Resuming coverage

Bank of Cyprus

Banks / Cyprus

Reuters / Bloomberg: BOCH L / BOCH LN

Rating Buy The storm before the calm vs. previous rating U/R

We resume coverage on Bank of Cyprus with a Buy rating and EUR 2.95 target price. The investment case Target Price (€) 2.95 gravitates towards the stock of NPEs, the real estate market and a swift recovery of the Cypriot banking U/R system. We add that the banking sector in Cyprus is currently going through a transformational period vs. previous target price (€) which could end up with meaningful changes to the current status of the system. The first highlight is Current Share Price* (€) 2.44 Bank of Cyprus reportedly engaging in a significant NPE transaction (up to EUR 4bn, according to our *23 / Jul / 2018 estimates) and the second highlight is the already announced acquisition of certain assets of CCB by Hellenic Bank. As far as Bank of Cyprus is concerned, we estimate that, a successful, capital neutral Stock Data disposal of the NPEs can add an 11% premium to our current target price, to EUR 3.29. For the time being, Market Cap (€ m) 1,081.7 we welcome the ongoing reduction of the NPE stock (EUR 5.6bn since 2015, or c.40% to EUR 8.3bn) Free Float 86% combined with efforts on restructurings and higher cash coverage. Going forward we expect the decline Outstanding Shares (m) 446 to continue and estimate an organic reduction of 36% in the stock until 2020. Additionally, the Shareholders Lamesa, EBRD, CY Pop. investment case is supported by a benign macro environment with expected cumulative GDP growth of Bank, TD AM, Senvest 10% for the next three years (3.2% average), according to the European Central Bank. For Bank of Cyprus, we estimate a return on tangible book value of 6% in 2020, supported by the reduction of the cost of Performance risk, which will start bringing the bank back to a more “normal” environment when compared to recent events such as the EUR 1bn capital raise in 2014 and the one-off impairments of EUR 630m in 2015 and 1m 3m 12m EUR 500m in 2Q17. We add that, as part of its restructuring plan, the bank proceeded with the disposals Absolute (%) 27.7 25.8 -25.6 of foreign subsidiaries (incl. Greece, Ukraine, Russian, certain assets in Romania and recently the UK CSE (Abs) 6.7 11.8 -1.1 business) as well as other non-core assets. Capital wise, Bank of Cyprus reported a fully loaded CET1 ratio of 11.7% in 1Q18, which is above the 9.375% SREP for 2018. We expect the bank to continue to build its capital organically, reaching 13.2% in 2020, although still booking impairments on loans around Daily avg. no. of traded shares – 12M (th.) 197.3 130bps, but on track to potentially resume the distribution of dividends in the coming years. Price high – 12 months (€) 3.40 Price low – 12 months (€) 1.41 The elephant in the room…may be leaving, adding 11% premium to target price. As far as we understand, Bank of Cyprus is working on the disposal of a significant NPE portfolio, which we estimate to potentially reach EUR 4bn vs. current stock of EUR 8.3bn. If successful, the bank’s NPE ratio would initially decline to 110 c.18% (from current 45%). We assume that the bank would be able to dispose the corporate and SME 100 90 portfolios, keeping the retail portfolio (to benefit from the Estia scheme) and the EUR 1.5bn of loans with 80 no arrears still sitting under the NPE perimeter. According to our estimates, a cleaner Bank of Cyprus would 70 be valued 11% above our current target price –assuming a capital ratio neutral disposal under the base 60 scenario for the transaction, implying a hit of EUR 390m to the equity, counterbalanced by RWA relief of 50 40 EUR 2.9bn. Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18Mar-18 Apr-18 May-18 Jun-18

Underlying trends and efforts are positive. Bank of Cyprus has been showing a sustained reduction in the BOCH CSE SX7E stock of NPEs, from EUR 15.2bn in Mar-15 to EUR 8.3bn in Mar-18, of which EUR 1.5bn are NPEs with forbearance measures and no arrears. Following the 2014 recap and the one-off impairment hits in 2015 Company Description: and 2017, the focus is on improving the balance sheet at the same time as delivering a healthy bottom line Bank of Cyprus was founded in 1899 and is in the years to come. We expect the bank’s RoTE to improve significantly in 2018, to 5.1%, increasing to headquartered in Nicosia, Cyprus. The bank offers a range 5.7% in 2020. Nevertheless, the bank still sits on a NPE ratio of 44.9%, covered at 50.8% (after the of financial products and services, including private implementation of IFRS 9). banking, fund management and investment banking, commercial banking, factoring and insurance. As of May Cypriot environment is supportive but uncertainties around banking sector still cause worries. Differently 2018, it operated through 123 branches, of which 121 in to other peripheral markets, the macro environment in Cyprus looks solid and supportive. The country Cyprus, 1 in Romania, and 1 in the United Kingdom, as delivered GDP growth of 3.9% in 2017, following 3.4% growth in 2016 and is heading to grow by an average well as representative offices in Russia, Ukraine, and of 3.8% in the next three years, according to the estimates from the IMF. However, the growth expectations China. need to be translated into improved dynamics for the banks’ income statement (i.e. improved profitability) and balance sheet (i.e. continuous reduction of the NPE portfolio and loan granting). On a side note, Jonas Floriani Cyprus’ incumbent president, Nicos Anastasiades, won the recent elections and had his term renewed until [email protected] 2023. This should keep main political risks at bay, but we do not discard volatility stemming from the + 44 20 8068 3516 geopolitical front, namely the Cyprus dispute. Argyrios Gkonis Risks and valuation. As main sources of risk for BoC we highlight: (i) worsening GDP and macro dynamics; [email protected] (ii) slow-down in the pace of the NPE reduction; (iii) delays in the organic build-up of capital; (iv) aggressive +30 210 741 4462 competition putting pressure on the margin developments; (v) renewed political uncertainty and; (vi) potential escalation of the Cyprus dispute, directly affecting the way forward with the energy resources. Celia Hjioannou Regarding the upcoming stress test, to be announced in November, we expect no negative surprises given [email protected] the assumptions announced in February, point to cumulative GDP contraction of -0.2%, under the adverse +357 22 742 013 scenario over three years in Cyprus. Based on our estimates, Bank of Cyprus should achieve a RoTE of 6% in 2020. On our numbers the bank trades on 0.46x TE18e and our valuation is based on ROE/COE model with capital allocation of 12%, cost of equity of 10.5% and 0% growth in perpetuity.

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Executive summary ...... 3 Valuation and risks ...... 3 Cypriot Banking system: the new era ...... 4 Cyprus Banking sector stock performance ...... 4 Disposal of NPEs potentially adds 11% premium to target price ...... 5 How the balance sheet would look like? ...... 6 What would be the impact on the income statement? ...... 6 Will Bank of Cyprus need to raise capital? ...... 7 Further haircuts to collateral may come at a cost for the bank ...... 7 REMU and NPL servicing ...... 8 The underlying story ...... 9 Amendments in the legal framework ...... 9 Asset quality improving ...... 10 Real Estate Management Unit ...... 11 Capital seems to be enough ...... 12 IFRS 9 impact is manageable ...... 12 What about the rest of the balance sheet? ...... 13 The lending environment in Cyprus ...... 14 Deposit levels slowly trending up ...... 15 Macro and politics ...... 16 The recovery of the real estate sector ...... 17 Political risks to remain under control ...... 18 Heading towards investment grade ...... 19 Income statement dynamics ...... 20 Net interest income outlook ...... 20 Asset side ...... 20 Funding costs ...... 22 Fees and commissions ...... 24 Expenses – the search for efficiency ...... 24 Credit impairments to remain above 100bps ...... 25 The sale of the UK operations ...... 25 Appendix 1 ...... 26 Financial institutions in Cyprus ...... 26 Cyprus Cooperative Bank – sale of assets and recent developments ...... 26 Bank of Cyprus – Management ...... 27 Bank of Cyprus shareholders ...... 27 Appendix 2 - More on NPEs: BoC x system ...... 28 Asset quality targets and the Central Bank’s monitoring ...... 32 New approach on solving the NPE issue ...... 33 Sale of Portfolios ...... 34 Legal framework on the sale of loans (amended in July 2018) ...... 35 Foreclosed assets – what is going on? ...... 36 Extension to capital gains tax waiver ...... 36 In-house management of NPLs ...... 38 Cyprus Cooperative Bank’s actions on NPEs ...... 38 Estia Scheme...... 38 The ECB on Cypriot NPLs ...... 40 Financial Estimates ...... 42

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Executive summary

We resume coverage of Bank of Cyprus with a Buy rating and target price of EUR 2.95, implying an upside of 21% vs. the closing price of 23 July 2018. The Cypriot banking system is currently going through a period of deep transformation, where Bank of Cyprus is reportedly considering the disposal of a large portfolio of non- performing exposures (we estimate to potentially reach EUR 4.4bn, out of the EUR 8.3bn the bank currently sits on) and Hellenic Bank recently announced the acquisition of certain assets (EUR >10bn) from Cyprus Cooperative Bank (CCB). These two events bring significant changes to the system, transforming the competitive landscape but also intruducing a new era to the banking sector in the country, with institutions expected to report significantly lower NPE ratios (c.25% or below), suggesting the potential start of a good momentum for sustained new lending and higher profitability. In our view, if Bank of Cyprus successfully manages to dispose the corporate and SME portfolios in a capital neutral way, we would expect a 11% premium to our target price. Additionally, we would expect the bank’s 2020 return on tangible equity to improve to 8%, from the current estimate of 6% - driven by a higher percentage of performing loans in the book and therefore lower credit impairments (75bps on gross loans). Without considering the potential transaction, we expect Bank of Cyprus to reduce its stock of NPEs by 36% between now and 2020, with the respective ratio declining by 11pp, to 34%. As it stands, the bulk of the reduction is likely to come from smaller transactions as well as write-offs, whilst restructurings will support a sustainable back-loaded improvement of the banks’ balance sheets. On the profitability side, the introduction of IFRS 9, leading to higher coverage levels, and the good momentum of the country’s macro are expected to support the ongoing negative NPE formation, resulting in lower needs for credit impairments. As a result, we forecast impairments to decrease to 130bps on gross loans by 2020, supporting our estimate of 6% return on tangible equity and at the same time giving the bank potential upside in case of the booking of lower cost of risk going forward.

We note that the gradual improvement of the Cypriot banking system has been supported by a positive macro environment and sustained economic growth (11% GDP growth since 2015, on a twelve month rolling basis) on top of a series of changes at the regulatory and supervisory level, especially on the NPE arena. We highlight the cooperative borrower framework introduced by the Central Bank of Cypus, key performance indicators for reducing the stock and amendments to the foreclosure and insolvency laws which allow the sales of portfolios. Additionally, we add that the government is working on a subsidy for borrowers with mortgages on primary residences in arrears, which will support the recovery of the banks’ NPEs. Moreover, the minimum capital ratio banks are required to hold (SREP) published on a yearly basis, with the input from the European Single Supervisory Mechanism (SSM), gives us some confidence that dilutive capital actions and changes to capital plans, under the current environment, are unlikely. Bank of Cyprus’ current 2018 CET1 SREP ratio stands at 9.375% vs. 1Q18 fully loaded CET1 ratio of 11.7% - allowing for IFRS 9 transitional arrangements. On the other hand, and despite the recent positive developments and the macro momentum, we still expect the environment to remain challenging for the banks. By that we mean the continuation of the deleveraging in the economy, additional top line pressure from increased competition (especially with HB taking assets from CCB), the low interest rates and an expected moderate level of cost of risk. Valuation and risks

We value Bank of Cyprus using a ROE/COE methodology on 2020 estimates, discounted back to the end of 2018, assuming a cost of equity of 10.5% and growth of 0% in perpetuity, for a target price of EUR 2.95 per share. As the main sources of risks we highlight: (i) worsening GDP and macro dynamics; (ii) slow-down in the pace of the NPE reduction; (iii) delays in the organic build-up of capital; (iv) aggressive competition putting pressure on the margin developments; (v) renewed political uncertainty and; (vi) potential escalation of the Cyprus dispute, directly affecting the way forward with the energy resources.

Figure 1: Valuation table Target Stock P/TBV (x) RoTBV P/E Price (€) (€) rating 2018E 2019E 2020E 2018E 2019E 2020E 2018E 2019E 2020E Bank of Cyprus 2.44 2.95 Buy 0.45 0.43 0.41 5.1% 5.6% 5.7% 8.6 7.8 7.3 Greece 0.36 0.34 0.32 2.6% 4.4% 5.3% 13.8 9.8 7.8 Italy 0.70 0.67 0.64 7.7% 7.5% 7.3% 9.8 8.4 7.5 Spain 1.10 1.03 0.97 11.6% 10.9% 10.3% 9.8 9.4 8.6

Source: Capital IQ and AXIA Research. Note: Systemic banks for Greece and sample of banks for the other countries.

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Cypriot Banking system: the new era

The three main Cypriot Banks, Bank of Cyprus, Cyprus Cooperative Bank and Hellenic bank are involved in two significant transactions which could materially transform the face of the Cypriot banking system. Currently, Bank of Cyprus is the biggest bank in the country by assets and market share on loans and deposits, as per the figure below.

As far as we understand, Bank of Cyprus is working on the sale of NPEs, which we estimate to potentially reach EUR 4bn, out of the current stock of EUR 8.3bn. If this goes ahead we would see the bank with a NPE ratio of around 18% vs. 45% reported in 1Q18. We acknowledge the complexity of the deal, the number of exposures and collateral involved and therefore understand that the final impact for the bank, on a capital basis, may come in different shapes and forms. We believe that there are no specific sets of NPE portfolios available for sale and the transaction will depend on the bid(s) received by Bank of Cyprus. Under our base case scenario, discussed on this report, Bank of Cyprus may be able to dispose the portfolio in a capital neutral way, meaning that a EUR 390m hit to the bank’s equity is counterbalanced by the derecognition of EUR 2.9bn of RWAs.

Figure 2: Main players in the Cypriot banking system, and the changes to the landscape

50%

40%

30% HB + CCB, EUR, 17bn

20% BoC, EUR 23.4bn CCB, EUR 13.8bn

Deposit market share market Deposit 10% Hellenic Bank, EUR 6.7bn 0% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Loans market share

Source: Company data and AXIA Research. Note: Jun-17 data for CCB, 1Q18 for others. Bubble size = total assets.

Additionally , Hellenic Bank is in the process of bidding for certain assets of Cyprus Cooperative Bank (CCB), which would transform the bank into the second biggest bank in the island and would change the environment of the system from a competition point of view. The acquisition, once concluded, will result in a bank with total assets of c.EUR 17bn and NPE ratio below 25%, according to the bank’s press release.

Cyprus Banking sector stock performance From the charts below, we can see that Bank of Cyprus’ share price have under performed the local market, European banks and the indices of other southern European countries.

Figure 3: BoC share price vs. Indices (SXXP Index & CY) Figure 4: BoC share price vs. Indices (IT, PT, ES & CY)

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May-18 May-18 CSE:BOCH FTSE MIB INDEX PSI-20 Index CSE:BOCH STOXX Europe 600 Banks Index CSE General Market Index Madrid Ibex 35 Index CSE General Market Index

Source: Capital IQ and AXIA Research.

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Disposal of NPEs potentially adds 11% premium to target price

On this exercise we assume that the bank will be able to dispose NPEs amounting to EUR 4.4bn, which includes corporate and SMEs portfolios. Taking into account the potential changes to the balance sheet and the income statement arising from the potential sale of a significant part of the NPE portfolios, we would see Bank of Cyprus trading just below tangible book value, at EUR 3.29, which represents a 11% upside to our base case target price. The amount of public information about Bank of Cyprus’ transaction is quite limited at this stage.

Although we consider that Bank of Cyprus would be able to sell EUR 4.4bn of NPEs, at the same time we add that there is not specific set of NPEs for sale, with the transaction depending on the appetite of the bidders as well as the bid levels. We do not discard the possibility of having more than one buyer for different portfolios, although we understand that BoC will prefer to transact with a single buyer. We note that Bank of Cyprus’ management has mentioned they want to dispose the NPEs in a capital neutral way. Finally, we expect binding bids to be received until the end of July, or beginning of August, 2018 and the announcement of potential sales to be made sometime in September 2018.

