Fitch: The pros and cons of a cap on interest rates – How Greece's credit rating is affected

Eurobank (BB-/Stable), National Bank of Greece (BB-/Stable), Alpha Bank (B+/Stable) and Piraeus Bank (B/Positive) recently announced that they will absorb interest rate increases on performing domestic retail mortgage loans for 12 months from May 2023. Rates will be capped at the end-March 2023 reference rate minus about 20bp. Customers will still benefit if rates fall below the cap.

Profitability is healthy

Fitch expects the banks’ profitability to remain sound, with operating profit/risk-weighted assets at around 1.8% in 2023 despite forgone interest income of EUR100 million to EUR175 million from a 25bp-50bp rate increase. The cap could also reduce the pressure on the banks to raise retail deposit rates, mitigating the impact on profitability. Fitch expects ECB rates to peak 50bp above current levels by end-2023, before falling in 2024

Mitigation of pressures

The cap will mitigate near-term asset-quality pressures by limiting debt payments for customers struggling with higher living costs. We do not expect the application of the cap to result in loan reclassification to forborne or credit impaired, as it will be applied unilaterally by the banks. The cap also creates an incentive for payment discipline, as it only applies to performing loans.

Risks

The interest rate cap could put profitability at risk if it is extended beyond 12 months or if interest rates rise more than currently expected and banks are unable to limit pass-through rates to deposits. It also partly masks borrowers' structural ability to service debt and could create cliff-edge risks to asset quality if mortgage rates increase materially when the cap expires. If it is extended, there is an increased risk that the banks will need to reclassify higher-risk loans that rely on the cap to remain performing.

The introduction of the cap follows government and social calls for banks to relieve affordability pressures on households from interest rate rises. The four biggest banks have already implemented an interest rate subsidy scheme for vulnerable low-income borrowers, launched in December 2022, which was more limited in scope and impact than the interest rate cap.

Fitch expects banks' profitability to remain healthy, with operating weighted assets at around 1.8% in 2023, despite lost interest income of €100m to €175m from the 25 basis point rate hike basis up to 50 basis points.

Morgan Stanley is on the same wavelength

The view of Morgan Stanley is similar, which a few days ago announced that it does not see any impact on the balance sheets of Greek banks from the measure of keeping mortgage interest rates stable, starting from May 2023 for one year.

As the US bank reported, this is an initiative by banks to support mortgage borrowers by limiting potential asset quality risks to the system.

Morgan Stanley continues to be positive on Greek banks and does not foresee a material negative impact, as the forecasts for 2023 are based on an ECB interest rate of 2.5-2.8%, so there is no negative impact on the banks due to this of the measure.

However, it will limit further upside from rate hikes in the mortgage portfolio above 3% with mortgages accounting for 26% of lending. In essence, this initiative is a horizontal measure that provides a bonus to those borrowers who continue to make payments on time.

It is recalled that the investment bank maintains the "overweight" recommendation for the shares of Piraeus and Eurobank, with target prices of 2.24 euros and 1.45 euros and the "equal positions" recommendation weight) for National Bank and Alpha Bank with target prices of 4.86 euros and 1.37 euros respectively.

"Buy" recommendation from HSBC

Yesterday, HSBC announced that it maintains its "buy" recommendations for all four systemic Greek banks, pointing out that the 15% reduced valuations from the high provide a good entry opportunity for investors.

The British bank prefers the shares of National Bank and Piraeus Bank. The target prices are 3.35 euros (from 3.30 euros) for Piraeus Bank, 6.75 euros (from 5.20 euros) for National Bank, 1.60 euros for Eurobank (unchanged) and 1.45 euros (from 1.40 euros) for Alpha Bank.

“Greek banks appear attractive at 0.55 times price-to-book value (P/TBV) ratios, 20% below emerging markets and 25% below European banks. We still see the best risk/reward combination in Piraeus Bank at 0.46 times, a valuation that seems unjustified for the profitability ratio it will display.