Interim Financial Report 2022-2

RNS Number : 7199X

Bank of Cyprus Holdings PLC

31 August 2022

 

The Interim Financial Report relates to Bank of Cyprus Holdings Public Limited Company (the Company) and together with its subsidiaries the Group, which was listed on the London Stock Exchange (LSE) and the Cyprus Stock Exchange (CSE) as at 30 June 2022.

Activities

The Company is the holding company of the Group and of Bank of Cyprus Public Company Ltd (BOC PCL). The principal activities of BOC PCL and its subsidiary companies involve the provision of banking, financial, and insurance services and the management and disposal of property predominately acquired in exchange of debt.

All Group companies and branches are set out in Note 34 to the Consolidated Condensed Interim Financial Statements. The Group has established branches in Greece. There were no acquisitions of subsidiaries and no material disposals of subsidiaries during the six months ended 30 June 2022. Information on Group companies and acquisitions and disposals during the period are detailed in Note 34 to the Consolidated Condensed Interim Financial Statements.

Group financial results on the underlying basis

The main financial highlights for the six months ended 30 June 2022 are set out below:

Consolidated Condensed Interim Income Statement on the underlying basis

	Six months ended 30 June
€ million	20221	20211,2 (restated)
Net interest income	145	152
Net fee and commission income	94	84
Net foreign exchange gains and net gains/(losses) on financial instruments	11	9
Insurance income net of claims and commissions	33	31
Net gains from revaluation and disposal of investment properties and on disposal of stock of properties	7	6
Other income	9	6
Total income	299	288
Staff costs	(100)	(101)
Other operating expenses	(73)	(70)
Special levy on deposits and other levies/contributions	(17)	(15)
Total expenses	(190)	(186)
Operating profit before credit losses and impairments	109	102
Loan credit losses	(23)	(35)
Impairments of other financial and non‑financial assets	(13)	(11)
Provisions for litigation, claims, regulatory and other matters	(1)	(4)
Total loan credit losses, impairments and provisions	(37)	(50)
Profit before tax and non‑recurring items	72	52
Tax	(12)	(1)
Profit attributable to non‑controlling interests	(1)	(0)
Profit after tax and before non‑recurring items (attributable to the owners of the Company)	59	51
Advisory and other restructuring costs‑organic	(5)	(18)
Profit after tax ‑ organic (attributable to the owners of the Company)	54	33
Provisions/net loss relating to NPE sales3	(0)	(16)
Restructuring and other costs relating to NPE sales3	(1)	(16)
Restructuring costs ‑ Voluntary Staff Exit Plan (VEP)	(3)	-
Profit after tax (attributable to the owners of the Company)	50	1

[1] The financial information is derived from and should be read in conjunction with the accompanied Consolidated Condensed Interim Financial Statements.

2 Comparative information was restated following a reclassification of approximately €1 million loss relating to disposal/dissolution of subsidiaries and associates from 'Net foreign exchange gains and net gains/(losses) on financial instruments' to 'Other income'. More information is provided in Note 3.1 of the Consolidated Condensed Interim Financial Statements.

3 ' Provisions/net loss relating to NPE sales' refer to the net loss on transactions completed during the period and the net loan credit losses on transactions under consideration, whilst 'Restructuring and other costs relating to NPE Sales' refer mainly to the costs relating to these trades.

Group financial results on the underlying basis (continued)

Consolidated Condensed Interim Income Statement on the underlying basis (continued)

	Six months ended 30 June
	2022	2021
Key Performance Ratios4
Net interest margin (annualised)	1.32%	1.56%
Cost to income ratio	63%	64%
Cost to income ratio excluding special levy on deposits and other levies/contributions	58%	59%
Operating profit return on average assets (annualised)	0.9%	0.9%
Basic earnings per share attributable to the owners of the Company (€ cent)	11.23	0.17
Basic earnings after tax and before non‑recurring items per share attributable to the owners of the Company (€ cent)5	13.51	11.24
Return on tangible equity (ROTE) after tax and before non‑recurring items (annualised)6	7.3%	6.1%