Figure 5: Valuation scenario Valuation 2020E current 2020E (post) RWA 16,304 13,414 CET 2,146 1,812 COE 10.5% 10.5% Growth 0.0% 0.0% ROE 6.9% 10.4% Net profit 147 188 Valuation 1,609 1,792

Shares 446.1 446.1 EUR / share 3.61 4.02 NPV per share 2.95 3.29

ROE/COE 0.65 0.99

Source: Company data and AXIA Research.

Below we show the different target prices given lower cost of risk and cost of equity after the diposal of NPEs.

Figure 6: Valuation – sensitivity analysis 2020E Target price CoR (on gross loans) ROE COE Base case 2.95 1.48% 5.7% 10.5% Base post transaction 3.29 0.75% 10.4% 10.5% Base post transaction (50bps CoR) 3.72 0.50% 11.8% 10.5% Base post transaction (50bps CoR + 10% COE) 3.95 0.50% 11.8% 10.0%

Source: Company data and AXIA Research.

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How the balance sheet would look like? We add the NPE disposal on top of our current financial estiamates for Bank of Cyprus, which already include some normalization in the income statement and the balance sheet (including the reduction of NPEs). By 2020 we would expect that the benefit from the government backed ESTIA scheme will be live and, at the time, Bank of Cyprus will be a step closer, but still far, from the NPE level expected by the European Banking Authority (EBA) of 5%. Below we show the dynamics of a capital neutral disposal, which would imply a EUR 390m hit to the bank’s equity, maintaining the CET1 ratio at 13.5%.

Figure 7: Bank of Cyprus 2020 balance sheet – pre and post transaction (EUR m) 2020E (pre) 2020E (post) Gross loans 15,556 11,156 Loan loss reserves (2,623) (463) Net loans 12,933 10,693 NPEs 5,331 2,000 NPE ratio 34.3% 17.9% Total assets 22,342 20,102 RWA 16,304 13,414

CET1 2,202 1,812 CET1 ratio 13.5% 13.5% Tangible equity 2,667 2,277

C/I ratio 42% 41% ROE 5.5% 8.3% Source: Company data and AXIA Research. We expect Bank of Cyprus to be able to dispose the NPE portfolios linked to the corporate and SME book, leaving untouched the EUR 1.5bn which has been earmarked for leaving the NPE perimeter in the coming years for having no arrears, despite still being under the NPE perimeter. Additionally, we believe that the bank may be able to sell unsecured retail exposures at the same time as getting benefits from the government backed ESTIA scheme, which will support borrowers in arrears on their mortgage loans.

Figure 8: Perimeter up for sale (AXIAe) Portfolio breakdown and deleverage (1Q18) Gross loans NPEs Legacy interest income Corporate 8,650 2,600 102 SME 3,658 1,800 70 Retail Housing 4,266 2,400 94 Retail Other 2,012 1,500 59 Total 18,586 8,300 325

NPEs to be disposed NPEs Coverage Coverage RWA Corporate 2,600 45.9% 1,193 1,612 SME 1,800 53.7% 967 1,278 Total 4,400 2,160 2,890

Source: Company data and AXIA Research.

What would be the impact on the income statement? As expected, significant changes to the balance sheet come alongisde significant changes to the bank’s income statement as well. The main drivers here are on the interest income and the need for impairments on the non- performing exposures. Bank of Cyprus breaks down some income statement lines between the performing and non-performing (legacy) book, as shown below.

Figure 9: Bank of Cyprus: performing vs. legacy Loans EUR m 2015 2016 2017 Performing 9,900 10,000 10,200 Legacy 7,200 5,600 4,400

Interest income Performing 444 420 Legacy 411 325

2017 Income Statement EUR m Performing Legacy Other Group Interest income 420 325 745 Provisions 4 (297) (486) (779) Net Interest income 424 28 452 Cost of risk 0.0% 3.3% 4% Yield 4.20% 7.05% 4.93% Risk adjusted yield 4.24% 0.61% 2.99%

Avg Net loans 10,004 4,608 486 15,098 RWA intensity 58% 110% 73%

Source: Company data and AXIA Research.

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We make the relevant adjustments to the banks’ income statement, based on our 2020 estimates, as seen in the figure below.

Figure 10: Projected income statement BoC pre/post transaction EUR m 2020E (pre) 2020E (post) NII 378.6 266.7 Other 334.0 267.2 Total revenues 712.6 533.8 Opex (299.3) (219.3) PPI 413.3 314.5 Total Impairments (230.4) (84.1) PBT 182.9 230.4 Tax (25.6) (32.3) Other (10.0) (10.0) Net profit 147.3 188.2

C/I ratio 42% 41% ROE 5.5% 8.3% Impairments on gross loans 1.48% 0.75%

Source: Company data and AXIA Research.

Despite having a smaller balance sheet than our estimate in 2020, we see Bank of Cyprus able to deliver higher profitability on the back of lower equity and total impairments, given that most loans will be performing or restructured.

Will Bank of Cyprus need to raise capital? We believe that the transaction can be done without the need of fresh capital or the dilution of current shareholders. In regards to this specific transaction, we understand that the bank is working towards a non- dilutive solution, meaning that, depending on the bid levels, the hit to equity and capital are going to be offset by the derecognition of RWAs, unless the bank manages to get bids which will also bring positive impact to the income statement.

Given that the bank’s total coverage on the corporate and SME portfolios is above 100%, sitting at 117.5% and 123.5%, respectively, a bid at 100% would mean that the bidder is haircutting the collateral by 24% on the corporate side and 34% on the SME side. Having said that, we believe that the bank has a case for being able to transact the portfolios at book value, avoiding hits to the equity of shareholders. The deconsolidation of EUR 2.9bn of RWAs alone supports the capital ratio with 290bps.

Figure 11: Transaction scenarios Transaction scenarios CET1 CET1 impact RWA CET1 ratio CET1 change Sold at book value (net NPE) 2,202 0% 13,414 16.4% 2.9% Capital neutral 1,812 -18% 13,414 13.5% 0.0%

Source: Company data and AXIA Research.

Further haircuts to collateral may come at a cost for the bank Below we show that if we increase the haircut on the collateral to 50% across the board (vs. 25% and 35% under the base case) we would see a 5% decrease to our valuation. Finally, with a haircut to collateral of 58% the bank would reach its SREP ratio of 9.375%, so we see this as the maximum haircut to collateral the bank is able to absorb without capital actions. Nevertheless, we believe that the bank will aim for a capital neutral transaction whilst trying to avoid getting close to the SREP level.

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Figure 12: Transaction scenarios Valuation 2020E current 2020E (post) 50% coll. Haircut At SREP level RWA 16,304 13,414 13,414 13,414 CET 2,146 1,812 1,521 1,257 COE 10.5% 10.5% 12.0% 13.0% Growth 0.0% 0.0% 0.0% 0.0% ROE 6.9% 10.4% 12.4% 15.0% Net profit 147 188 188 188 Valuation 1,609 1,792 1,568 1,448

Shares 446.1 446.1 446.1 446.1 EUR / share 3.61 4.02 3.52 3.25 NPV per share 2.95 3.29 2.80 2.54

ROE/COE 0.65 0.99 1.03 1.15 Change to target price 11% -5% -14%

CET1 ratio 13.2% 13.5% 11.3% 9.4%

Source: Company data and AXIA Research.

REMU and NPL servicing Given that the visibility on the transaction is still limited, we also see as unclear of what is going to happen with the bank’s Real Estate Management Unit and its NPL servicing agreement with Pepper Europe (for the SME and retail portfolios). At the same time, the investors acquiring the NPEs would need to make sure they will have servicing capabilities and assign as soon as possible a team to work on the recovery of the exposures.

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The underlying story

If we leave the NPE transaction aside we still find a bank focused on improving its asset quality whilst aiming for higher profitability. From a capital perspective, Bank of Cyprus experienced three major capital events in recent years: 1) a EUR 1bn recapitalization in 2014; 3) one-off impairment adjustment of EUR 630m in 4Q15 and; 3) a one-off EUR 500m impairment hit in 2017.

Apart from that, the bank keeps delivering on the organic reduction of the stock of NPEs and the income statement trends, based on 1Q18 results, are encouraging. We expect the bank to deliver a return over tangible equity of 5% in 2018.

Before going into the details, which will be discussed throughout this report, we want to highlight recent changes to the framework approved by the Cypriot Parliament. In an extraordinary session held on July 8, the plenary of the Parliament approved a number of bills aiming at improving the legal framework and tackling the high stock of NPLs in the Cypriot banking sector. Further to the amending laws which relate to foreclosures and insolvency, securitization of loans was also approved. Moreover, on a plenary session held on July 17, the Parliament extended the capital-gains tax waiver.

Amendments in the legal framework The amendments in regards to foreclosures provide, amongst others, the following:  Enable the banks to split a mortgage to cover other loan agreements so that no loan will remain unsecured when collateral is transferred to the buyer of the loan;  Limit the cases the borrower can bring to court;  Amendments in the way letters are being delivered to the borrowers and relevant time slots;  Termination of the privileged status if the value of the primary residence exceeds EUR 350k and if the borrower receives a government grant to cover part of its debts;  Old court decisions, rulings or arbitrations to fall under the new procedure of foreclosures;  The borrower will be required to allow the lender to enter the property for valuation purposes (i.e. to define the market value of the property);  Introduction of e-auctions (the Ministry of Finance is expected to issue relevant guidelines);  The foreclosure process is ceased if a court decree is issued.

In addition, sale of loans process changes are as follows:  Buyer of the loan is exempted from payment of fees resulting from the transfer of the collateral;  Buyers of loans to have full access to all documentation pertaining to a loan in order to be able to properly assess their prospective purchase;  Banks are allowed to offset deposits and debts of the borrowers prior to the sale of the loan;  Continuation of legal proceedings if initiated by the assignor.

In regards to securitization of loans:  Banks to establish a special purpose vehicle (SPV);  Banks then proceed with the transfer of loans to the SPV;  After the transfer, SPV will proceed with the securitization of the loans (Central Bank of Cyprus to be responsible for the securitization of loans) and issue securities which will be sold to investors in order to raise capital. Through this process bank facilities cease to be recognized in the bank’s books.

Turning focus on the insolvency framework, the amendments include:  Government and local authorities lose priority repayment;  Eligibility criteria are extended: (i) market value of residence of up to EUR 350k (from EUR 300k previously); and (ii) total value of the rest of the borrowers’ assets up to EUR 500k (from EUR 250k previously);  Protection is ceased if the borrower fails to pay his loan instalments for three months;  Guarantors’ protection is extended.

Last but not least, tax changes approved include:  Sale of real estate to third parties to be tax exempt, when proceeds are used to repay loans listed as non-performing as of the end of 2015;  The capital gains tax exemption applies if the property is sold to a third party and the proceeds are used for full or partial repayment of the loan and in cases where credit-acquiring companies (after the purchase of loans) proceed to a debt-to-asset swap with the property of the mortgage.

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Asset quality improving The ongoing large stock of NPEs is the main challenge faced by Bank of Cyprus and the Cypriot banks in general. Nevertheless, in March 2018 , Bank of Cyprus reported its 12th consecutive quarter of NPE reduction, from EUR 15.2bn in Mar-15 to EUR 8.3bn, with the NPE ratio declining from 63% to 45%.

Figure 13: Bank of Cyprus - NPE stock and ratio (EUR bn)

24,000 63.0% 61.9% 62.2% 61.8% 61.0% 70% 59.3% 57.8% 54.8% 51.8% 50.0% 60% 19,000 47.6% 46.9% 44.9% 15,175 14,809 50% 14,225 13,968 13,327 12,493 11,901 14,000 11,034 40% 10,372 9,752 9,164 8,804 8,349 9,000 30% 20% 4,000 10% (1,000) 0% 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18

NPEs NPE ratio

Source: Company data and AXIA Research.

The NPE reduction was achieved whilst increasing the NPE cash coverage to 51% (including the implementation of IFRS 9) from 38% in 2016.

Figure 14: Bank of Cyprus - NPE cash coverage

47.6% 48.8% 47.8% 50.8% 39.0% 39.0% 39.5% 41.0% 41.8% 35.3% 36.3% 34.7% 38.1%

1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18

NPE cash coverage

Source: Company data and AXIA Research.

The bank’s NPE portfolio is skewed towards corporates (41%) and SMEs (26%). As seen below, the corporate ex posures have been on a downtrend in the last years.

Figure 15: BoC NPE portfolio EUR m Figure 16: BoC NPE portfolio – relative breakdown 13,968 10% 11% 14% 14% 1,371 11,034 14% 1,963 16% 18% 19% 1,268 8,804 8,349 3,442 1,773 25% 27% 1,220 1,166 23% 26% 2,996 1,569 1,593 2,027 2,181 7,192 51% 45% 45% 41% 4,997 3,988 3,410

2015 2016 2017 1Q18 2015 2016 2017 1Q18

Corporate SME Retail Housing Retail Other Corporate SME Retail Housing Retail Other Source: Company data and AXIA Research.

Bank of Cyprus’ reduction of non-performing loans has been achieved by a mix of restructurings/collections, write-offs, consensual foreclosures and non- consensual debt x equity, whilst the redefault rates have been improving with more recent vintages presenting a lower amount of defaults/redefaults than the stock. Nevertheless, the majority of NPE inflows are coming from redefaults – EUR 0.56bn from EUR 0.93bn in total for 2017.

It is important to highlight that EUR 1.5bn out of EUR 8.3bn NPEs are forborne exposures with no arrears and expected to leave the perimeter in the coming years. Bank of Cyprus estimates that EUR 0.5bn will leave the perimeter in 2018, EUR 0.4bn in 2019 and EUR 0.6bn from 2020.

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The new classification of non-performing exposures, under IFRS 9, means that banks have the loan book broken down in three stages, according to its quality. Below we show the breakdown of the bank’s exposure by Stages and coverage levels. Stage 3 are non-performing exposures, with cash coverage of 48%.

Figure 17: BoC – exposures breakdown and provisions Provisions over Provisions over 1Q18 (EUR bn) Gross loans % of gross loans NPEs Provisions gross loans NPEs Stage 1 5.8 31% - 0.06 1.0% n/a Stage 2 4.4 24% - 0.13 3.0% n/a Stage 3 8.4 45% 8.3 4.01 47.7% 48% Total 18.6 8.3 4.2 22.6% 51%

Gross loans Provisions Provisions over gross loans 4Q17 1Q18 4Q17 1Q18 4Q17 1Q18 Stage 1 5.2 5.8 0.1 0.1 1.3% 1.0% Stage 2 4.8 4.4 0.1 0.1 2.7% 3.0% Stage 3 8.8 8.4 4.3 4.0 49.0% 47.7% Total 18.8 18.6 4.5 4.2 24.0% 22.6%

Source: Company data and AXIA Research. Note: 4Q17 data for illustrative purpose.

Real Estate Management Unit Bank of Cyprus’ real estate management unit (REMU) has been focusing on increasing the volume of sales of real estate assets, with the average transaction happening above book value –linked to the bank’s onboarding policy (real estate assets normally onboarded at a 25-30% discount from open market valuations). Nevertheless, the stock of properties is on the rise given the increasing number of foreclosures. Bank of Cyprus will need to continue with its strategic approach on foreclosures but as well as on the disposal of assets, avoiding to put pressure on property prices, given the significant supply and, so far, unmatching demand.

Figure 18: REMU (EUR m) – book value

134 1,641 1,552 -55 3 -5 -166

Dec-17 Additions Sales Transfer to Impairment loss Other Mar-18 Investment Properties

Source: Company data and AXIA Research.

Figure 19: Breakdown of real estate assets (Mar-18) Figure 20: Breakdown of real estate assets (Mar-18)

Greece and EUR m # Assets Romania Residential Under 8% 10% Residential 159 487 construction 4% Offices and comm. 229 195 Offices and comm. Manufacturing and industrial 94 45 Golf 15% Hotels 57 10 17% Land and plots 566 1,261 Manufacturing Golf 265 3 and industrial 6% Under construction 60 43 Hotels Greece and Romania 122 596 4% Total 1,552 2,640 Land and plots 36%

Source: Company data and AXIA Research.

