All three major Cypriot banks have significantly enhanced their profitability and the quality of their assets in 2006, although challenges remain in sustaining their improvement. The banks are the newly created Marfin Popular Bank (MPB), Bank of Cyprus Public Company Ltd (BOC) and Hellenic Bank Ltd (HB), Fitch Ratings said in a special report issued yesterday «Maintaining the current level of income generation remains one of the key challenges for the banks,» said Paolo Fioretti, the director of Fitch’s Financial Institutions team. «All banks benefited from strong growth in their operating income, thanks to the enormous loan growth and a benign capital market environment. Large gains from financial assets expanded at a rapid pace, contributing positively to the banks’ operating income in 2006.» However, Fitch views this revenue stream as less stable. The banks also benefited from foreign exchange income contributions, which will lessen with the introduction of the euro as the official currency. However, it will also give the banks opportunities to expand into new business areas and should partly reduce the volatility in financial gains from foreign exchange assets. BOC and HB reported sound profitability and generated adequate internal capital. Both banks benefited from restructuring and improved asset quality, which resulted in smaller impairment charges in 2006. MPB was created by a merger of Cyprus Popular Bank Public Company (Laiki Group) and two Greek banks, Marfin Financial Group (Marfin) and Egnatia Bank (Egnatia) in 2006. Its profitability is slightly weaker than its Cypriot peers due to high integration expenses in 2006. However, the bank has given positive profit guidance for its first-quarter results and plans to complete the merger by end-2007. Outward-looking The three largest banks have only limited growth possibilities in Cyprus, given their dominant share of about two-thirds of the domestic market and can only expand upon small bases by taking shares from the cooperative banks. Naturally, a key element of the major banks’ strategy is international expansion. All three banks are already in Greece, which represents their second «local» market. Some Cypriot banks are considering expanding further into Southeast Europe, targeting countries with fast-expanding economies, unsophisticated banking sectors and cultural affinities or large Cypriot communities, such as the Balkans, Romania, Ukraine and Russia. Fitch is watching these activities closely. In 2006, asset quality at all three major banks continued to improve. All three banks strengthened their loan impairment coverage to more than 70 percent. Fitch views this level as satisfactory, considering the banks hold a high level of collateral and guarantees against both performing loans and impaired loans. However, the average recovery period in Cyprus remains long. The three banks also improved their loan impairment ratios by adopting more conservative lending approaches while the Cypriot economy continued to grow. At end-2006 the Cypriot banks reported adequate solvency ratios. Although their capital ratios compare well with international standards, Fitch believes the banks need to maintain additional capital to offset their large stocks of impaired loans, strong loan growth and further acquisitions, especially in less developed markets. Fitch’s special report «Major Cypriot Banks: Annual Review and Outlook» is available on the agency’s website www.fitchratings.com. MPB is rated at Issuer Default BBB+/ Stable/ F2/C/2. BOC is rated at Issuer Default A- (A minus)/ Stable/ F2/ C/ 2 and HB is rated at Issuer Default BBB/ Stable/ F3/ D/ 2. The support floors for all three banks remains unchanged at BBB.