Consolidated Condensed Interim Balance Sheet on the underlying basis

€ million	30 June 20227	31 December 20217
Cash and balances with central banks	9,905	9,231
Loans and advances to banks	312	292
Debt securities, treasury bills and equity investments	2,102	2,139
Net loans and advances to customers	10,144	9,836
Stock of property	1,054	1,112
Investment properties	102	118
Other assets	1,877	1,876
Non‑current assets and disposal groups held for sale	348	359
Total assets	25,844	24,963
Deposits by banks	492	457
Funding from central banks	2,955	2,970
Customer deposits	18,450	17,531
Debt securities in issue	299	303
Subordinated liabilities	312	340
Other liabilities	1,243	1,281
Total liabilities	23,751	22,882
Shareholders' equity	1,850	1,839
Other equity instruments	220	220
Total equity excluding non‑controlling interests	2,070	2,059
Non‑controlling interests	23	22
Total equity	2,093	2,081
Total liabilities and equity	25,844	24,963

4 Including the NPE portfolios classified as 'Non‑current assets and disposal groups held for sale', where relevant.

5As of 30 June 2021, management monitors 'Basic earnings/(losses) per share attributable to the owners of the Company' calculated using 'Profit/(loss) after tax and before non‑recurring items (attributable to the owners of the Company)', rather than 'Profit/(loss) after tax - organic (attributable to the owners of the Company)' which was previously the case, as management believes it is a more appropriate measure of monitoring recurring performance, as it excludes 'Advisory and other restructuring costs - organic' which do not relate to the underlying or recurring business of the Group.

6 Return on tangible equity (ROTE) after tax and before non‑recurring items (annualised)' is calculated as the profit after tax and before non‑recurring items (annualised) divided by the shareholders' equity minus intangible assets.

7 The financial information is derived from and should be read in conjunction with the accompanied Consolidated Condensed Interim Financial Statements.

Group financial results on the underlying basis (continued)

Consolidated Condensed Interim Balance Sheet on the underlying basis (continued)

Key Balance Sheet figures and ratios8	30 June 2022 (pro forma)9	30 June 2022 (as reported)8	31 December 2021 (as reported)8
Gross loans (€ million)	10,477	11,047	10,856
Allowance for expected loan credit losses (€ million)	355	677	792
Customer deposits (€ million)	18,450	18,450	17,531
Loans to deposits ratio (net)	55%	56%	57%
NPE ratio	5.7%	10.6%	12.4%
NPE coverage ratio	59%	58%	59%
Leverage ratio	7.4%	7.4%	7.6%
Capital ratios and risk weighted assets8
Common Equity Tier 1 (CET1) ratio (transitional for IFRS 9)10	14.2%	14.6%	15.1%
Total capital ratio	19.3%	19.5%	20.0%
Risk weighted assets (€ million)	10,260	10,600	10,694

Commentary on underlying basis

The financial information presented below provides an overview of the Group financial results for the six months ended 30 June 2022 on the 'underlying basis' which management believes best fits the true measurement of the performance and position of the Group, as this presents separately the exceptional and one‑off items. Reconciliations between the statutory basis and the underlying basis are included in section 'Reconciliation of the Consolidated Condensed Interim Income Statement for the six months ended 30 June 2022 between the statutory and underlying basis' below and in 'Definitions and explanations on Alternative Performance Measures Disclosures' of the Interim Financial Report 2022, to facilitate the comparability of the underlying basis to the statutory information.

References to pro forma figures and ratios as at 30 June 2022 refer to Projects Helix 3 and Sinope (as explained in the paragraphs further below) and to the Voluntary Exist Plan completed in July (VEP) (as explained in the paragraphs further below) (where applicable). All relevant figures are based on 30 June 2022 results, unless otherwise stated. Numbers on a pro forma basis are based on 30 June 2022 underlying basis figures and are adjusted for Projects Helix 3 and Sinope and for VEP (where applicable), and assume their completion. The completion of Project Helix 3 remains subject to customary regulatory and other approvals and is currently expected to occur in the second half of 2022. Project Sinope was completed in August 2022. As at 30 June 2022, the portfolios of loans, as well as the real estate properties included in Project Helix 3 and Project Sinope, were classified as disposal groups held for sale. 

Where numbers are provided on a pro forma basis, this is stated and referred to as 'Pro forma for held for sale and VEP' or 'Pro forma for HFS and VEP'.

The below definitions are used in the commentary that follows the presentation of the underlying basis financial information:

NPE sales: NPE sales refer to sales of NPE portfolios completed, as well as contemplated sale transactions, irrespective of whether or not they meet the held for sale classification criteria at the reporting dates.

Project Helix 3: Project Helix 3 refers to the agreement the Group reached in November 2021 with funds affiliated with Pacific Investment Management Company LLC ('PIMCO'), for the sale of a portfolio of loans with gross book value of €568 million, as well as real estate properties with book value of approximately €120 million as at 30 September 2021, the reference date.