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Capital seems to be enough

Bank of Cyprus reported a CET1 capital ratio of 12.0% in March 2018 and 11.7% on a fully loaded basis, allowing for IFRS transitional arrangements. This is comfortably above the 2018 SREP ratio of 9.375% (reduced from 9.5% in 2017) the bank needs to meet. In any case, we acknowledge the fact that investors may require Bank of Cyprus to show a higher capital given the bank’s high amount of non-performing exposures, but understand that given the implementation of IFRS 9, and the potential sale of NPEs with no dilutive capital actions, could result in even lower capital requirements for 2019 and beyond.

Under our base case, Bank of Cyprus will be able to increase its fully loaded CET1 ratio by 100bps to 13.2% between 2017 and 2020, on the back of cumulative pre-provision income of EUR 1.3bn and credit impairments of EUR 0.6bn.

Figure 21: Solid capital ratio to continue 13.9% 13.1% 13.0% 13.2% 25,000 12.2% 12.8% 15% 20,000 10% 15,000

10,000 5% 5,000

- 0% 2015 2016 2017 2018E 2019E 2020E

CET1 fully loaded RWA CET1 fully loaded ratio (rhs)

Source: Company data and AXIA Research.

IFRS 9 impact is manageable Bank of Cyprus announced an estimated impact from IFRS 9 of c.EUR 0.3bn on equity, which represents c.180bps on CET1 ratio of 12.7% (phased) published in Dec-17. We show the phased impact on the static Dec- 17 CET1 ratio below.

Figure 22: BoC IFRS 9 impact

0.09% 0.27% 0.54% 0.90% 1.35% 1.80%

12.7% 12.6% 12.4% 12.1% 11.8% 11.3% 10.9%

2017 2018 2019 2020 2021 2022 2023

CET1 ratio cum. Impact

Source: Company data and AXIA Research.

Figure 23: IFRS 9 – stages Provisions over Provisions over 1Q18 (EUR bn) Gross loans % of gross loans NPEs Provisions gross loans NPEs Stage 1 5.8 31% - 0.06 1.0% n/a Stage 2 4.4 24% - 0.13 3.0% n/a Stage 3 8.4 45% 8.3 4.01 47.7% 48% Total 18.6 8.3 4.2 22.6% 51%

Gross loans Provisions Provisions over gross loans 4Q17 1Q18 4Q17 1Q18 4Q17 1Q18 Stage 1 5.2 5.8 0.1 0.1 1.3% 1.0% Stage 2 4.8 4.4 0.1 0.1 2.7% 3.0% Stage 3 8.8 8.4 4.3 4.0 49.0% 47.7% Total 18.8 18.6 4.5 4.2 24.0% 22.6%

Source: Company data and AXIA Research. Note: 4Q17 data for illustrative purposes.

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What about the rest of the balance sheet?

The two main drivers of a bank’s balance sheet, loans and deposits, are still not seeing a normalized dynamic in Cyprus. By that we mean that we see the deposit base growing just below the GDP estimates, at 2-2.5% with net loans growing at a higher rate but as a function of the reduction of NPEs (and its effect on gross loans) and the reduction of loan loss provisions. On a gross loan basis we estimate Bank of Cyprus’ book to shrink by 2% per year, on a compound basis, between 2017 and 2020, under our baseline scenario.

On the other hand, Bank of Cyprus is ready to lend, with a net loan/deposit ratio around 80%, but the deleveraging of the economy and the lack of demand add pressure to the ratio.

Figure 24: Loans to deposit ratio Loans to deposit ratio 2015 2016 2017 1Q18 Group (gross) 159% 122% 105% 103% Cyprus (gross) 163% 121% 105% 102%

Net loans / deposits (group) 121% 95% 82% 80%

Source: Company data and AXIA Research.

Figure 25: BoC Group Loans by segment (EUR m) Figure 26: BoC Group Loans by geography* (EUR m)

22,592 22,592 725 20,130 20,130 1,207 2,184 18,755 18,586 18,755 18,586 565 1,296 320 345 2,091 1,621 4,304 2,064 2,012 1,764 4,216 4,171 4,684 4,266 4,346 3,510 3,658 20,661 18,269 16,814 16,478 11,421 9,477 9,010 8,650

2015 2016 2017 1Q18 2015 2016 2017 1Q18

Corporate SME Retail Housing Retail Other Cyprus United Kingdom Other

Source: Company data and AXIA Research. *We highlight that Bank of Cyprus’ UK operations were sold as of 3Q18 and will be deconsolidated in due course.

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The lending environment in Cyprus Looking at the lending environment in Cyprus as a whole, we conclude that the loan volumes remain under pressure. Banks are, in theory, ready to lend, given that the loan to deposit ratios remain below 100%. This was the result of the deleveraging of the economy.

Figure 27: Credit impulse (May’18) (€bn/%) Figure 28: HHs & NFCs Credit (May’18) (€/bn)

80 40% 70 60 60 50 20% 40 40 30 0% 20 20 10 0

0 -20%

Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18

Aug-15 Aug-13 Aug-14 Aug-16 Aug-17

Nov-13 Nov-12 Nov-14 Nov-15 Nov-16 Nov-17

May-17 May-13 May-14 May-15 May-16 May-18

Jul-12

Jan-09 Jan-16

Jun-08 Jun-15

Oct-10 Oct-17

Apr-07 Apr-14

Feb-13 Sep-13

Dec-11

Aug-09 Aug-16

Nov-07 Nov-14

Mar-10 Mar-17

May-11 May-18 System Loans Flow y-o-y (rhs) Households Corporate

Source: Central Bank of Cyprus and AXIA Research.

Figure 29: HHs & NFCs credit volume by segment (May’18) (€/bn) Figure 30: System credit by currency (May’18) (€/bn) (€/bn) 70 80 60 70 60 50 50 40 40 30 30 20 20 10 10 0 0

Jul-12

Jul-16

Jan-16 Jan-09

Jan-11

Jun-08 Jun-15

Jun-06 Jun-17

Oct-10 Oct-17

Apr-14

Oct-13

Feb-13 Sep-13

Apr-08

Feb-10 Sep-14

Dec-11

Aug-09 Aug-16 Dec-11

Aug-15

Nov-07 Nov-14

Nov-12

Mar-10 Mar-17

Mar-09

May-11 May-18

May-07 May-18 Consumer Mortgage Other retail Corporate Euro Non-euro Source: Central Bank of Cyprus and AXIA Research.

Figure 31: System Loans-to-Deposit Ratio (May’18) (€bn/%) Figure 32: System credit by segment y-o-y evolution (May’18) (%)

80 160% 5.0%

0.0% 60 120% -5.0% 40 80% -10.0% 20 40% -15.0%

0 0% -20.0%

Feb-18 Feb-14 Feb-15 Feb-16 Feb-17

Aug-13 Aug-14 Aug-15 Aug-16 Aug-17

Nov-13 Nov-14 Nov-15 Nov-16 Nov-17

May-06 May-07 May-08 May-09 May-10 May-11 May-12 May-13 May-14 May-15 May-16 May-17 May-18

May-13 May-14 May-15 May-16 May-17 May-18

L-t-D (rhs) Loans (lhs) Deposits (lhs) Consumer Mortgage Other retail Corporate Source: Central Bank of Cyprus and AXIA Research.

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Deposit levels slowly trending up Prompted by the complete abolition of capital controls on deposit withdrawals in April 2015, nevertheless, system deposits in Cyprus have been on a slow upward trend since 2014. In total, (including government deposits) system deposits stood at EUR 50.9bn at end of May 2018 with 78% being driven by domestic residents and 22% from foreigners, an increase of 3.7% y-o-y (EUR 1.8bn).

Figure 33: System Deposits and Commercial Gap (1Q18) (€/bn) Figure 34: Aggregate Deposits (May’18) (€/bn and y-o-y) 80 30% 70 16 14 60 15% 12 60 50 10 0% 40 8 40 30 6 -15% 4 20 20 2 -30% 10 0

0 -2 0 -45%

1Q15 1Q17 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 2Q17 3Q17 4Q17 1Q18

Jan-07 Jan-09 Jan-11 Jan-13 Jan-15 Jan-17

Sep-13 Sep-07 Sep-09 Sep-11 Sep-15 Sep-17

May-08 May-10 May-12 May-14 May-16 May-18 Deposits (HHs & NFCs) (lhs) Commercial Gap (rhs) NFCs (lhs) Households (lhs) System Deposits y-o-y (rhs) Source: Central Bank of Cyprus and AXIA Research.

On the figures below we show the breakdown of Bank of Cyprus’ deposits by type and segment. The majority of the bank’s deposits are linked to time deposits, followed by demand accounts and savings. In regards to segments, the majority of the deposits come from local customers, followed by funds’ international activity companies registered in Cyprus and abroad and non-residents.

Figure 35: BoC Group Deposits by type (EUR m) Figure 36: BoC Deposits by geography* (EUR m) 17,850 17,996 16,510 17,850 17,996 16,510 14,181 - - 2 1,867 1,890 14,181 1,465 10,000 9,918 3 4,163 3,995 9,266 1,487 4,495 8,160 3,754

1,062 1,537 1,681 1,034 12,111 10,549 11,820 6,313 6,397 8,937 4,987 6,182

2015 2016 2017 1Q18 2015 2016 2017 1Q18

Demand Savings Time or notice Cyprus - non IBU Cyprus - IBU7 United Kingdom Romania

Source: Company data and AXIA Research. *We highlight that Bank of Cyprus’ UK operations were sold as of 3Q18 and will be deconsolidated in due course.

Figure 37: Deposits by category – evolution (May’18) (%) Figure 38: Deposits by currency (May’18) (€/bn)

60% 80

40% 70 60 20% 50 0% 40 -20% 30 20 -40% 10

-60% 0

Jan-15 Jan-09 Jan-11 Jan-13 Jan-17

Jan-07 Jan-09 Jan-11 Jan-13 Jan-15 Jan-17

Sep-11 Sep-07 Sep-09 Sep-13 Sep-15 Sep-17

Sep-07 Sep-09 Sep-11 Sep-13 Sep-15 Sep-17

May-18 May-08 May-10 May-12 May-14 May-16

May-12 May-08 May-10 May-14 May-16 May-18 NFCs HHs System Deposits Euro Non-euro

Source: Central Bank of Cyprus and AXIA Research.

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Macro and politics

The Cypriot economy is experiencing a positive momentum that is expected to be maintained in the medium term. Following three years of severe economic contraction, the near collapse of its banking sector, a bail-in of depositors of the two biggest local banks back in 2013, weak sovereign economics, Cyprus has entered a period of economic growth. Following the successful completion of the three year economic adjustment programme (EAP) at the end of March 2016 (two months ahead of the official expiration date) Cyprus remains under post-programme surveillance (reviews occur twice a year) until the country repays at least 75% of the financial assistance received or EUR 5.5bn.

Exceeding all expectations, Cyprus’ economy expanded by 3.9% in 2017, while it is expected to remain robust, albeit somewhat decelerating over the medium term. In particular, the 1Q18 marks the 13th succeeding quarter posting a positive growth (both on annual and quarterly basis), with the Cypriot economy growing by 4% y-o-y (+1% q-o-q) on seasonally adjusted terms, reaching c. EUR 4.2bn (in real terms). The economic growth was mainly driven by a dynamic tourism sector, an accelerating construction activity and strong private consumption. Private consumption is supported by falling unemployment, which according to latest data released by Eurostat, reached 8.4% in May’18, registering the largest decrease (-300bps y-o-y) among the EU member states.

The Ministry of Finance’s projections estimate a real GDP growth of 3.8% and 3.6% in 2018 and 2019 respectively, whereas, the IMF estimates call for a 4.0% growth in the current year and 4.2% in 2019. We note that over the past few years the performance has been slightly better than the IMF expectations.

Figure 39: Real GDP (y-o-y; q-o-q) Figure 40: Gross Value Added by sector as of 1Q18 (%) Agriculture 2.0% 6.0% Arts and other Industrials services 2% 8% 1.5% 4.0% 1.0% 4.0% 4% 1.0% Construction 2.0% 6% 0.5% Public administration and 0.0% 0.0% defence, Education and -0.5% -2.0% Health -1.0% 23% Tourism, trade -4.0% -1.5% and transport -6.0% -2.0% Professional and 24% -2.5% -8.0% administrative activities 10%

Financials Information and

1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 1Q17 3Q17 1Q18 3Q11 Real Estate 9% communication 4% Real GDP q-o-q Real GDP y-o-y 10%

Source: CySTAT and AXIA Research.

Figure 41: Unemployment vs. employment rate (%) Figure 42: Tourist arrivals vs. revenues

50.0% 76.0% 600 450.0 74.6% 400.0 40.0% 75.0% 500 406.9 350.0 74.0% 400 357.2 300.0 nono 30.0% 73.0% 250.0 251.5 269.4 20.0% 22.4% 300 Note 72.0% 200.0 200 150.0 10.0% 71.0% 9.4% 100.0 0.0% 70.0% 100 50.0

0 0.0

1Q12 1Q11 3Q11 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 1Q17 3Q17 1Q18

Feb-15 Feb-16 Feb-17 Feb-18

Aug-14 Aug-15 Aug-16 Aug-17

Nov-15 Nov-16 Nov-17

Unemployment rate (lhs) Youth Unemployment (15-24) (lhs) Nov-14

May-15 May-16 May-17 May-18

Employment rate (15-64) (rhs) Tourist Arrivals Revenues (€/mn) (rhs)

Source: CySTAT, Eurostat and AXIA Research.

Public debt-to-GDP ratio declined to 97.5% in 2017, exceeding the Ministry of Finance’s estimation of 98.4%.

Recall that public debt peaked at 107.5% of GDP in 2014-15, but managed to fall below 100% last year. In April 2018, the government proceeded with a deposit of EUR 2.5bn at the Cyprus Cooperative Bank, consisting of: (i) nine private placement bond issues for the total amount of EUR 2.35bn maturing between 15 and 20 years; and (ii) EUR 0.15bn of state cash reserves. This was done in order to bolster the bank, which was going through

nono a process of identifying an investor at the time, and secure the stability of the banking system. This resulted to a significant increase in the public debt-to-GDP ratio. Note

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However, on July 16, five new government bonds were issued, again with private placement to CCB, for a total nominal amount of EUR 3.19bn maturing between 5 and 53 months. Note that the latter debt issuance was under the transaction perimeter of Hellenic Bank and CCB. Despite the material impact, we believe that strong GDP growth (c. 4% in 2018 and 2019) and primary surpluses will allow the debt-to-GDP ratio to resume its downward path going forward.

Figure 43: General Government Public Debt (% of GDP)³ Figure 44: Public debt maturity profile (EUR/bn) – as of Dec’17

120 107.5 107.5 2.0 102.6 106.6 105.6 97.5 100.0 94.6 1.6 1.6 1.6 100 88.0 1.6 79.7 1.3 1.3 1.4 80 1.2 1.2 65.7 1.1 1.2 1.2 1.2 56.3 1.2 1.0 1.1 60

40 0.8

20 0.4 0.2 0.0 0.0 0.1 0

0.0

2013 2010 1011 2012 2016 2017

2014¹

2015²

2018e 2019e 2020e 2021e

2020 2018 2019 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035+ Public Debt (% of GDP) Foreign-Law Securities Domestic-law Securities IMF/ESM Loans Other Loans

Source: CySTAT, Ministry of Finance and AXIA Research. Notes: ¹Including the equity injection of EUR 1.5bn to Cooperative Central Bank, ²Including the equity injection of EUR 175mn to Cyprus Cooperative Bank, ³Estimations take into consideration government’s deposit of EUR 2.5bn to CCB but not the additional EUR 1bn agreed later on.

