Moody’s upgraded the Bank of Cyprus mortgage covered bonds from Baa3 to Baa1 yesterday (Tuesday), citing upgrades to the sovereign, the issuer, and positive developments in the Cypriot housing market in recent years.

The rating agency on Friday upgraded Cyprus’s rating from Ba2 to Ba1, citing a reduction in its exposure to event risks because of a decrease in banking sector risks, as well as its economic resilience to the pandemic shock and robust medium term GDP growth prospects, supported by sizeable European funds.

Last Wednesday (21 July), Moody’s also upgraded Bank of Cyprus’s ratings, including its counterparty risk (CR) assessment from B1(cr) to Ba3(cr). It said the rating action captures the bank’s strengthened standalone credit profile and improved solvency, providing an increased buffer to the bank to navigate still-challenging conditions following the pandemic.

When upgrading the sovereign rating, Moody’s lifted Cyprus’ local and foreign currency country ceilings from A2 to A1. But it said that at present, covered bonds cannot reach the country ceiling because of: high correlation of risks within the banking system, resulting from the small number of players and their large size relative to the size of the economy; a still-high number of nonperforming loans in the banking sector; and challenging economic conditions posed by the coronavirus pandemic.

“In a hypothetical scenario where the sovereign were to default and a covered bond anchor event were to occur for the Bank of Cyprus, a disruption of servicing may result in a weakening of collections activities, leading to increased delinquencies, lower recoveries, and ultimately higher losses on the cover pool,” said Moody’s.

The effective servicing of the cover pool and likely recoveries from the assets are commensurate with a Baa1 rating, it noted.

To reflect a reduction of risks in the housing market in the past few years, Moody’s has lowered its collateral risk calculation for Bank of Cyprus covered bonds. However, it noted this also reflects downside risks related to the potential formation of new nonperforming loans, due to the fluidity of the pandemic and Cyprus’s exposure to the tourism sector and a high number of restructured loans in the country.

The rating agency noted that it does not apply its timely payment indicator (TPI) framework to Bank of Cyprus’ covered bonds programme, which has a conditional pass-through structure.