8 Including the NPE portfolios classified as 'Non‑current assets and disposal groups held for sale', where relevant.

9 Pro forma for HFS and VEP (as applicable) (please refer to 'Commentary on underlying basis')

1 ⁰ The CET1 fully‑loaded ratio as at 30 June 2022 amounts to 13.9% and 13.4% pro forma for HFS and completion of VEP, compared to 13.7% as reported and 14.3% pro forma for HFS as at 31 December 2021.

Group financial results on the underlying basis (continued)

Consolidated Condensed Interim Balance Sheet on the underlying basis (continued)

Project Sinope: Project Sinope refers to the agreement the Group reached in December 2021 for the sale of a portfolio of loans with gross book value of €12 million, as well as properties in Romania with carrying value €0.6 million, as at 31 December 2021, the reference date. Project Sinope was completed in August 2022.

VEP: F or the purposes of the reference to pro forma figures and ratios as at 30 June 2022, VEP refers to the Voluntary Staff Exit Plan that the Group completed in July 2022, through which approximately 550 applicants were approved to leave at a total cost of approximately €99 million, expected to be recorded in the consolidated income statement in the third quarter of 2022.

Further details of the Project Helix 3 and Project Sinope transactions are provided in 'Loan portfolio quality' under the 'Balance Sheet Analysis' section below.

Reconciliation of the Consolidated Condensed Interim Income Statement for the six months ended 30 June 2022 between the statutory and underlying basis

€ million	Underlying basis	NPE sales	Other	Statutory basis
Net interest income	145	-	-	145
Net fee and commission income	94	-	-	94
Net foreign exchange gains and net gains/(losses) on financial instruments	11	-	(1)	10
Net gains/(losses) on derecognition of financial assets measured at amortised cost	-	-	2	2
Insurance income net of claims and commissions	33	-	-	33
Net gains from revaluation and disposal of investment properties and on disposal of stock of properties	7	-	-	7
Other income	9	-	-	9
Total income	299	-	1	300
Total expenses	(190)	(1)	(9)	(200)
Operating profit before credit losses and impairments	109	(1)	(8)	100
Loan credit losses	(23)	-	23	-
Impairments of other financial and non‑financial assets	(13)	-	13	-
Provision for litigation, claims, regulatory and other matters	(1)	-	1	-
Credit losses on financial assets and impairment net of reversals of non-financial assets	-	-	(37)	(37)
Profit before tax and non‑recurring items	72	(1)	(8)	63
Tax	(12)	-	-	(12)
Profit attributable to non‑controlling interests	(1)	-	-	(1)
Profit after tax and before non‑recurring items (attributable to the owners of the Company)	59	(1)	(8)	50
Advisory and other restructuring costs‑organic	(5)	-	5	0
Profit after tax ‑ organic* (attributable to the owners of the Company)	54	(1)	(3)	50
Provisions/net loss relating to NPE sales	0	-	-	0
Restructuring and other costs relating to NPE sales	(1)	1	-	0
Restructuring costs - Voluntary Staff Exit Plan (VEP)	(3)	-	3	0
Profit after tax (attributable to the owners of the Company)	50	0	0	50

* This is the profit after tax (attributable to the owners of the Company), before the provisions/net loss relating to NPE sales, related restructuring and other costs, and restructuring costs related to a Voluntary Staff Exit Plan (VEP) of a subsidiary.

Group financial results on the underlying basis (continued)

Reconciliation of the Consolidated Condensed Interim Income Statement for the six months ended 30 June 2022 between the statutory and underlying basis (continued)

The reclassification differences between the statutory basis and the underlying basis mainly relate to the impact from 'non-recurring items' and are explained as follows:

NPE sales 

· Total expenses include restructuring costs of €1 million relating to the agreements for the sale of portfolios of NPEs and are presented within 'Restructuring and other costs relating to NPE sales ' under the underlying basis.

Other reclassifications

· Net losses on loans and advances to customers at FVPL of €2 million included in 'Loan credit losses' under the underlying basis are included in 'Net losses on financial instruments' under the statutory basis. Their classification under the underlying basis is done to align their presentation with the loan credit losses on loans and advances to customers at amortised cost.

· 'Net gains /(losses) on derecognition of financial assets measured at amortised cost' of approximately €2 million under the statutory basis comprise of the below items which are reclassified accordingly under the underlying basis as follows:

· €3 million net gains on derecognition of loans and advances to customers included in 'Loan credit losses' under the underlying basis as to align to the presentation of the loan credit losses arising from loans and advances to customers.