Figure 45: 10Y Cyprus government bond yields (%) Figure 46: Government vs. primary surplus (% of GDP)

6%

4.5% 4.7% 4.6% 4.6%

3.5 4.4% 3.4%

4% 3.0%

1.9%

1.8% 1.8%

1.7% 1.7%

3 1.7%

0.9%

2% 0.3% 2.5 0% nono 2 -2%

-4%

1.3% 1.8%

Note1.5 -

-

2.4%

2.4%

- -

-6% 3.1%

3.5% -

1 -

4.5% -

-8% 5.1%

5.4%

-

5.5%

5.7%

-

5.9%

- - 0.5 -10% -

0 -12% 9.0%

-

2008 2009 2010 2011 2012 2013 2016 2017

2014¹

2015²

Jul-17 Jul-18

2018e 2019e 2020e 2021e

Jan-18

Jun-18

Oct-17

Apr-18

Sep-17 Feb-18

Dec-17

Aug-17

Nov-17 Mar-18 May-18 Budget Balance Primary Balance

Source: Capital IQ, CySTAT, Ministry of Finance and AXIA Research. Notes: ¹Including the equity injection of EUR 1.5bn to Cyprus Cooperative Bank, ²Including the equity injection of EUR 175mn to Cyprus Cooperative Bank

The recovery of the real estate sector Following a 31% property price reduction since 3Q08, consistent signs of recovery are now being observed in the real estate sector. Currently, prices in the real estate sector follow an upward trend, as both construction activity and real estate demand picks up and prices improve. The Central Bank of Cyprus’ Residential Property Price Index (RPPI) in 1Q17, recorded for the first time since 2008, positive growth rates both on annual and quarterly terms with these trends continuing during 1Q18 as well.

In the first half of 2018, contracts of sales reached 4.5k, posting an increase of 23.8% y-o-y. Since the beginning of 2018, the definition of ‘local’ and ‘foreigner’ property buyers has changed and therefore cannot be compared with the respective data of previous years. However, it is interesting to note that during the period January-June 2018, the number of foreign buyers slightly exceeds the number of domestic buyers. The revitalization of the island’s real estate market owes much to the increasing interest of foreign investors, and particularly to the citizenship and permanent residence schemes, as well as to numerous tax incentives.

In parallel, building permits are also on the rise with a 8.8% y-o-y increase in number and 27.5% y-o-y in value during January-April 2018. The sustained recovery of the real estate sector and the recovery of property prices will provide additional support to the Cypriot banks’ deleveraging efforts and improve their asset quality.

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Figure 47: Residential Property Price Index (y-o-y %) Figure 48: Residential Property Price Index by district 110 4% 1.5% 2% 100 0% -1.8% -2% 90 -1.2% -4% 80 -6% -9.4% -8% -5.0% 70 -10% 60

-12%

Q2 Q1 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q2 Q3 Q4 Q1 Q2 Q3 Q4

Q1 Q4 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2010 2011 2012 2013 2014 2015 2016 2017 2011 2012 2013 2014 2015 2016 2017 Nicosia Limassol Larnaca RPPI Paphos Famagusta Source: CBC and AXIA Research.

Figure 49: Building Permits Number vs. Value (EUR/bn) Figure 50: Contracts of sale Overseas vs. Domestic (until 2017)

10,000 8,896 8,950 8,777 3.5 16 14.7 100% 9,000 7,506 3 14 7,172 80% 8,000 12 6,072 2.5 nono7,000 5,728 8.6 5,341 5,354 10 8.2 8.4 60% 6,000 4,933 5,014 2 7.0 7.1 5,000 8 6.3 Note 3.8 4,000 1.5 6 4.5 5.0 40% 3,000 1 4 2,000 20% 1,000 0.5 2

0 0 0 0%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

2010 2008 2009 2011 2012 2013 2014 2015 2016 2017 2018e Domestic Foreigners Number lhs) Value (rhs) Domestic % share Foreigns % share Source: CySTAT, Department of Lands and Surveys and AXIA Research.

Figure 51: Total contracts of sale Figure 52: Contracts of sale Overseas vs. Domestic (Jan-Jun'18)

1,800.0 200.0% 1,600.0 Paphos 1,400.0 150.0% nono1,200.0 Limassol 100.0% 1,000.0 Note800.0 50.0% Larnaca 600.0 400.0 0.0% Famagusta 200.0

0.0 -50.0% Nicosia

Jun-15 Jun-16 Jun-17 Jun-18

Jun-14 0% 20% 40% 60% 80% 100%

Sep-14 Sep-15 Sep-16 Sep-17

Dec-15 Dec-14 Dec-16 Dec-17

Mar-14 Mar-15 Mar-16 Mar-17 Mar-18

Total Contracts of sales (lhs) y-o-y change (rhs) Domestic EU residents Non-EU residents

Source: CySTAT, Department of Lands and Surveys, AXIA Research

Political risks to remain under control

The recent re-election of the President of the Republic, Nicos Anastasiades, along with the continuation in office of the Minister of Finance, Harris Georgiades, ensures the continuation of the economic and fiscal policy, which are expected to remain on the same path in the medium-term.

With regards to the reunification of the island, talks remain at a stand still. There has been minimal official nono contact between the two sides, with only one informal meeting held between the Turkish Cypriot leader, Note Mustafa Akinci, and Anastasiades since the conference in Crans-Montana in July 2017. The UN Secretary General, António Guterres, recently appointed Jane Holl Lute for the conduction of consultations with interested parties in Cyprus, in late July, in Turkey, Greece and the UK to probe the potential resumption of settlement talks. Jane Holl Lute has been accepted by all involved parties and already had meetings in Cyprus. In his latest report, Guterres encourages the parties to recognize the importance of the exercise and to seize

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the opportunity, while stressing that should the two leaders agree to resume talks, they will need to demonstrate strong political commitment and determination.

In addition, the recent tensions between Cyprus and Turkey in the Cypriot EEZ, demonstrate the challenges to reunification. In February 2018, Turkish military ships stopped Saipem 12000 vessel, a ship hired by Eni, on its way to drill for gas in block 3 of the Cypriot EEZ. EC and other foreign authorities have repeatedly urged Turkey to respect Cyprus’ sovereign rights over its EEZ and avoid any further actions that could cause more friction. Issues with Turkey will likely remain as a noise in the background, however, and under the current environement, we do not expect any negative surprises to affect the overall economy.

House of Representatives’ composition Following the action of the Supreme Court to annul the election of a Solidarity Movement’s MP in May 2017, leaving the seat vacant, ruling party DISY regained the ability to reach consensus on economic issues having only the centrist party DIKO’s support. Note that during parliament’s plenary session on June 13, a legislation in regards to the procedure to be followed in case a seat at the House is unoccupied was passed, however, Anastasiades refused to sign it into law. Thus, a hearing is scheduled to take place in November for final arguments on the matter.

Figure 53: Previous/Current Compositions of Parliament

May'11 20 19 8 5 1 1 1 1

May'16 18 16 9 3 3 3 2 2

As of today 18 16 10 3 1 3 2 2 1

DISY AKEL DIKO² EDEK Citizens Alliance²·⁴

Solidarity Movement¹·³ Green Party ELAM Independent⁴ European Party¹

Source: Cypriot Parliament and AXIA Research. Note¹: Solidarity Movement absorbed the European Party in March 2016. Note²: In May 2017, Citizens Alliance’s MP Pavlos Mylonas, left the party and became an Independent MP. In May 2018, Mylonas joined the centrist party, DIKO. Note³: The Supreme Court annulled the election of Solidarity Movement’s MP Georgios Papadopoulos to parliament, after he had inherited his seat from his party leader, Eleni Theocharous, who after her election as MP in May 2016, she left her seat to party’s runner-up (i.e. Georgios Papadopoulos). The seat is currently vacant. Note⁴: In February 2018, Citizens Alliance’s MP Anna Theologou, left the party and became an Independent MP.

Heading towards investment grade Since 2013, Cyprus’ sovereign credit ratings have been progressively improving as Credit Rating Agencies (CRAs) have upgraded Cyprus from 2 to 5 notches. However, Cyprus is still in the speculative grade.

On April 20, Fitch upgraded Cyprus’ sovereign rating by one notch to BB+ (one notch below investment grade), with the outlook being positive. Fitch also noted that future developments that may lead to an upgrade include: (i) reduction in the high stock of NPEs; and/or (ii) track record of declining public debt-to-GDP ratio; and/or (iii) continued deleveraging of the private sector. On the other hand, S&P review affirmed the sovereign rating of the country to BB+, while maintaining the positive outlook.

In general, the recent measures taken to tackle the high stock of NPLs in the banking system, along with the acquisition of the Cyprus Cooperative Bank by Hellenic Bank seem to be viewed as positive, despite the increase in the public debt.

Figure 54: Sovereign Ratings Latest rating Short Term Long Term Outlook Next Review action Fitch Ratings B BB+ Positive 20 April 2018 19 October 2018 Standard & Poor’s B BB+ Positive 16 March 2018 14 September 2018 Moody’s Investor Service Not provided Ba3 Positive 28 July 2017 27 July 2018 Source: Rating Agencies, Ministry of Finance and AXIA Research.

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Income statement dynamics

Net interest income outlook The system’s net interest margin (NIM) remained under pressure in recent years, averaging 238bps in 2017 vs. the recent highs of 308bps in 2014. The reduction has been primarily driven by the ongoing deleveraging efforts of the banks and the restructuring solutions offered to customers as well as the increased competition in some segments such as mortgages.

Figure 55: System NIM (%) Figure 56: System – RoA and RoE (rhs)

3.5 2% 40%

3.0 0% 0%

2.5 -2% -40%

2.0 -4% -80% 1.5 -6%

1.0 -8% -120%

1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17

Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17

Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-17

Dec-12 Dec-14 Dec-10 Dec-11 Dec-13 Dec-15 Dec-16 Dec-17

Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 RoA RoE Source: Central Bank of Cyprus and AXIA Research.

As a result, we expect the de-risking actions to negatively weigh on the banks’ NIM in the short-term; although we should anticipate a relative improvement/stabilization further down the road given that the economy’s

outperformance would allow the banks to proceed with the granting of new loans.

nonoFigure 57: BoC - NII over total assets Figure 58: BoC - Return on tangible equity 4.0% 3.62% Note 5.1% 5.6% 5.7% 3.5% 3.02% 2.2%

3.0% 2.55%

2.5% 1.94% 1.79% 1.72% 2.0% 1.5% 1.0%

0.5% -15.0% 0.0% 2015 2016 2017 2018E 2019E 2020E -19.5%

BoC 2015 2016 2017 2018E 2019E 2020E

Source: Company data and AXIA Research.

Asset side On the asset side, the banks in Cyprus are experiencing pressure on the top line, mainly due to the low interest rate environment. The interest income margin on gross loans (from 4.97% in 2015 to 3.9% in 2020) and the net interest income over average total assets (3.6% in 2015 to 1.72% in 2020) reflect the challenging nono environment.

Note

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Figure 59: Bank of Cyprus – Interest income Interest income 2015 2016 2017 2018E 2019E 2020E Loans and advances to customers 1,009.8 853.9 744.8 598.8 549.9 546.6 Loans and advances to banks and central banks 4.5 5.4 11.7 11.1 10.2 10.1 Investments available-for-sale 13.7 10.9 19.9 12.7 11.7 11.6 Investments amortised cost ------Investments FVOCI 88.5 11.2 - 5.2 4.7 4.7 Investments classified as loans and receivables ------Trading investments 0.1 0.0 0.0 0.0 0.0 0.0 Derivative financial instruments 4.8 4.6 31.8 28.8 26.4 26.3 Other investments at fair value through profit or loss 0.7 0.6 0.1 0.0 0.0 0.0 Total 1,122.1 886.6 811.0 658.7 604.8 601.2

Interest income over gross loans 4.97% 4.15% 4.17% 3.82% 3.90% 3.90% Interest income over net loans 6.5% 5.4% 5.4% 4.9% 4.9% 4.8% NII/total assets 3.62% 3.02% 2.55% 1.94% 1.79% 1.72%

Source: Company data and AXIA Research.

Figure 60: Front book loans – HHs (Cyprus) % Figure 61: Front book loans – NFCs (Cyprus) %

9.0 8.0 8.0 7.0 7.0 6.0 6.0 5.0 5.0 4.0 3.0 4.0 2.0 3.0 1.0 0.0 2.0

-1.0

Feb-10 Feb-13 Feb-16

Aug-08 Aug-11 Aug-14 Aug-17

Nov-10 Nov-13 Nov-16

May-09 May-12 May-15 May-18

Feb-10 Feb-13 Feb-16

Aug-14 Aug-08 Aug-11 Aug-17

Nov-10 Nov-13 Nov-16

May-09 May-12 May-15 May-18 Consumer Retail Mortgage Other lending Euribor 1 year NFCs: Overdrafts NFCs: Loans up to €1mn NFCs: Loans over €1mn

Source: ECB, Central Bank of Cyprus and AXIA Research.

Figure 62: Front book loans vs. peers – Consumer up to 1 yr. (%) Figure 63: Back book loans vs. peers – Consumer over 5 yrs. (%)

14.0 10.0

12.0 8.0 10.0 6.0 8.0 4.0 6.0 4.0 2.0 2.0 0.0

0.0

Jan-09 Jan-11 Jan-13 Jan-15 Jan-17

Sep-09 Sep-11 Sep-13 Sep-15 Sep-17

May-08 May-10 May-12 May-14 May-16 May-18

Jan-09 Jan-11 Jan-13 Jan-15 Jan-17

Sep-09 Sep-11 Sep-13 Sep-15 Sep-17

May-08 May-12 May-14 May-16 May-18 May-10 Greece Spain Italy Greece Spain Italy Cyprus Portugal Germany Cyprus Portugal Germany Source: ECB and AXIA Research.

Figure 64: Front book loans vs. peers – Housing up to 1 yr. (%) Figure 65: Back book loans vs. peers – Housing over 5 yrs. (%)

8.0 8.0 7.0 6.0 6.0 5.0 4.0 4.0 3.0 2.0 2.0 1.0

0.0 0.0

Jan-09 Jan-11 Jan-13 Jan-15 Jan-17

Jan-09 Jan-11 Jan-13 Jan-15 Jan-17

Sep-09 Sep-11 Sep-13 Sep-15 Sep-17

Sep-09 Sep-11 Sep-13 Sep-15 Sep-17

May-08 May-10 May-12 May-14 May-16 May-18

May-08 May-10 May-12 May-14 May-16 May-18 Greece Spain Italy Greece Spain Italy Cyprus Portugal Germany Cyprus Portugal Germany Source: ECB and AXIA Research.

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Figure 66: Front book loans vs. peers – NFCs (<1yr; <€1mn) (%) Figure 67: Back book loans vs. peers – NFCs (<1yr) (%)

9.0 10.0 8.0 7.0 8.0 6.0 5.0 6.0 4.0 4.0 3.0 2.0 2.0 1.0

0.0 0.0

Jan-09 Jan-11 Jan-13 Jan-15 Jan-17

Sep-15 Sep-09 Sep-11 Sep-13 Sep-17

Jan-17 Jan-09 Jan-11 Jan-13 Jan-15

Sep-13 Sep-09 Sep-11 Sep-15 Sep-17

May-08 May-10 May-12 May-14 May-16 May-18

May-10 May-08 May-12 May-14 May-16 May-18

Greece Spain Italy Greece Spain Italy Cyprus Portugal Germany Cyprus Portugal Germany Source: ECB and AXIA Research.

Figure 68: Front book loans vs. peers – NFCs (<1yr; >€1mn) (%) Figure 69: Back book loans vs. peers – NFCs over 5 yrs. (%)

8.0 8.0 7.0 6.0 6.0 5.0 4.0 4.0 3.0 2.0 2.0 1.0 0.0

0.0

Jan-13 Jan-09 Jan-11 Jan-15 Jan-17

Sep-09 Sep-11 Sep-13 Sep-15 Sep-17

May-08 May-10 May-12 May-14 May-16 May-18

Jan-09 Jan-11 Jan-13 Jan-15 Jan-17

Sep-09 Sep-11 Sep-13 Sep-15 Sep-17

May-12 May-18 May-08 May-10 May-14 May-16 Greece Spain Italy Greece Spain Italy Cyprus Portugal Germany Cyprus Portugal Germany

Source: ECB and AXIA Research.

Funding costs The liability side of the interest income is linked to the amount the banks have to pay in order to fund their lending capacity. As expected, the majority of the funding costs are related to the cost of the deposits the banks need to attract and maintain in the balance sheet. This, as seen in the following figures, is a function of the market rates but also of the bank’s need to lend. Bank of Cyprus’ net loans to deposit ratio stood at 80% in 1Q18. In theory, this number shows that the bank is not in desperate need for deposits to fund the growth of the loan book. Differently from rates on the asset side we discussed previously, the rates on the liability side have remained broadly stable in the last years.

