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. AXIA Research Page 1 Resuming coverage 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 ............................................................................................................................................................................................