· Net losses on derecognition of debt securities measured at amortised cost of approximately €1 million included in 'Net foreign exchange gains and net losses on financial instruments' under the underlying basis in order to align their presentation with the gains/(losses) arising on financial instruments.

· Provision for litigation, claims, regulatory and other matters amounting to €1 million included in 'Other operating expenses' under the statutory basis, is separately presented under the underlying basis, since it mainly relates to cases that arose outside the normal activities of the Group.

· Advisory and other restructuring costs of approximately €5 million included in 'Other operating expenses' under the statutory basis are separately presented under the underlying basis since they comprise mainly fees to external advisors in relation to the transformation programme and other strategic projects of the Group.

· Total expenses under the statutory basis include restructuring costs relating to the voluntary staff exit plan (VEP) of JCC Payment Systems Ltd of €3 million and are separately presented under the underlying basis, since they represent one-off items.

· 'Credit losses on financial assets' and 'impairment net of reversals of non-financial assets' under the statutory basis include: i) credit losses to cover credit risk on loan and advances to customers of €24 million, which are included in 'Loan credit losses' under the underlying basis, and ii) credit losses of other financial instruments of €1 million and impairment net of reversals of non-financial assets of €12 million which are included in 'Impairments of other financial and non-financial assets' under the underlying basis, as to be presented separately from loan credit losses.

Group financial results on the underlying basis (continued)

Balance Sheet Analysis

Capital Base

Total equity excluding non-controlling interests totalled €2,070 million as at 30 June 2022 compared to €2,059 million at 31 December 2021 . Shareholders' equity totalled €1,850 million as at 30 June 2022 compared to €1,839 million at 31 December 2021.

The Common Equity Tier 1 capital (CET1) ratio on a transitional basis stood at 14.6% as at 30 June 2022 and 14.2% pro forma for held for sale portfolios and Voluntary Staff Exit Plan (collectively referred to as 'pro forma for HFS and VEP'), compared to 15.1% as at 31 December 2021 (and 15.8% pro forma for HFS). During the six months ended 30 June 2022, the CET1 ratio was positively affected mainly by the pre-provision income, and negatively affected mainly by provisions and impairments, the payment of AT1 interest and the movement in the fair value through Other Comprehensive Income reserves. The capital ratios (and pro forma capital ratios) as at 30 June 2022, throughout the Interim Financial Report, include reviewed profits for the six months ended 30 June 2022, unless otherwise stated.

The Group has elected to apply the EU transitional arrangements for regulatory capital purposes (EU Regulation 2017/2395) where the impact on the impairment amount from the initial application of IFRS 9 on the capital ratios is phased-in gradually, with the impact being fully phased-in (100%) by 1 January 2023. The phasing-in for 2022, of the impairment amount from the initial application of IFRS 9 had a negative impact of approximately 60 bps on the CET1 ratio on 1 January 2022. In addition, a prudential charge in relation to the onsite inspection on the value of the Group's foreclosed assets is being deducted from own funds since June 2021, the impact of which is 36 bps on Group's CET1 ratio as at 30 June 2022.

The CET1 ratio on a fully loaded basis amounted to 13.9% as at 30 June 2022 and 13.4% pro forma for HFS and VEP compared to 13.7% as at 31 December 2021 (and 14.3% pro forma for HFS).

The Total Capital ratio stood at 19.5% as at 30 June 2022 and 19.3% pro forma for HFS and VEP, compared to 20.0% as at 31 December 2021 (and 20.8% pro forma for HFS).

The Group's capital ratios are above the Supervisory Review and Evaluation Process (SREP) requirements.

In the context of the annual SREP conducted by the European Central Bank (ECB) in 2021 and based on the final 2021 SREP Decision received in February 2022, the Pillar II requirement has been set at 3.26%, compared to the previous level of 3.00%. The additional Pillar II requirement add-on of 0.26% relates to ECB's prudential provisioning expectations as per the 2018 ECB Addendum and subsequent ECB announcements and press release in July 2018 and August 2019. This component of the Pillar II requirement add-on takes into consideration Project Helix 3.

BOC PCL has been designated as an Other Systemically Important Institution (O-SII) by the Central Bank of Cyprus (CBC) in accordance with the provisions of the Macroprudential Oversight of Institutions Law of 2015, and since November 2021 the O-SII buffer has been set to 1.50%. This buffer is being phased-in gradually, having started from 1 January 2019 at 0.50%. Currently the O-SII buffer stands at 1.25% and will be fully phased-in on 1 January 2023. 