Figure 70: Interest expense Interest expense 2015 2016 2017 2018E 2019E 2020E Customer deposits (154.8) (138.0) (140.7) (132.4) (131.0) (132.7) Funding from central banks and deposits by banks (95.6) (39.6) (4.1) (4.6) (4.5) (4.6) Subordinated loan stock - - (22.2) (22.3) (22.1) (22.3) Repurchase agreements (7.6) (6.5) (10.2) (9.8) (9.7) (9.8) Negative interest on loans and advances to banks and central banks - - (7.1) (8.6) (8.5) (8.6) Derivative financial instruments (21.7) (16.4) (44.0) (44.4) (44.0) (44.5) Total (279.7) (200.4) (228.3) (222.1) (219.8) (222.6)

Interest expense over total liabilities -1.38% -1.02% -1.14% -1.10% -1.14% -1.14% Source: Company data and AXIA Research.

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Figure 71: 1M and 3M Euribor rates (Jun’18) (%) Figure 72: New Deposits rates vs. Euro Area (up to 1yr) 0.40 7.0 0.30 0.20 6.0 0.10 5.0 0.00 4.0 -0.10 3.0 -0.20 2.0 -0.30 -0.40 1.0

-0.50 0.0

Jan-09 Jan-11 Jan-13 Jan-15 Jan-17

Jun-14 Jun-13 Jun-15 Jun-16 Jun-17 Jun-18

Oct-13 Oct-14 Oct-15 Oct-16 Oct-17

Feb-17 Feb-13 Feb-14 Feb-15 Feb-16 Feb-18

Sep-09 Sep-11 Sep-13 Sep-15 Sep-17

May-12 May-08 May-10 May-14 May-16 May-18

Euribor 3m Euribor 1m HHs NFCs HHs: Euro Area NFCs: Euro Area

Source: ECB, Central Bank of Cyprus and AXIA Research.

Figure 73: Deposit back book – HHs (Cyprus) Figure 74: Deposit front book – NFCs (Cyprus)

6.0 6.0

5.0 5.0 4.0 4.0 3.0 3.0 2.0 2.0

1.0 1.0

0.0 0.0

Jul-12

Jan-09 Jan-16

Jun-08 Jun-15

Oct-17 Oct-10

Apr-14

Jul-12

Feb-13 Sep-13

Dec-11

Aug-09 Aug-16

Nov-14

Mar-10 Mar-17

Jan-09 Jan-16

Jun-08 Jun-15

May-11 May-18

Oct-10 Oct-17

Apr-14

Feb-13 Sep-13

Dec-11

Aug-09 Aug-16

Nov-14

Mar-10 Mar-17

May-11 May-18 HHs: Overnight HHs: Up to 2 yrs NFCs: Overnight NFCs: Up to 2 yrs

Source: ECB, Central Bank of Cyprus and AXIA Research.

Figure 75: Deposit front book vs. peers – HHs up to 1 year (%) Figure 76: Deposit front book vs. peers – NFCs up to 1 year (%)

1.6 6.0 1.4 5.0 1.2 4.0 1.0 0.8 3.0 0.6 2.0 0.4 1.0 0.2 0.0 0.0

-1.0

Jul-16 Jul-17

Jan-17 Jan-18

Sep-16 Sep-17

Nov-16 Nov-17

Mar-17 Mar-18

May-17 May-16 May-18

Jan-09 Jan-11 Jan-13 Jan-15 Jan-17

Sep-09 Sep-11 Sep-13 Sep-15 Sep-17

May-14 May-08 May-10 May-12 May-16 May-18 Greece Spain Italy Greece Spain Italy Cyprus Portugal Germany Cyprus Portugal Germany

Source: ECB, Central Bank of Cyprus and AXIA Research.

Figure 77: Deposit back book vs. peers – HHs up to 2 years (%) Figure 78: Deposit back book vs. peers – NFCs up to 2 years (%) 6.0 6.0 5.0 5.0 4.0 4.0 3.0 3.0 2.0 2.0 1.0 1.0

0.0 0.0

Jan-09 Jan-11 Jan-13 Jan-15 Jan-17

Sep-11 Sep-09 Sep-13 Sep-15 Sep-17

Jan-09 Jan-11 Jan-13 Jan-15 Jan-17

Sep-09 Sep-11 Sep-13 Sep-15 Sep-17

May-08 May-10 May-12 May-14 May-16 May-18

May-12 May-08 May-10 May-14 May-16 May-18 Greece Spain Italy Greece Spain Italy Cyprus Portugal Germany Cyprus Portugal Germany

Source: ECB and AXIA Research.

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Fees and commissions The fees and commissions line for Bank of Cyprus is on a positive trend both in absolute terms, and also as a percentage of total assets. The growing economy and the growth of the loan book are expected to support the growth in fees and commissions income.

Figure 79: Fees and commissions

300 1.20% 0.93% 0.96% 250 0.83% 1.00% 0.79% 210 0.73% 200 180 187 200 0.66% 167 0.80% 153 150 0.60% 100 0.40% 50 0.20%

- 0.00%

Fees and commissions F&C % total assets

Source: Company data and AXIA Research. Expenses – the search for efficiency The bank’s restructuring, which included the closing of branches and the dismissal of employees, have helped in bringing down the cost/income ratio. On a simple comparison, the Cypriot banks are not the most “efficient” when compared to EU peers (although BoC screens well and HB and CCB sit in the middle of the pack), but are on the right track. Bank of Cyprus is targeting 2018 cost/income ratio below 50% (excluding special levy and SRF contribution) and for income to grow in excess of cost over the medium term.

Figure 80: Cost income ratios across Europe (admin expense over total operating income) (1H17)

93%

81%

74%

74%

72%

69%

67%

67%

66%

65% 64%

62%

57%

57%

52%

49%

49%

48%

46%

46%

46%

46%

45% 44%

43%

42% 41% 34%

Source: EBA and AXIA Research.

Figure 81: Cost/Income ratio – Bank of Cyprus

46.5% 45.3%

43.0% 42.0% 41.3% 39.2%

2015 2016 2017 2018E 2019E 2020E

Source: Company data and AXIA Research.

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Figure 82: BoC Group employees and branches

600 5,000 4,605 4,352 4,334 4,355 500 4,284 4,500 400 358 4,000 300 259 3,500 200 135 127 123 100 3,000

- 2,500 2013 2014 2015 2016 2017 Branches Employees (rhs)

Source: Company data and AXIA Research. Note: Cyprus employees in 2013 and 2014, group employees from 2015 onwards. Credit impairments to remain above 100bps We expect Bank of Cyprus to remain booking a relatively high amount of credit impairments as the bank will continue to seek improvements in the quality of the balance sheet. We estimate credit impairments over gross loans of 131bps in 2018, to remain at 130bps in 2019 and 2020. This roughly means annual average credit impairments of EUR 209m on average pre-provision income of EUR 416m, leaving Bank of Cyprus to deliver a return on tangible equity of 5-6% and short of 2018’s EPS guidance of EUR 0.40, at EUR 0.28.

Figure 83: Cost of risk and profitability

1,000 632 10% 566 485 431 404 413 5% 500 0% - -5% -10% (500) (226) (202) (200) (370) -15% (1,000) (779) -20% (959) (1,500) -25% 2015 2016 2017 2018E 2019E 2020E

PPI Credit impairments Credit impairments (as % of gross loans) (rhs) RoTE (rhs)

Source: Company data and AXIA Research.

The sale of the UK operations Bank of Cyprus recently announced the sale of its UK business to Cynergy Capital. Our financial estimates already account for the changes to the financial statements and the bank maintains the EPS guidance of EUR 0.40 for 2018. The sale consideration of EUR 117m is expected to add c.65bps to the bank’s CET1 capital ratio.

Figure 84: Group x UK business (1Q18) – EUR m

16,856 16,971 16,106

1,730 1,890 989

Gross loans (ex-UK) Gross loans UK Deposits (ex-UK) Deposits UK RWA (ex-UK) RWA UK

Source: Company data and AXIA Research.

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Appendix 1

Financial institutions in Cyprus Currently, there are 34 credit institutions operating in Cyprus with total assets amounting to EUR 67.6bn as of December 2017, according to data from the Central Bank of Cyprus. Bank of Cyprus, Hellenic Bank and the Cyprus Cooperative Bank combined hold 70% of the total gross loans in the system and almost 60% of total deposits. Despite the business concentration within three banks (and RCB), the existence of so many banks in a small-sized economy suggests the need for consolidation moves, likely to be initiated once there is clear progress by the system on the asset quality front, in our view.

Note that a consolidation move was completed in December 2016 when Piraeus Bank proceeded with the sale of 26% of its share capital in its Cypriot subsidiary, Piraeus Bank Cyprus, to Holding M. Sehnaoui (HMS). As a result, Piraeus Bank remained a minority shareholder in the bank with 17.7% stake, while Piraeus Bank Cyprus was later on renamed to Astrobank. Similar actions are possible to follow in the future (i.e. National Bank of Greece, USB Bank, etc.). Additionally, and as previously discussed on this report, Hellenic Bank has submited a bid for certain assets of Cyprus Cooperative Bank.

Figure 85: Main credit institutions in Cyprus Bank of Hellenic 2017 - €/m CCB RCB Alpha Bank Eurobank NBG CY Astrobank HFC SGBCy Cyprus Bank NII 583 188 218 131 64 67 22 22 16 9 Total revenues 907 218 254 234 77 97 28 38 19 15 Total expenses (549) (123) (101) (201) (55) (30) (21) (30) (6) (9) PPI 358 95 153 34 23 67 7 8 14 6 Provisions (953) (149) (39) (83) (107) (16) (15) (1) (15) (5) Net Income (554) (63) 97 (46) (87) 41 (7) 5 (3) 1

NPEs (€/m) 8,804 6,716 15 2,162 1,725 99 508 406 304 n.a NPE ratio 47% 59% 0% 53% 66% 5% 68% 56% 44% n.a NPE coverage 48% 45% 82% 60% 52% 73% 49% 52% 25% n.a

CET1 ratio 12.7% 16% 20% 14% 14% 27% 27% 17% 18% 17% RWAs (€/m) 17,260 7,528 2,196 3,420 1,828 1,526 662 654 515 314 CET1 (€/m) 2,184 1,168 442 483 252 406 177 111 90 54

Gross loans 18,755 11,417 6,886 4,055 2,629 1,967 747 724 686 368 Net loans 14,602 8,375 6,860 2,767 1,735 1,895 494 514 606 281 Deposits 17,850 11,971 3,010 5,808 2,205 4,265 573 1,103 880 488

Source: Company data and AXIA Research. Cyprus Cooperative Bank – sale of assets and recent developments

Hellenic Bank announced that is going ahead with the acquisition of certain assets of Cyprus Cooperative Bank

(CCB). The acquisition comprises a balance sheet of EUR 10.3bn which includes EUR 4.6bn in performing loans,

EUR 4.1bn in CGBs and EUR 1.6bn in cash. Additionally, it includes deposits of EUR 9.7bn and other liability

items. Hellenic Bank will pay CCB EUR 74m for the transaction and will offer current shareholders pre-emptive

rights in order to increase its capital by EUR 150m at EUR 0.70 per share, suggesting that the share count will increase to c.413m, from the current 198m. The transaction also implies that the combined entity will trade around 0.55x tangible equity, from 0.24x for Hellenic Bank now. We view this transaction, alongside a potential sale of NPEs by Bank of Cyprus to be a positive event for the Cypriot banking system.

For more details please see our published note here.

Figure 86: Hellenic Bank + CCB transaction – financial impacts EUR m Pre Post Capital Raise - EUR 150m 150 Market Cap 120 270 Equity 529 679 CET1 479 679 P/B 0.23 0.40 P/TBV 0.24 0.40 New shares at 0.70 214.3 Shares 198.5 412.8 RWA 3,456 4,964 RWA density 51% 29% CET1 13.9% 13.7%

Source: Company data and AXIA Research.

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Bank of Cyprus – Management John Patrick Hourican – CEO Date of appointment: October 2013 (CEO) and November 2013 (BoD member). Mr. Hourican currently serves as the chief executive officer of the Bank. He previously served as chief executive of The Royal Bank of Scotland Group’s Investment Bank (Markets & International Banking) from October 2008 until February 2013. Between 2007 and 2008 he served on behalf of a consortium of banks (RBS, Fortis and Santander) as chief financial officer of ABN AMRO Group and as a member of its managing board. He joined RBS in 1997 and is a leveraged finance banker. He held a variety of senior positions within RBS’s wholesale banking division, notably on the division’s board as finance director and chief operating officer. He also ran RBS’s leveraged finance business in Europe and Asia. Mr. Hourican started his career at Price Waterhouse and he is a fellow of the Institute of Chartered Accountants in Ireland. Mr. Hourican is a graduate of the National University of Ireland and Dublin City University.

Mr Hourican’s appointment finishes at the end of 2018. Although he previously mentioned that it was more likely for him to leave the bank as planned, we do not rule out seeing the current CEO extending the contract. In our view, the NPE transaction may play an important part on his decision. We would expect to hear about Mr Hourican’s plan towards the end of summer.

Christodoulos Patsalides – Deputy CEO & COO Date of appointment: 20 November 2014. Dr Patsalides currently serves as Bank of Cyprus’ deputy chief executive officer and chief operating officer. From 1989 to 1996, Dr. Patsalides previously worked for the Central Bank of Cyprus in the management of Government External Debt and Foreign Exchange Reserves Department. In 1996, Dr. Patsalides joined the Bank where he has held a number of positions in corporate banking, treasury and private banking, among others. From December 2013 to April 2016, Dr. Patsalides served as finance director and was responsible for finance, treasury, investor relations, economic research and procurement.

In his current capacities as the deputy chief executive officer and chief operating officer, he is responsible for human resources, corporate affairs, compliance, central operations, legal services, organisation and change, information technology, digital transformation and administrative operations.

Dr. Patsalides holds a doctor of philosophy degree and a master of science degree in economics from the London School of Economics and a bachelor of science degree in economics from Queen Mary College in London.

Eliza Livadiotou – Finance Director Date of appointment: April 2016. Under her current role, she is responsible for Financial Control, Treasury, Strategy and Corporate Finance, Investor Relations, Procurement and Economic Research.

Eliza studied economics at the University of Cambridge (MA Hons) on a Cambridge Commonwealth Trust scholarship. Between 1995-1999 she worked for the audit firm Arthur Andersen in Cambridge, where she qualified as a Chartered Accountant having obtained the prizes 1st in Order of Merit at Intermediate level and 7th in Order of Merit at Final level. In 1999 she returned to Cyprus and has been employed by Bank of Cyprus, initially as Assistant to the Group Chief General Manager and since 2005 as Manager Group Finance and Tax Planning. In 2012 her duties were extended to include Group Strategy and Corporate Finance.

In December 2013 she was appointed as Chief Financial Officer and in April 2016 as Finance Director. She is a member of the Financial Services Committee of the Institute of Certified Public Accountants of Cyprus since 2006 and she chaired the Committee during 2014-2016.

Bank of Cyprus shareholders Figure 87: Bank of Cyprus – Shareholder base (%)

Lamesa, 9.27% EBRD, 5.02%

CPB, 4.81%

TD AM, 4.34% Senvest, 3.67% Other, 65.94% Eaton Vance, 3.63%

Osome, 3.32%

Source: Company data.

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Appendix 2 - More on NPEs: BoC x system

In our view, the investment case of the Cypriot banks in general is a derivative of the reduction in the stock of NPEs as well as the Real Estate market given that Bank of Cyprus hold EUR 1.6bn in Real Estate assets mainly coming from foreclosures, and collateral coverage represents 68% of total NPE coverage. Banks will continue to focus on the reduction of the stock of NPEs in a way that avoids further capital increases, at least in the short-term. A swift reduction of the stock of non-performing loans will reduce the risks to the bank’s capital position at the same time as it improves the banks’ lending capabilities which in turn will support the increase in the system’s pre-provisioning profits and, consequently, healthier bottom lines.

