Fitch Ratings said in a report yesterday that the three largest Cypriot banks — Bank of Cyprus, Cyprus Popular Bank (Laiki Bank) and Hellenic Bank — all reported strengthened profitability with significant operating profit increases in 2005, thanks to declining but still-large loan impairment charges (LICs). The agency expects the banks to reinforce their profitability and improve their asset quality further, underpinned by broadly positive prospects for the domestic economy.

“Overall net interest revenues grew thanks to a good increase in the banks’ lending books and improved assets and liabilities management, which allowed the banks to underpin their net interest margin despite a 125bp decrease in the official Cypriot interest rates in 2005. Non-interest revenues rose on the back of both buoyant economic expansion in Cyprus and Greece and good performances by the banks’ insurance activities. On the cost side, the banks benefited from their efforts to improve productivity through merging smaller branches, increasing automation and freezing recruitment in Cyprus. In particular, Bank of Cyprus and Laiki reported satisfactory cost-to-income ratios.

“Although in 2005 the performance of the Cypriot banks continued to be affected by large LICs, their impact on operating profits was reduced, both as a proportion of the banks’ pre-impairment operating profit and in absolute terms. Loan impairment to gross impaired loans stands at 50-60 percent for the major Cypriot banks.

“However, Fitch considers that the banks may need to strengthen loan impairment coverage further. While they generally hold a high level of collateral and guarantees against both performing loans and impaired loans, average recovery periods in Cyprus remain long. Moreover, Fitch notes more stringent criteria by the Central Bank of Cyprus from January 2006, which defines impaired loans as loans in arrears more than 90 days and that are not 100 percent secured. However, this should have a manageable impact on the banks’ stock of impaired loans as the banks have already improved their credit and recollection processes or are overhauling them.

“At end 2005 the Cypriot banks reported adequate solvency ratios. Although their solvency ratios are quite good compared to international standards, Fitch considers the banks need to maintain additional capital to offset their large stocks of impaired loans,” Fitch said.