As a result, the Group's minimum phased-in CET1 capital ratio has been set at 10.08% compared to the previous level of 9.69% (comprising a 4.50% Pillar I requirement, a 1.83% Pillar II requirement, the Capital Conservation Buffer of 2.50% and the O-SII Buffer of 1.25%) and the Group's Total Capital requirement was set at 15.01% compared to the previous level of 14.50% (comprising an 8.00% Pillar I requirement, of which up to 1.50% can be in the form of AT1 capital and up to 2.00% in the form of T2 capital, a 3.26% Pillar II requirement, the Capital Conservation Buffer of 2.50% and the O-SII Buffer of 1.25%). The ECB has also provided revised lower non-public guidance for an additional Pillar II CET1 buffer (P2G). Pillar II add-on capital requirements derive from the SREP, which is a point in time assessment, and are therefore subject to change over time. The new SREP requirements became effective as from 1 March 2022.

Group financial results on the underlying basis (continued)

Balance Sheet Analysis (continued)

Capital Base (continued)

Own funds held for the purposes of P2G cannot be used to meet any other capital requirements (Pillar I, Pillar II requirements or the combined buffer requirement), and therefore cannot be used twice.

Based on the SREP decision of prior years, Bank of Cyprus Holdings Public Limited Company (the Company) and BOC PCL are under a regulatory prohibition for equity dividend distribution and hence no dividends were declared or paid during 2021. Following the final 2021 SREP Decision received in February 2022, the Company and BOC PCL still remain under equity dividend distribution prohibition for 2022. This prohibition does not apply if the distribution is made via the issuance of new ordinary shares to the shareholders, which are eligible as CET1 capital. No prohibition applies to the payment of coupons on any AT1 capital instruments issued by the Company or BOC PCL. Following the final 2021 SREP Decision, the previous restriction on variable pay was lifted.

The Group participated in the 2022 ECB supervisory Climate Risk Stress Test and participated in the 2021 ECB SREP Stress Test. For further information please refer to the 'Additional Risk and Capital Management Disclosures' of the Interim Financial Report 2022 and the Annual Financial Report 2021.

Voluntary Staff Exit Plan

In July 2022, the Group completed a Voluntary Staff Exit Plan with an estimated cost of approximately € 99 million which will be recognised in the consolidated income statement in the third quarter 2022, resulting in a negative impact of approximately 95 bps both on the Group's CET1 and Total Capital ratios.

For further information please refer to Section 'Total expenses'.

Project Helix 3

In November 2021, the Group reached agreement for the sale of a portfolio of NPEs with gross book value of €568 million as at 30 September 2021, as well as real estate properties with book value of approximately €120 million as at 30 September 2021, known as Project Helix 3. Further details are provided in Section 'Loan portfolio quality'.

Project Helix 3 is expected to have a positive capital impact of approximately 60 bps on the Group's CET1 ratio on the basis of 30 June 2022 figures.

Pro forma calculations are based on 30 June 2022 financial results, unless otherwise stated, and assume completion of the transaction, which remains subject to customary regulatory and other approvals.

Tier 2 Capital Notes

In April 2021, the Company issued €300 million unsecured and subordinated Tier 2 Capital Notes (the 'New T2 Notes').

The Company and BOC PCL entered into an agreement pursuant to which the Company on-lent to BOC PCL the entire €300 million proceeds of the issue of the New T2 Notes (the 'Tier 2 Loan') on terms substantially identical to the terms and conditions of the New T2 Notes. The Tier 2 Loan constitutes an unsecured and subordinated obligation of BOC PCL.

The New T2 Notes were priced at par with a fixed coupon of 6.625% per annum, payable annually in arrears and resettable on 23 October 2026. The maturity date for the New T2 Notes is 23 October 2031. The Company will have the option to redeem the New T2 Notes early on any day during the six-month period from 23 April 2026 to 23 October 2026, subject to applicable regulatory consents.

At the same time, BOC PCL invited the holders of its €250 million Fixed Rate Reset Tier 2 Capital Notes due January 2027 (the 'Old T2 Notes') to tender their Old T2 Notes for purchase by BOC PCL at a price of 105.50%, after which Old T2 Notes of €43 million remained outstanding. On 19 January 2022, BOC PCL exercised its option and redeemed the outstanding €43 million Old T2 Notes.