Figure 88: Cypriot stock of NPEs - consolidated

35 50% 28.7 49% 30 28.4 28.1 28.0 27.3 26.3 48% EUR bn EUR 25.3 24.7 24.3 23.6 25 22.8 22.4 47% 21.8 20.9 46% 20 45% 15 44% 43% 10 42% 41% 5 40% - 39% 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 Feb-18

NPEs NPE ratio (rhs)

Source: Central Bank of Cyprus and AXIA Research. Note: 4Q17 estimated by AXIA Research.

As seen in the figure above, the stock of NPEs is on a downward trend in the last few years. More importantly, the related metrics such as NPE ratio, coverage, percentage of forborne and restructured loans, have also been improving as shown in the figure below. This is illustrated, for example, by the Bank of Cyprus’ forborne loans of EUR 1.5bn, with no arrears, which still fall under the NPE category. That is to say that the “real” NPE ratio of the bank is c.800bps lower, at c.37%. Additionally, with the introduction of IFRS 9 we are now able to check the banks’ coverage of Stage 3 exposures, which are the NPEs. They currently stand at 45%, with cash coverage of 48% for Bank of Cyprus.

In regards to NPE coverage, the Cypriot level was above the European average, before the implementation of IFRS 9 – data to be released after the publication of 1Q18 results by the European Central Bank.

Figure 89: NPE coverage (4Q17)

62.1% 50.9% 47.9% 46.3% 48.6% 48.1% 41.3% 41.6% 44.1% 37.4% 34.3% 31.2% 32.0% 26.2% 28.1% 28.3%

NPE cash coverage average

Source: ECB and AXIA Research.

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Figure 90: NPE ratios and coverage – EBA Transparency exercise (2017 exercise, based on 2Q17 data)

65.8%

58.8%

54.6%

54.2%

54.0%

53.8%

52.9%

49.9%

49.9%

49.3%

49.3%

48.9%

47.3%

43.8%

43.3%

42.4%

33.5%

32.5%

32.2%

29.2%

15.4%

10.1%

8.9% 4.5%

CY NPE ratio CY NPE Cash GR NPE ratio GR NPE Cash PT NPE ratio PT NPE Cash SP NPE ratio SP NPE Cash coverage coverage coverage coverage

NFCs SMEs Households

Source: EBA and AXIA Research.

After the implementation of IFRS 9 the banks’ cash coverage has increased and the loan book is now broken down into three stages according to their impairment condition. Performing loans would fall under Stage 1 (covered by provisions related to 12 months expected losses), performing loans with significant deterioration in credit quality would fall under Stage 2 (covered by provisions related to lifetime expected losses) and non- performing exposures (i.e. total NPEs) would fall undert Stage 3 (covered by provisions related to lifetime expected losses). Below we show the stages breakdown for Bank of Cyprus.

Figure 91: IFRS 9 – stages Provisions over Provisions over 1Q18 (EUR bn) Gross loans % of gross loans NPEs Provisions gross loans NPEs Stage 1 5.8 31% - 0.06 1.0% n/a Stage 2 4.4 24% - 0.13 3.0% n/a Stage 3 8.4 45% 8.3 4.01 47.7% 48% Total 18.6 8.3 4.2 22.6% 51%

Gross loans Provisions Provisions over gross loans 4Q17 1Q18 4Q17 1Q18 4Q17 1Q18 Stage 1 5.2 5.8 0.1 0.1 1.3% 1.0% Stage 2 4.8 4.4 0.1 0.1 2.7% 3.0% Stage 3 8.8 8.4 4.3 4.0 49.0% 47.7% Total 18.8 18.6 4.5 4.2 24.0% 22.6%

Source: Company data and AXIA Research. Note: 4Q17 for illustrative purposes.

As far as the Cypriot banking system is concerned, the majority of NPEs are linked to households (53%) and SMEs (40%), according to the figure below.

Figure 92: NPE volumes by segments (4Q17) (EUR 20.9bn) Figure 93: NFC NPEs by industry (4Q17) By industry EUR m % of total General Agriculture, forestry and fishing 177.4 2% Households Mining and quarrying 80.8 1% 53% governments Manufacturing 668.6 7% 0% Other financial Electricity, gas, steam and air conditioning supply 29.7 0% corporations Water supply 9.4 0% Construction 3,147.8 33% 2% Wholesale and retail trade 1,884.5 20% Transport and storage 337.1 4% NFCs Accommodation and food service activities 691.5 7% 5% Information and communication 116.7 1% Real estate activities 1,515.8 16% Professional, scientific and technical activities 372.0 4% Administrative and support service activities 103.8 1% Public administration and defence, compulsory social security - 0% Education 51.1 1% Human health services and social work activities 27.7 0% SMEs Arts, entertainment and recreation 56.4 1% 40% Other services 173.1 2% Total 9,443.6

Source: Central Bank of Cyprus and AXIA Research.

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The NPE cash coverage of Bank of Cyprus does not differ significantly from other European banks, as seen below.

Figure 94: NPE ratios and coverage of selected banks in Southern Europe (1Q18)

68.8%

62.0%

60.3%

60.2%

59.0%

57.4%

56.1%

55.7%

55%

52.0%

51.8%

51% 51%

51.0%

50%

49.8%

48.0%

44.9%

42.7%

41.8%

25%

19.3%

17.6%

16.9%

14.0%

12.7%

8.9% 4.7%

UCG CGD UBI BCP LBK MPS BPER New HB* Eurob NBG BoC Alpha HB Piraeus

NPE ratio NPE coverage

Source: Company data and AXIA Research.

We highlight some positive trends in the Cypriot banking system, as far as NPEs are concerned, such as the increase in the proportion of restructured loans as percentage of total NPEs. Nevertheless, and as shown in the following section, the improvement is still below the targets agreed with the Central Bank of Cyprus.

Figure 95: Systemic NPE related metrics – positive trends

80%

60%

40%

20%

0% 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 Feb-18

Restructured ratio as % of NPEs FNPE as % of NPEs Impairments as % of NPEs

Source: Central Bank of Cyprus and AXIA Research.

Additional efforts to reduce the stock of NPEs are found in the efforts from NPL servicers partnering with the Cypriot banks. Bank of Cyprus started a partnership (in 4Q17) with Pepper Europe (UK) Ltd., where it would outsource the management of up to EUR 800m in SME and retail non-performing exposures to the company. Hellenic Banks has partnered with APS Holding to create APS Cyprus, which now manages the bank’s NPEs and real estate portfolios – EUR 2.2bn and EUR 0.2bn, respectively. Finally, CCB announced a joint-venture with Altamira for the management of non-performing exposures and real estate. We expect the joint efforts between the banks and the servicers to start bearing fruits throughout 2018.

Looking at the formation, we view the macro environment, and the economic growth, playing an important role on what is the root of the problem: the formation of non-performing loans. Below we show the Bank of Cyprus’ progression in regards to the formation of loans in arrears and the economic growth, with a major change in the trend in 2013/14 and improvements in 2015/16.

The bank stopped reporting 90+dpd data as of 1Q18, with the focus being exclusively on NPEs from now on.

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Figure 96: Bank of Cyprus – 90+dpd formation and stock

Slow deterioration Economic crisis Stabilization Recovery 4,000 14

3,500 3,319 12 3,000

2,500 10 1,972 2,000

1,319 8 1,500 1,240

1,000 609

558 6

410

402

386

329 265

500 232

156

136

100

96

64

38 20 0 4

(500)

(85) 2

(143)

(164)

(247)

(277)

(298) (325)

(1,000) (379)

(450)

(459)

(501)

(649) (668)

(1,500) 0

(1,020) (1,041)

Quarterly change of 90+ DPD (€ mn) 90+ DPD (€ bn) (rhs)

Source: Bank of Cyprus and AXIA Research.

The part that we can consider to be under the banks’ control are the efforts on the restructuring and curing of non-performing loans. As seen in the following figure, the pace of restructuring has been consistent across the years with a slowdown in recent quarters.

Figure 97: Bank of Cyprus – restructuring activity

2.2 0.3 2.0 0.4 0.4 1.3 0.3 1.1 0.9 0.9 0.8 0.8 0.8 0.2 0.7 0.7 0.2 0.1 1.5 0.2 0.5 0.1 1.3 1.3 0.2 0.1 0.2 0.2 0.2 0.1 0.3 0.4 0.7 0.8 0.7 0.2 0.5 0.4 0.6

0.2 0.3 0.3

4Q16 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 1Q17 2Q17 3Q17 4Q17 1Q18 Restructured loans Write offs & non-contractual write offs DFAs

Source: Company data and AXIA Research.

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With an improving macro, higher coverage on NPEs and new, stricter, lending policies, the result has been felt on the amount of loans that go into redefault. Recent vintages show an improving trend for Bank of Cyprus, as seen in the following figure.

Figure 98: Bank of Cyprus – Restructured loans with no arrears

98% 94% 99% 99%

87%

86%

100%

84% 84%

83%

82%

80% 80%

78% 78% 78%

77% 77% 77% 77%

76%

75%

74% 74% 74% 73%

72%

71% 71% 71% 71%

70%

69%

65%

64% 64% 64%

63%

62% 62% 62%

61% 61%

60% 60%

59% 57%

48%

Corporate SMEs Retail Total Bank - Cyprus 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17

Source: Company data and AXIA Research.

Asset quality targets and the Central Bank’s monitoring NPL targets were introduced back in September 2015 by the Central Bank of Cyprus and focus on four main indicators. CBC’s main objective is to create incentives for the credit institutions to restructure the loans in arrears in their books.

Figure 99: Target Indicators Indicator 1: Proposed sustainable solutions as a percentage of the loans presenting arrears over 90 days. This indicator is not cumulative and is calculated for the quarter under reporting and for each of the next quarters Indicator 2: Approved, viable restructurings, accepted by the borrower as a percentage of the loans presenting arrears over 90 days. This indicator is not cumulative and is calculated for the quarter under reporting and for each of the next quarters Indicator 3: Loans that have been restructured and present arrears of less than 8 days as a percentage of the total loans which have been restructured. This indicator is cumulative and covers the loans restructured from 1st January 2014 up to the beginning of the quarter under report and measures the success rate of the loan restructurings Indicator 4: Loans that presented arrears over 30 days and up to 90 days at the beginning of the quarter but by the end of the quarter do not present any arrears (due to restructuring or other measures taken by the bank) as a percentage of the loans that presented arrears over 30 days and up to 90 days at the beginning of the quarter. This indicator is intended to exert pressure on the banks to act proactively on loans with early arrears before they become non-performing. It is reminded that a non-performing loan that is restructured, remains classified as non-performing for at least 12 months even if the new repayment programme is fully adhered to and there are no arrears Source: Central Bank of Cyprus.

The financial institutions submit their quarterly data to CBC and targets are set by the Central Bank, in agreement with the institutions. The institutions are responsible for proposing targets which are evaluated by the Central Bank for the next two quarters. If an institution misses the proposed target it will then need to submit detailed explanations and propose corrective measures to be taken.

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Despite the positive progress on many areas around the NPEs, banks are still struggling to meet the targets set by them in agreement with the Central Bank. The only area where banks outperform the targets are in relation to the proposed sustainable solutions, as seen in the figure below.

Figure 100: Asset quality targets – up until June 2017 Banking System Loan Arrears Resolution Targets 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 (I) Banking system target rates and actual rates on debt restructuring of non-performing loans Banking system target rate 1 = "Proposed sustainable solutions rate" = The percentage of the balances of sustainable solutions proposed during n/a n/a 9.4% 12.5% 11.6% 14.8% 14.6% 15.0% 14.6% 14.7% the quarter in relation to the borrowers with loans exhibiting arrears of over 90 days at the beginning of the quarter Banking system actual rate 1 n/a 6.1% 6.3% 13.3% 14.9% 25.4% 18.7% 21.8% 16.7% 21.1% Difference (Banking system actual rate 1 minus Banking system target n/a n/a -3.1% 0.8% 3.3% 10.6% 4.1% 6.8% 2.1% 6.3% rate 1) Banking system target rate 2 = "Concluded sustainable solutions rate" = The percentage of the balances of sustainable solutions concluded n/a n/a -9.4% 11.6% 11.1% 15.2% 15.0% 15.2% 15.1% 15.1% during the quarter in relation to the borrowers with loans exhibiting arrears of over 90 days at the beginning of the quarter Banking system actual rate 2 n/a 4.7% -6.3% 13.0% 11.8% 16.2% 10.2% 11.3% 7.2% 10.4% Difference (Banking system actual rate 2 minus Banking system target n/a n/a 3.1% 1.4% 0.8% 1.0% -4.8% -3.9% -7.9% -4.7% rate 2) Banking system target rate 3 = "Terms-being-met rate" = The percentage of the balances of solutions concluded from 1/1/2014 upto n/a n/a 9.4% 72.9% 71.7% 72.4% 72.4% 72.2% 72.2% 71.9% the end of the previous quarter which exhibited arrears of less than 8 days at the end of the reporting quarter Banking system actual rate 3 n/a 65.8% 6.3% 69.9% 69.0% 72.4% 72.7% 71.9% 68.7% 68.2% Difference (Banking system actual rate 3 minus Banking system target n/a n/a -3.1% -3.0% -2.7% -0.1% 0.3% -0.3% -3.5% -3.7% rate 3)

(II) Banking system target cure rates and actual cure rates on early arrears management

Banking system target rate 4 = "Aggregate early-arrears cure rate" = The percentage of the amount of loans that presented early arrears (i.e. 31-90 days in arrears) at the beginning of the reporting quarter which n/a n/a 27.8% 40.0% 40.0% 43.2% 43.9% 44.1% 44.5% 43.8% were cured during the quarter (i.e. presenting no arrears at the end of the reporting quarter ) by (i) being restructured with a sustainable repayment schedule and (ii) other effective means

Banking system actual rate 4 n/a 28.1% 31.2% 38.6% 35.5% 35.8% 41.3% 42.9% 33.3% 25.5% Difference (Banking system actual rate 4 minus Banking system target n/a n/a 3.4% -1.4% -4.5% -7.4% -2.6% -1.2% -11.3% -18.2% rate 4)

Source: Central Bank of Cyprus and AXIA Research. New approach on solving the NPE issue

The country’s economic programme forced the framework on non-performing exposures to be addressed in a

strong manner. A new insolvency framework was introduced from May 2014. Additionally, a new foreclosure

law started from September 2014 and subsequent completion of auctions started in the second half of 2016.

The new legislation supporting the sale of loans came into force in late 2015. Finally, it also introduced tax

incentives to customers enganging in consensual agreements and tax incentives (such as capital gains) when properties are sold to the banks.

The introduction of the NPL framework in 2015 brought important changes to the way the sale of non- performing loans are addressed. In summary, the law approved in 2015 set the guidelines for portfolios to be acquired by non-banks, which increases the universe of potential buyers. Below we highlight the guidelines introduced by the law.

Cyprus Parliament – approval of new Law on the Sale of Loans – amended in July 2018 The new Law “On the Sale of Credit Facilities and Other Related Issues” (“Law”) adopted by Parliament on November 12, 2015 has the following key features described below. 1. Scope: Loans to individuals and micro and small SMEs not exceeding € 1.0m. Exempt from the scope of the law are loans to non-residents, loans to finance operations and/or investments outside Cyprus, loans secured by property located outside of Cyprus, and loans governed by foreign law. However, the provisions concerning notification of the borrower by the original creditor and the acquiring party (see 3 below) also apply to loans in excess of €1.0m (“big loans”).

