross loans of 36%, including the potential NPE sale.

The bank’s improved capital levels would provide it with more flexibility to use part of its excess capital in the form of additional provisions, if needed, to dispose of further NPEs.

Cyprus follows other European Union countries that have already implemented similar legislation, including Italy, Spain, Portugal and Greece.

Unlike Greece’s legislation, in Cyprus there is no dilution to bank shareholders because no shares are transferred to the government as reimbursement for any realised government claims.

Source: The Financial Mirror