The Group continues to monitor opportunities for the optimisation of its capital position, including Additional Tier 1 capital.

Group financial results on the underlying basis (continued)

Balance Sheet Analysis (continued)

Capital Base (continued)

Legislative amendments for the conversion of DTA to DTC

Legislative amendments allowing for the conversion of specific deferred tax assets (DTA) into deferred tax credits (DTC) became effective in March 2019. The law amendments cover the utilisation of income tax losses transferred from Laiki Bank to BOC PCL in March 2013. The introduction of Capital Requirements Directive (CRD) IV in January 2014 and its subsequent phasing-in led to a more capital-intensive treatment of this DTA for BOC PCL. With this legislation, institutions are allowed to treat such DTAs as 'not relying on profitability', according to CRD IV and as a result not deducted from CET1, hence improving a credit institution's capital position.

In response to concerns raised by the European Commission with regard to the provision of state aid arising out of the treatment of such tax losses, the Cyprus Government has proceeded with the adoption of modifications to the Law, including requirements for an additional annual fee over and above the 1.5% annual guarantee fee already provided for in the Law, to maintain the conversion of such DTAs into tax credits. In May 2022, the Cyprus Parliament voted these amendments which became effective since then. As prescribed by the amendments in the Law, the annual fee is to be determined by the Cyprus Government on an annual basis, providing however that such fee to be charged is set at a minimum fee of 1.5% of the annual instalment and can range up to a maximum amount of €10 million per year, and also allowing for a higher amount to be charged in the year the amendments are effective (i.e. in 2022).

The Group since prior years, in anticipation of modifications in the Law, acknowledged that such increased annual fee may be required to be recorded on an annual basis until expiration of such losses in 2028. The Group estimates that such fees could range up to €5.3 million per year (for each tax year in scope i.e. since 2018) although the Group understands that such fee may fluctuate annually as to be determined by the Ministry of Finance. An amount of €5.3 million was recorded during the year ended 31 December 2021, bringing the total amount provided by the Group for such increased fee to approximately €21 million for the years 2018-2021. In the third quarter of 2022, BOC PCL has been levied an amount within the provisions level maintained.

Regulations and Directives

The 2021 Banking Package (CRR III and CRD VI and BRRD)

In October 2021, the European Commission adopted legislative proposals for further amendments to Capital Requirements Regulation (CRR), CRD IV and the BRRD (the '2021 Banking Package'). Amongst other things, the 2021 Banking Package would implement certain elements of Basel III that have not yet been transposed into EU law. The 2021 Banking Package is subject to amendment in the course of the EU's legislative process; and its scope and terms may change prior to its implementation. In addition, in the case of the proposed amendments to CRD IV and the BRRD, their terms and effect will depend, in part, on how they are transposed in each member state. As a general matter, it is likely to be several years until the 2021 Banking Package begins to be implemented (currently expected in 2025); and certain measures are expected to be subject to transitional arrangements or to be phased in over time. 

Bank Recovery and Resolution Directive (BRRD)

Minimum Requirement for Own Funds and Eligible Liabilities (MREL)

The Bank Recovery and Resolution Directive (BRRD) requires that from January 2016 EU member states shall apply the BRRD's provisions requiring EU credit institutions and certain investment firms to maintain a minimum requirement for own funds and eligible liabilities (MREL), subject to the provisions of the Commission Delegated Regulation (EU) 2016/1450. On 27 June 2019, as part of the reform package for strengthening the resilience and resolvability of European banks, the BRRD Ι came into effect and was required to be transposed into national law. BRRD II was transposed and implemented in Cyprus law in early May 2021. In addition, certain provisions on MREL have been introduced in CRR Ι which also came into force on 27 June 2019 as part of the reform package and took immediate effect.

Group financial results on the underlying basis (continued)

Balance Sheet Analysis (continued)

Regulations and Directives (continued)

In December 2021, BOC PCL received notification from the Single Resolution Board (SRB) of the final decision for the binding minimum requirement for own funds and eligible liabilities (MREL) for BOC PCL, determined as the preferred resolution point of entry. As per the decision, the final MREL requirement was set at 23.74% of risk weighted assets and 5.91% of Leverage Ratio Exposure (LRE) (as defined in the CRR) and must be met by 31 December 2025. Furthermore, an interim requirement to be met by 1 January 2022 was set at 14.94% of risk weighted assets and 5.91% of LRE. The own funds used by BOC PCL to meet the Combined Buffer Requirement (CBR) will not be eligible to meet its MREL requirements expressed in terms of risk-weighted assets. BOC PCL must comply with the MREL requirement at the consolidated level, comprising BOC PCL and its subsidiaries.