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2. Licensing and regulation of loan acquiring companies: Loans of less than €1m mentioned above can be sold to: (i) Cypriot authorized credit institutions, (ii) subsidiaries or branches of credit institutions authorized by the EU that operate in Cyprus, or (iii) non-bank “credit acquiring companies”. Further re-sale is allowed to any of the above mentioned institutions, or to other persons with the prior written approval of the CBC. A non-bank company seeking to buy loans should be incorporated in Cyprus and obtain a license from the CBC. The licensing conditions include a minimum capital requirement (€100,000), “fit and proper” requirements for shareholders and directors, and an assessment that the company can provide proper services and that its operations plan does not pose risks to financial stability in Cyprus. The CBC is required to supervise on an ongoing basis the company’s management, the books and records, and financial reporting. In addition, all credit institutions should report to the CBC semi-annually on their sale of loans activities. Violations of the Law are subject to administrative and criminal liability. 3. Other Conditions: In addition to the conditions mentioned in 2 above, the sale of loans covered by the law is also subject to several conditions: First, prior to the sale of all or part of the loan portfolio, the credit institution should notify its intention to sell either (i) through a publication in the Official Gazette and in three daily newspapers, or (ii) by a letter to the borrower and its guarantors. In both cases the borrower and the guarantors may (but are not required to) submit, within 45 days, a proposal to purchase the loan. Such a proposal is not binding on the creditor. Second, the acquirer should notify the borrower within five days of the acquisition and provide new contact and payment information. In the case of small loans, borrowers retain the protections under the Code of Conduct. According to the IMF, while the law now allows loans to be sold, it remains to be seen whether it will be used actively to facilitate the clean-up of banks’ balance sheets. The IMF also notes that so far banks indicated publicly that they do not foresee selling mortgage loans related to primary residences. In addition, in the case of small loans, the discount needed to attract potential buyers may make sales unappealing for banks. According to the IMF, it is therefore expected that the law would be applied more frequently in the case of big loans, and to buyers with demonstrated expertise in recovering value. Nonetheless, some of the provisions of the Law could reduce the attractiveness of loan purchases due to concerns about legal and compliance risks. Source: IMF Sale of Portfolios So far, given the challenging market conditions, we haven’t seen many transactions of NPL portfolios in Cyprus. Nevertheless we have seen the sale of a portfolio from Hellenic Bank to B2Kapital and more recently, Bank of Cyprus engaging in what could be a sizeable transaction for the bank and for the country.

Figure 101: Market activity (EUR bn)

53.3

51.7

40.3

37.8

28.2

28

27.6

22.9

21.9

17.4

16.7

15.8

14.3

14

13 13

11.8

7.5

6.6

6.4

5.3

3.7

3.6

3.1

2.3

2.2 2.2 2.2 2.2

2.1

1.8

1.6

0.6 0.6

0.5

0.3

0.2

0 0 0

Italy UK Ireland Spain Portugal Germany Netherlands Greece & Austria & France Cyprus CEE

2014 2015 2016 2017

Source: Deloitte and AXIA Research. Note: includes ongoing deals for 2017.

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On the chart below we show the main buyers of European NPLs since the first half of 2015.

Figure 102: Main buyers of NPLs 2015-2017 (EUR bn) 55.8 47.3

15.7 11.0 10.6 9.9 9.7 8.0 7.4 5.6

Cerberus Blackstone Fortress Lone Star Goldman Deutsche Oaktree Banca IFIS Italian Rec. Bain Sachs Bank Fund Capital

2015 2016 2017

Source: Deloitte and AXIA Research.

Below we add the ECB’s take on the sales of portfolios in Cyprus:

The Cypriot market for NPE portfolios is not developed. In addition, there have not been any transfers to a public/private investment vehicle. In November 2015, the Parliament of Cyprus approved a new law on the sale of credit facilities and other related issues, enabling the sale of all loans. Loans to individuals and microenterprises and SMEs not exceeding €1 million43 can only be sold to certain types of investors: (i) credit institutions authorised in Cyprus; (ii) branches of credit institutions authorised by the EU that operate in Cyprus; and (iii) non-bank companies authorised by the CBC. Further resale is allowed to any of the aforementioned institutions, or to other entities with the prior written approval of the CBC. A non-bank company wishing to buy loans needs to be registered as a company in Cyprus and to obtain a licence from the CBC. The CBC is required to supervise the company’s management, its books and records, and its financial reporting on an ongoing basis. In addition, all credit institutions have to report their loan sales to the CBC semi-annually.

Prior to the sale of all or part of a loan portfolio, the credit institution needs to notify its intention either (i) through a publication in the Official Gazette and in three daily newspapers, or (ii) by a letter to the borrower and its guarantors. The consent of borrowers and guarantors is not required. In both cases, the borrower and the guarantors may (but are not required to) submit, within 45 days, a proposal to purchase the loan. Such a proposal is not binding for the creditor. Banks may sell loans above the described threshold (€ 1 million), but without providing safeguards other than following the rules regarding the prior notification, as well as the notification after the sale with the details of the entity which has purchased the loans.

Legal framework on the sale of loans (amended in July 2018) In November 2015, a law was adopted allowing Cypriot banks to engage in the sale and acquisition of loans and other credit facilities. Note that the sale of loans concerns the total balance or segments of the loan portfolio relating to individuals or SMEs borrowers. The sale of the abovementioned loans concerns exclusively one borrower and one Cypriot bank, whereas the law provides a safety net for small borrowers whose loans are sold, per Code of Conduct guidelines.

In the case of smaller loans, the law does not materially affect incentives for restructuring or materially increase moral hazard concerns, under which borrowers would stop remaining committed to their payment schemes. In particular, note that, given the high concentration of NPL volumes, the law calls for large (above EUR 1m) loans to be sold with fewer obligations imposed on the selling bank or the purchaser, thereby providing incentives to all parties involved for engaging in similar transactions. The credit facilities falling under the scope of application of the law are:

1. credit facilities granted to natural persons, which natural persons do not, at the time of purchase of their credit facilities, have a total balance of credit facilities exceeding EUR 1m towards each bank; 2. credit facilities granted to SMEs, which at the time of purchase of their credit facilities, do not have a total balance of credit facilities exceeding EUR 1m towards each bank.

Note that for a party acquiring credit exposures to be authorized by the CBC pursuant to the provisions of the legislation, as well as a number of conditions should be met, including, inter alia, the ability of such legal entity to fully comply with the provisions of the law. The CBC is granted with wide spectrum supervision authority in an attempt to maintain financial stability.

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Furthermore, the CBC is authorized to engage in investigations as well as to revoke licenses granted, if necessary, whereas to impose administrative fines of up to EUR 300k concerning violation of certain provisions of the law. At the same time, credit-acquiring third parties or other acquirers of credit facilities are expected to grant access to the CBC in relation to data and comply with reporting of their operating activities accordingly.

Foreclosed assets – what is going on? The foreclosure law, voted by the Cypriot Parliament in September 2014 (ammended in July 2018 as previously shown), provides the necessary regulations for the execution of private auctions and sales of mortgaged properties by mortgage creditors, without the interference of governmental bodies. Note that the trigger point for the initiation of the foreclosure procedure is defaulting on service payments for more than a 120 days period. Furthermore, another significant key point of the foreclosures legislation is the importantly shortened timeframe for foreclosing property. In particular note that from an initial time period of ten years required, the process has now accelerated to as little as eighteen months by establishing clear procedures for timing of repossession, valuation and auction processes. With regard to foreclosures, banks have indicated their intention to sell a number of foreclosed commercial and non-primary residences. In addition, the authorities have reported that the necessary elements required to hold real estate auctions according to the law have been put in place.

Foreclosures target strategic defaulters in an effort to incentivize debt borrowers and improve payment culture by reducing moral hazard. We view that mass foreclosures will be avoided mainly because they would result in an excess supply in the real estate market, hence further negatively impacting real estate prices, as well as causing greater congestion in the country’s local courts. We highlight that Bank of Cyprus, for example, has been able to reduce its stock of real estate at profit, given the bank’s policy to onboard assets at 25-30% discount vs. market prices, front-loading potential losses.

On the other hand, and given the small size of the Cypriot economy, we believe that it will be difficult for banks to dispose a significant amount of assets without negative effects on prices, which in turn would affect the collateral prices the banks have against their NPE exposures.

Figure 103: Bank of Cyprus – RE sales agreements Figure 104: Bank of Cyprus – Sales and prices 119% 104% 108% 124% 126% Net proceeds / BV 235 99% 97% 87% 96% 102% Gross proceeds / OMV

60 97

17 61 12 9 59 17 97

Offers accepted In process SPA in preparation SPA signed Sold Total sales (YTD) Hotels Commercial Residential Land OMV: open market value

Source: Bank of Cyprus and AXIA Research.

Extension to capital gains tax waiver We highlight the recent vote by the parliament and Moody’s comments as a credit positive event for Cypriot banks on the extension of the waiver of the 20% capital gains tax applied when properties are sold when proceeds are used to repay problem loans, and to properties sold or relinquished to credit-acquiring

companies, which are the only Cypriot entities allowed to buy problems loans from banks, to settle existing

debt. According to Moody’s “Until now, this tax break was applicable only to properties sold in debt-for-asset swaps with banks. The benefit's extension to other sales categories is credit positive for Cypriot credit-acquiring companies because it will increase the recoverable amount of problem loans and banks should garner better prices offered for nonperforming loan exposures (NPEs). The government introduced the waiver of the capital gains tax in 2015 to facilitate debtfor-asset swaps as a means to reduce the large stock of NPEs in the Cypriot banking sector. Almost all these exposures are backed by real estate collateral and around one-third of these troubled loans are terminated loans, which are mostly dated exposures to non-viable businesses or loans to individuals without sufficient means to repay. For these terminated exposures, the only way for banks to recover and reduce their losses is by selling the real estate collateral.”

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We add the ECB’s take on collateral valuation below:

Immovable property has to be evaluated by an independent appraiser listed on the bank’s approved panel. Only appraisers licensed by the Technical Chamber of Cyprus can provide this kind of service. Banks have to carry out an ongoing assessment of the performance of its appraisers, to decide whether they should or should not remain on the mentioned panel. The panel should include expertise in various areas of the property sector, as appropriate to the lending business of the bank. Moreover, banks must set a limit on the total number of valuations to be performed by each single appraiser or firm of valuers. Market valuations should be carried out in accordance with the Royal Institute of Chartered Surveyors (RICS) Valuation Standards (“Red Book”), the European Valuation Standards (“Blue Book”) or the International Valuation Standards (“White Book”).

The required frequency for the valuation of immovable property collateral has to be clearly stated in the bank’s policy and guidelines, to ensure that it is carried out at regular intervals and reflects current market conditions. It must in all cases comply with the minimum CRR requirements (CRE; ≤ 12 months; RRE ≤ 3 years). The valuation method has to be defined according to the type of property, and banks are required to assess its appropriateness. The frequency of collateral valuation of defaulted assets is not defined separately. Banks have to use property price projections for each class of property held as collateral (based on transactions conducted, macroeconomic conditions, input from professional appraisers and the historical property price indices produced by the CBC), and these projections, which have to be based on conservative assumptions, can be produced internally by appropriately qualified personnel (not subject to validation by an external independent and credible party) or provided by external experts. If a restructuring plan is proposed, banks have to conduct an independent professional valuation to determine the open market value and forced sale value of properties in order to define suitable and sustainable solutions. When using adjustments based on internal indices, the estimated market value of property collateral at the point of liquidation cannot be higher than the current market value. However, the CBC has introduced a circular which allows limited exceptions to this rule. Banks have to record all supporting documentation for each individually assessed credit facility. With reference to the process of data collection to assess collateral recovery, banks need to have in place appropriate models to calculate the LGD on the basis of the type of collateral, the length of time taken for disposal and the timing of all available cash flows. In the absence of the appropriate LGD, banks may use, following a sample test, for each pool of credit facilities, the LGD used for credit facilities of similar characteristics which were individually assessed.

In Cyprus, there are no specific requirements for the calculation of the credit riskmitigating effect of collateral for risk management purposes under Pillar 2. The CBC has not provided additional incentives to reduce the reliance on collateral through an increase of provisioning or the assessment of valuation practices.

For valuing foreclosed assets on the foreclosure date, specific requirements were set by the Foreclosure Law, which lays out the details of the forced sale process. Banks are required to obtain two valuations from separate professional appraisers. If the difference is less than 25%, the value applied is the average of the two, otherwise a third valuation is obtained and then the value taken is the average of the two closest values. The starting price of the auction process is set at 80% of this value. If, instead of a forced sale, banks, in the context of a voluntary arrangement, acquire collateral from the debtor in the collection of debts, the classification of the asset is made according to the IFRS. So far, collateral has been disposed of through auctions organised by the land registry department of the Government, but banks are now applying the new Foreclosure Law, which permits auctions to be directly arranged by banks without any intervention by the land registry.

The leasing law was enacted on 28 April 2016. Some remaining obstacles relate to the securitisation framework.

Below we add the ECB’s take on debt enforcement and foreclosure:

In order to enable rapid out-of-court enforcement/foreclosure of the collateral, new laws and regulations have been introduced, and their effectiveness is currently being tested.

It should be noted that, over the course of 2016, banks have been actively engaging in voluntary debt-for- asset swaps, encouraged in part by the tax benefits arising from the temporary suspension of capital gains tax on the transfer or sale of assets until 31 December 2017. Some disposals have already been achieved.

The new insolvency framework may result in enforcement measures for the benefit of all claimants, whereas the previous framework did not provide for such a procedure.

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resulted in the granting of a postponement order in the majority of cases. In addition, the large scale of the problem was a disincentive for Cypriot banks to liquidate collateral, because a large volume of properties being sold in auctions could have led to a further drop in RE prices. The new foreclosure framework allows creditors to arrange a private auction which does not involve a government agency, with specific time limits on subsequent steps in the procedure, which is subject to a judicial review only where strictly necessary..

In-house management of NPLs Cypriot banks have individually launched internal units, aimed at finding customized ways to improve retail collections, corporate restructuring and collateral management. The primary aim is to shift from short term to long-term sustainable workouts, specifically on the corporate front. These solutions take into consideration borrowers’ payment capacity, according to the Code of Conduct guidelines as outlined by the CBC as well as recent amendments to the Insolvency Code for both households and corporates, in an attempt to optimize the debt restructurings offered to debtors. In addition, each bank, has taken a number of steps including, but not limited to:

 engagement of experienced enablers;  granular segmentation of NPL portfolios;  credit and collateral restructurings;  early reminder notifications systems;  a loss budget allocation mechanism; and  net present value frontline tools.

Cyprus Cooperative Bank’s actions on NPEs CCB has also established a special department of the management of NPLs for the effective administration of past due loans. The department addresses NPLs on behalf of the Cooperative Credit Institutions which will be determined on the basis of certain criteria such as: (i) the amount of the outstanding loans; (ii) days in arrears; and (iii) the amount in excess of the credit limit.

Note that the department for the management of NPLs is structured on the following units: (i) the Central Unit for the Management of Arrears Restructuring; and (ii) the Debt Recovery Unit.

Cyprus Cooperative Bank (CCB) announced back in July 2017 that it has reached a 10-year agreement with an international asset management company, Altamira Asset Management SA, for the servicing of its NPE portfolio (EUR 7.2bn) and the management of its real estate operations (EUR 0.4bn). For this purpose a new joint venture named Altamira Asset Management (Cyprus) has been created in which Altamira holds 51% of the share capital and CCB holds the remaining 49%. Employees of the bank were transferred to the new joint venture.

We highlight that given the transaction with Hellenic Bank, the government, via an Asset Management Company (AMC) will manage the bank’s NPEs, whilst transfering most of the good assets to Helenic Bank.

Estia Scheme Estia scheme aims to support vulnerable social groups and secure primary residence. The scheme, as annonunced by the government, will apply to all Cypriot banks and NPE servicers who will sign a relevant memorandum of understanding with the scheme administrator and will be based on socioeconomic criteria.

In particular, potential eligible participants will need to meet certain income and wealth-based criteria in order to avoid strategic defaulters abusing the scheme and to reduce moral hazard.

The implementation of the scheme achieves the main objectives below:

 Borrowers of vulnerable social groups who are unable to repay their loans, will benefit from: (i) a state subsidy; (ii) a lower interest rate; (iii) an extension of payback period depending on the borrower’s age; and in most cases (iv) debt forgiveness of the loan’s outstanding amount (estimated on average at c.32%).  Contributes to the reduction of the high stock of NPEs in the banking system, ideally without increasing the banks’ capital requirements.  The estimated burden which will be suffered by the government will be in line with its budgetary capabilities and will be done gradually, over the period of 25 years.