In June 2021, BOC PCL executed its inaugural MREL transaction issuing €300 million of senior preferred notes (the 'SP Notes'). The SP Notes were priced at par with a fixed coupon of 2.50% per annum, payable annually in arrears and resettable on 24 June 2026. The maturity date of the SP Notes is 24 June 2027 and BOC PCL may, at its discretion, redeem the SP Notes on 24 June 2026, subject to meeting certain conditions as specified in the Terms and Conditions, including applicable regulatory consents. The SP Notes comply with the criteria for MREL and contribute towards BOC PCL's MREL requirements.

The MREL ratio of BOC PCL as at 30 June 2022, calculated according to the SRB's eligibility criteria currently in effect and based on the BOC PCL's internal estimate, stood at 18.61% of risk weighted assets (RWA) and at 9.28% of LRE. Pro forma for HFS and VEP, the MREL ratio of BOC PCL as at 30 June 2022, calculated on the same basis, stood at 18.47% of risk weighted assets. The MREL ratio expressed as a percentage of risk weighted assets does not include capital used to meet the CBR amount, which stands at 3.75% since 1 January 2022 and is expected to increase to 4.0% on 1 January 2023. Throughout the Interim Financial Report, t he MREL ratios (and MREL ratios pro forma for HFS and VEP) as at 30 June 2022 include unaudited/un reviewed profits for the six months ended 30 June 2022, unless otherwise stated.

The successful Tier 2 capital refinancing in April 2021 and the inaugural issuance of MREL-compliant senior notes in June 2021 mark the foundation for BOC PCL's plan to meet applicable MREL requirements. The interim MREL requirement as at 1 January 2022 was satisfied, and BOC PCL will continue to evaluate opportunities to advance the build-up of its MREL liabilities.

Funding and Liquidity

Funding

Funding from Central Banks

At 30 June 2022, BOC PCL's funding from central banks amounted to € 2,955 million (including accrued interest), which relates to ECB funding, comprising solely of funding through the Targeted Longer-Term Refinancing Operations (TLTRO) III, compared to €2,970 million as at 31 December 2021.

BOC PCL borrowed an overall amount of €3 billion under TLTRO III by June 2021, despite its comfortable liquidity position, given the favourable borrowing terms, in combination with the relaxation of collateral requirements. The participation in TLTRO III is expected to be maintained to maturity, subject to no change in terms and conditions.

BOC PCL exceeded the benchmark net lending threshold in the period 1 March 2020 - 31 March 2021 and qualified for the beneficial rate of -1% for the period from June 2020 to June 2021. The NII benefit from its TLTRO III borrowing for the period from June 2020 to June 2021 stood at approximately €7 million and was recognised over the respective period in the income statement.

In addition, BOC PCL has exceeded the benchmark net lending threshold in the period 1 October 2020 - 31 December 2021 and qualified for a beneficial rate for the period from June 2021 to June 2022. The NII benefit from its TLTRO III borrowing for the period from June 2021 to June 2022 stood at approximately €15 million and was recognised over the respective period in the income statement.

Group financial results on the underlying basis (continued)

Balance Sheet Analysis (continued)

Funding and Liquidity (continued)

Funding (continued)

Deposits

Customer deposits totalled €18,450 million at 30 June 2022 (compared to €17,531 million at 31 December 2021).

BOC PCL's deposit market share in Cyprus reached 36.8% as at 30 June 2022, compared to 34.8% as at 31 December 2021. Customer deposits accounted for 71% of total assets and 78% of total liabilities at 30 June 2022.

The net Loans to Deposits (L/D) ratio stood at 56% as at 30 June 2022 (compared to 57% as at 31 December 2021 on the same basis). Pro forma for HFS, the L/D ratio as at 30 June 2022 stood at 55%.

Subordinated liabilities

At 30 June 2022, the Group's subordinated liabilities (including accrued interest) amounted to €312 million (compared to €340 million at 31 December 2021) and relate to unsecured subordinated Tier 2 Capital Notes.

For further information please refer to Section 'Capital Base' .

Debt securities in issue

At 30 June 2022, the Group's debt securities in issue (including accrued interest) amounted to €299 million (compared to €303 million at 31 December 2021) and relate to senior preferred notes.

For further information please refer to Section 'Bank Recovery and Resolution Directive (BRRD) / Minimum Requirement for Own Funds and Eligible Liabilities (MREL)'.