Cyprus Land Development Corporation (CLDC, or KOAG) will be responsible for the administration of the Estia scheme, and for the annual payment for part of the loans’ installments which: (i) have as mortgage the borrower’s primary residence; and (ii) have been already restructured by the bank/NPE servicer. AXIA Research Page 38

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The loan criteria for participation on the scheme will be as follows:  The loans (housing or other) of a natural or legal person is secured with the borrower’s primary residence as collateral.  The market value of the primary residence does not exceed EUR 350k. The market value will result from the average of two evaluations which will be conducted by independent appraisers within the application period (which will be announced at a later stage) and an additional 30-day period following the deadline for submitting applications.  As at 30 September 2017, at least 20% of the outstanding amount of the total loans held by the borrower, per bank, was non-performing for more than 90 days.

The socioeconomic criteria that the borrower should meet are:  The total annual household income should not exceed EUR 50k.  The market value of the household’s net assets (excluding primary residence and minus current loan obligations excluding the loan collateralized by primary residence) should not exceed 125% of the primary residence market value, as this will be estimated from the evaluations.  The borrower must be a Cypriot resident for the last 10 years or more.

Borrowers that are interested to participate in the Estia scheme will need to consent in writing in order to: (i) give access to KOAG to any data submitted by the borrower to any credit institution on the basis of the Directive on Arrears Management, as well as to request any additional information/documents; and (ii) enable KOAG to confirm and cross-check the borrower’s financial data.

According to the proposal, 15k loans are potentially eligible to participate in the scheme. The total value of these loans is estimated at EUR 3.4bn (as at 30 September 2017).

Loan restructuring by the banks and NPE servicers Given that the borrower complies with the aforementioned requirements, he will then proceed with declaring to the bank/AMC his intention to participate in the scheme. The latter will be responsible to restructure the borrower’s loan to an amount equal with the lower of: (a) the outstanding amount of the loan(s) as the restructuring date and (b) the primary residence market value (as will be estimated by the two evaluations). On this basis, banks and NPE servicers are estimated to contribute, on average, to a 32% debt forgiveness on the loans (that fall under Estia) outstanding amount. The interest rate of the restructured loan, up until maturity date, will be variable based on Euribor 6m+2.5%, while the interest rate cannot exceed 3.5%, or be lower than 2.5%. The terms of restructuring will be uniform for all borrowers, apart from the maturity date of the loan which cannot exceed 25 years and will be in accordance with the age of the borrower. Each bank and NPE servicer will be responsible to gather all relevant information and supporting documents and forward it to KOAG which will provide approval if the scheme eligilitiy criteria are met.

Government subsidy of 1/3 of the loan installment KOAG will pay to the bank/NPE servicer 1/3 of the loan installments throughout the repayment period of the restructured loan, provided that the borrower will continue to pay the remaining 2/3. In case the borrower stops paying his part of the restructured loan installment, KOAG will cease with the payment of its share and banks/NPE servicers will need to take legal measures, including enforcement for recovering obligations. Under the assumption that all potentially eligible borrowers will participate, and comply with the terms of the scheme, the cost of the government would be estimated at c.EUR 33mn per annum, for 25 years. KOAG will receive on a yearly basis a subsidy from the state budget, and will then contribute its share (1/s3 of the installment) to each participant of Estia at the end of each year. Prior to this, banks/NPE servicers need to confirm in writing that the borrower has paid its 2/3.

The implementation of Estia is subject to the approval of the European Commission Directorate General for Competition (DGComp).

In paralell, the Parliament passed a package of law amendments in order to enable the banks to deal with NPEs in a more efficient manner.

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The ECB on Cypriot NPLs The ECB also released, back in June 2017 the updated stocktake on national supervisory practices and legal frameworks related to NPLs. Cyprus ranked above the European average (following figure) on the NPL legal/judicial and extrajudicial framework as well on information framework.

Figure 105: Cyprus – NPL framework overview

Source: European Central Bank.

The European Central Bank identified the main challenges for NPL workout in Cyprus:  Sale of portfolios and market capacity: the law allowing the transfer of loans to public/private AMCs entered into force in 2015 and its effectiveness still needs to be tested; however, the efficiency of this tool could have a limited effect, at least in the short term, given the distressed market conditions (amplified by the inexistence of meaningful transactions in loans and collateral sales) and, until now, the lack of independent servicing capacity in the market;

 Corporate insolvency and restructuring: agreements on debt restructuring are difficult, especially taking into account the large amounts due to the public sector. The current framework includes a process for the partial clearance of public arrears. For microenterprises and SMEs, banks could perform restructurings under the provisions of the Arrears Management Directive, although the process is slow due to a lack of financial data and information or non-cooperation of the borrowers. Under the Directive, in corporate credit restructuring, it is not possible to change a company’s management or to sell the assets of the company through auctions or open-market bilateral sales without the shareholders’ consent. Furthermore, special in-court procedures are not considered successful. The recent reform of the Foreclosure Law and of the corporate insolvency framework might mitigate some of these constraints ;

 Household insolvency and restructuring: within the mandate of the Financial Ombudsman, a voluntary out-of-court settlement/mediation mechanism, subject to limits, was introduced in 2014. The Financial Ombudsman has been receiving increasing numbers of applications ever since. Although not yet fully operational, this mechanism is currently yielding satisfactory results, with a success rate of 85%. One constraint relates to the practice of providing multilateral guarantees, in a context where the legal regime, currently under reform, did not provide clear evidence on the liability

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of the guarantors. The changes made in the insolvency reform could mitigate the factors mentioned, particularly through the implementation of the Personal Repayment Plan (PRP), which allows an insolvent debtor, with the mandatory help of a licensed insolvency practitioner (IP), to develop a voluntary plan aimed at restructuring his/her debts, both secured and unsecured. Another version of the PRP is the compulsory PRP, which also allows the debtor to apply to the court for the imposition of a restructuring plan on the creditors. The Personal Insolvency Law gives a debtor the option to proceed with a coordinated scheme that could provide restructuring both for his/her personal loans and for his/her microenterprise. The discharge of uncollectable personal unsecured debt up to €25,000 is facilitated by the new Debt Relief Order procedure. Equal treatment (i.e. equal to the debtor’s unsecured discharged amount) is applied to the guarantors as long as the guarantors had not collateralised and/or secured the debtor’s discharged debt with their personal property/assets.

 The judicial system needs to be streamlined, because in-court procedures are lengthy and courts or judges are not specialised in insolvency issues. Time restrictions related to personal insolvency have only been introduced for a few insolvency processes in the recent reform.

 Although significant progress has been made by the banks in terms of establishing dedicated structures and procedures for NPL management and restructuring, there is still room for improvement in the experience, expertise and resources of banks, because these influence the pace, effectiveness/sustainability of NPL workout/restructuring plans. Additional supervisory action, taking account of the systemic nature of the problem, is considered an important tool to ensure a faster implementation of the NPL workout strategies.

Specific supervisory practices for addressing NPEs can be summarised as follows:

NPL measurement and provisioning: in the context of the loan impairment test, the CBC provides guidance to banks on what constitutes a loss event by formulating a number of trigger events (in line with the general principle of IAS 39) as well as macroeconomic triggers which might affect the future estimated cash flows of the borrowers. Moreover, the CBC requires banks to define their own additional trigger events relating to specific classes of credit facilities, such as mortgage and CRE portfolios.

Supervisory guidance on NPL governance: the CBC has addressed the topic of bank NPL management by issuing an Arrears Management Directive, as well as by monitoring policy deficiencies and operational bottlenecks in the institutions. Within this framework, the CBC has defined (based on proposals from the banks) quarterly bank-by-bank targets and assesses reports by external auditors regarding banks’ debt restructuring arrangements and strategies on a six-monthly basis.

Valuation of foreclosed assets: specific requirements for valuing foreclosed assets on the foreclosure date were set by the Foreclosure Law. Banks are required to obtain two valuations from separate professional appraisers. If the difference is less than 25%, the value applied is the average of the two. Otherwise, a third valuation is obtained and then the value taken is the average of the two closest values. The starting price of the auction process is set at 80% of this value.

Reporting: the supervisory reporting is based on EBA NPE templates, but in the context of the loan restructuring process, the CBC introduced an additional extensive framework aimed at supporting the assessment of the activities of each bank in 2015. It provides detailed information on bank performance relative to the targets set, the types of solutions proposed, the obstacles to completion of the restructuring and the effects on the portfolio in terms of success rates and migration between days-past-due (dpd) buckets.

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Financial Estimates

2015 2016 2017 2018E 2019E 2020E

Income statement Net interest income 842 686 583 437 385 379 Net fee and commission income 153 167 180 187 200 210 Net foreign exchange gains/(losses) and net gains/(losses) on other financial instruments 31 48 48 59 40 40 Insurance income net of insurance claims 48 44 50 54 48 48 Net gains/(losses) from revaluation and disposal of investment properties and on disposal of stock (53) of properties 6 26 34 20 20 Other income 18 12 19 18 16 16 Total income 1,040 964 907 789 709 713 Staff costs (234) (224) (228) (197) (168) (165) Special levy on banks and the SRF contribution (17) (20) (23) (16) (13) (13) Other operating expenses (157) (154) (172) (145) (124) (121) Total expenses (408) (398) (422) (357) (305) (299) Profit before provisions and impairments, gains/(losses) on derecognition of loans and changes 632 in expected cash 566 flows, restructuring 485 costs and discontinued 431 operations 404 413 Provisions for impairment of customer loans net of gains/(losses) on derecognition of loans and (959) changes in expected (370) cash flows (779) (226) (202) (200) Impairments of other financial and non-financial assets (62) (48) (65) (16) (10) (10) Provisions for litigation and regulatory matters (8) (18) (98) (17) (25) (25) Share of profit from associates and joint ventures 6 8 9 7 5 5 Profit/(loss) before tax, restructuring costs and discontinued operations (391) 139 (448) 181 173 183 Tax (9) (17) (77) (21) (24) (26) (Profit)/loss attributable to non-controlling interests 7 (4) 2 2 - - Profit/(loss) after tax and before restructuring costs, discontinued operations and net gain on disposal(394) of non-core 118 assets (523) 161 148 157 Advisory, VEP and other restructurings costs (43) (114) (29) (35) (10) (10) Loss from disposal groups held for sale/discontinued operations (38) - - - - - Net gain on disposal of non-core assets 37 60 - - - - Profit/(loss) after tax attributable to shareholders (438) 64 (552) 126 138 147 Source: Company data and Axia Research.

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Bank of Cyprus: Financial Estimates (cont.)

Balance sheet 2015 2016 2017 2018E 2019E 2020E Cash and balances with central banks 1,423 1,506 3,394 3,365 3,503 3,650 Loans and advances to banks 1,314 1,088 1,193 1,413 1,413 1,413 Debt securities, treasury bills and equity investments 1,009 674 1,121 988 988 988 Net loans and advances to customers 17,192 15,649 14,602 12,393 12,330 12,933 Stock of properties - - - 1,552 1,552 1,552 Other assets 1,768 1,816 1,641 1,806 1,806 1,806 Non-current assets and disposal group classified as held for sale 49 11 7 - - - Total assets 23,271 22,172 23,599 21,516 21,591 22,342

Deposits by banks 242 435 495 436 350 400 Funding from central banks 4,453 850 930 940 850 950 Repurchase agreements 368 257 257 260 200 250 Customer deposits 14,181 16,510 17,850 16,359 16,523 16,688 Debt securities in issue 1 - - - - - Subordinated loan stock - - 302 286 250 350 Other liabilities 945 1,014 1,147 1,043 1,062 1,173 Non-current liabilities and disposal group held for sale 4 - - - - - Total liabilities 20,193 19,066 20,982 19,323 19,234 19,811 Shareholders’ equity 3,055 3,071 2,586 2,382 2,520 2,667 Non-controlling interests 22 35 31 43 43 43 Total equity 3,077 3,106 2,617 2,425 2,563 2,710 Total liabilities and equity 23,271 22,172 23,599 21,748 21,797 22,521

Tangible equity 3,055 3,071 2,586 2,382 2,520 2,667 TE/share 0.34 0.34 5.80 5.34 5.65 5.98

Key ratios C/I ratio (total expenses/total income) 39.2% 41.3% 46.5% 45.3% 43.0% 42.0% Fee and Commission income to Total income2 14.8% 17.3% 19.9% 23.7% 28.2% 29.5% Return on average assets (annualised) -1.7% 0.3% -2.4% 0.6% 0.6% 0.7% ROE (annualised) -12.9% 2.1% -19.3% 5.0% 5.5% 5.6% ROTE (annualised) -15.0% 2.2% -19.5% 5.1% 5.6% 5.7% Basic earnings/(losses) per share (€ cent) (4.92) 0.71 (1.24) 0.28 0.31 0.33 NII / avg. Total assets 0.00% 3.02% 2.55% 1.94% 1.79% 1.72%

Asset quality NPEs 13,968 11,034 8,804 7,043 6,127 5,331 NPEs ratio 61.8% 54.8% 46.9% 44.7% 40.1% 34.3% NPEs coverage ratio 39.0% 41.0% 47.8% 47.6% 48.1% 49.2% Accumulated provisions 5,445 4,519 4,204 3,349 2,945 2,623 Stock of provisions as % of gross loans 24.1% 22.4% 22.4% 21.3% 19.3% 16.9% Provisions as % of gross loans 4.25% 1.73% 4.01% 1.31% 1.30% 1.30% Provisions as % of net loans 5.58% 2.26% 5.15% 1.67% 1.63% 1.59%

Capital CET1 2,748 2,728 2,184 2,126 2,159 2,202 CET1 ratio 14.0% 14.5% 12.7% 13.1% 13.3% 13.5% CET1 fully loaded 2,576 2,622 2,098 2,069 2,102 2,146 CET1 fully loaded - ratio 13.1% 13.9% 12.2% 12.8% 13.0% 13.2% RWAs 19,666 18,865 17,260 16,168 16,191 16,304 Source: Company data and Axia Research.

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Disclosures General information This research report was prepared by AXIA Ventures Group Limited, a company incorporated under the laws of Cyprus (referred to herein, together with its subsidiary companies and affiliates, collectively, as “AXIA”) which is authorised and regulated by the Cyprus Securities and Exchange Commission (authorisation number 086/07). AXIA is authorized to provide investment services in the United Kingdom, Cyprus, Greece and in Portugal pursuant to its permissions under the Markets in Financial Instruments Directive and may also provide similar services in other countries, inside or outside of the European Union, subject to the applicable provisions. AXIA Ventures Group Limited is not a registered broker-dealer in the United States (U.S.), and, therefore, is not subject to U.S. rules regarding the preparation of research reports and the independence of research analysts. In the U.S., this research report is intended solely for persons who meet the definition of “major U.S. institutional investors” in Rule 15a-6 under the U.S. Securities and Exchange Act, as amended, or persons listed under Rule 15a-6(4)) and is meant to be disseminated only through “Axia Capital Markets LLC”, a wholly owned subsidiary of AXIA Ventures Group Limited and associated US registered broker-dealer in accordance with Rule 15a-6 of the US Securities and Exchange Act.

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Persons responsible for this report: (Analyst) Argyrios Gkonis, (Director) Jonas Floriani and (Analyst) Celia Hjioannou.

Key Definitions AXIA Research 12-month rating* Buy The stock to generate total return** of and above 10% within the next 12-months Neutral The stock to generate total return**between -10% and 10% within the next 12-months Sell The stock to generate total return** of and below -10% within the next 12 months Under Review Stock’s target price or rating is subject to possible change Applicable Laws / Regulation and AXIA Ventures Group Limited policies might restrict certain Restricted types of communication and investment recommendations Not Rated There is no rating for the company by AXIA Ventures Group Limited * Exceptions to the bands may be granted by the Investment Review Committee of AXIA taking into account specific characteristics of the Subject Company **Total return: % price appreciation equals percentage change in share price from current price to projected target price plus projected dividend yield.

Rating history for Bank of Cyprus Date Rating Share Price (€) Target Price (€) 21/04/2016 Neutral 0.151 0.20 02/06/2016 Neutral 0.164 0.20 24/07/2018 Buy 2.44 2.95

AXIA Ventures Group Limited Rating Distribution as of today Of which Investment Coverage Universe Count Percent Count Percent Banking Relationships Buy 18 82% 3 3 13% Neutral 2 9% Sell Restricted Not Rated Under Review 2 9%

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