Liquidity

At 30 June 2022, the Group Liquidity Coverage Ratio (LCR) stood at 299% (compared to 298% at 31 December 2021), well above the minimum regulatory requirement of 100%. The LCR surplus as at 30 June 2022 amounted to €6.7 billion (compared to €6.3 billion at 31 December 2021), well positioned to benefit from further interest rates increases. The increase is mainly driven by the increase in customer deposits.

At 30 June 2022, the Group Net Stable Funding Ratio (NSFR) stood at 160% (compared to 147% at 31 December 2021), well above the minimum regulatory requirement of 100%, enforced in June 2021 as per CRR II.

Loans

Group gross loans (inclusive of those classified as held for sale) totalled €11,047 million at 30 June 2022 , compared to €10,856 million at 31 December 2021, increased by 2% since the beginning of the year.

New lending granted in Cyprus reached €1,159 million for the six months ended 30 June 2022 (compared to € 894 million for the six months ended 30 June 2021), reaching higher levels than the equivalent period pre-pandemic (i.e. during the six months ended 30 June 2019), whilst maintaining strict lending criteria. The increase is driven by increase in lending activity across all sectors, with corporate being the main driver. New lending in the six months ended 30 June 2022 comprised €496 million of corporate loans, €392 million of retail loans (of which €273 million were housing loans), €119 million of SME loans and €152 million of shipping and international loans. 

At 30 June 2022, the Group net loans and advances to customers (excluding those classified as held for sale) totalled €10,144 million (compared to €9,836 million at 31 December 2021).

In addition, at 30 June 2022 net loans and advances to customers of €247 million were classified as held for sale in line with IFRS 5, of which €241 million related to Project Helix 3 and €6 million to Project Sinope (see below), compared to €250 million as at 31 December 2021, of which €243 million related to Project Helix 3 and €7 million to Project Sinope.

Group financial results on the underlying basis (continued)

Balance Sheet Analysis (continued)

Loans (continued)

BOC PCL is the single largest credit provider in Cyprus with a market share of 41.2% at 30 June 2022, compared to 38.8% at 31 December 2021. The increase during the six months ended 30 June 2022 is due to a reduction in loans in the banking system.

Loan portfolio quality

The Group has continued to make steady progress across all asset quality metrics. As the balance sheet de-risking is largely complete, t he Group's priorities include maintaining high quality new lending and preventing asset quality deterioration following the deteriorating macroeconomic landscape.

The loan credit losses for the six months ended 30 June 2022 totalled €23 million (excluding 'Provisions/net loss relating to NPE sales'), compared to € 35 million for the six months ended 30 June 2021 . Further details regarding loan credit losses are provided in Section 'Profit before tax and non-recurring items'.

While defaults have been limited, the additional monitoring and provisioning for sectors vulnerable to the deteriorated macroeconomic environment remain in place to ensure that potential difficulties in the repayment ability are identified at an early stage, and appropriate solutions are provided to viable customers. 

The Group will continue to monitor the situation, so that any changes arising from the uncertainty on the macroeconomic outlook and geopolitical developments are timely captured.

Non-performing exposures reduction

Non-performing exposures (NPEs) as defined by the European Banking Authority (EBA) were reduced by €175 million to €1,168 million during the six months ended 30 June 2022 (compared to €1,343 million as at 31 December 2021) (comprising net organic NPE reductions of € 170 million and further net NPE reductions of € 5 million relating to the NPE sales lockbox). Pro forma for HFS, NPEs are reduced by a further €568 million to €600 million on the basis of 30 June 2022 figures.

The NPEs account for 10.6% of gross loans as at 30 June 2022, compared to 12.4% as at 31 December 2021, on the same basis, i.e. including the NPE portfolios classified as 'Non-current assets and disposal groups held for sale'. Pro forma for HFS, the NPE ratio is reduced to 5.7% on the basis of 30 June 2022 figures.

The NPE coverage ratio stands at 58% at 30 June 2022, compared to 59% as at 31 December 2021 on the same basis, i.e. including the NPE portfolios classified as 'Non-current assets and disposal groups held for sale'. When taking into account tangible collateral at fair value, NPEs are fully covered. Pro forma for HFS, NPE coverage ratio is 59% on the basis of 30 June 2022 figures.

Project Helix 3

In November 2021, the Group reached agreement for the sale of a portfolio of NPEs with gross book value of €568 million as at 30 September 2021, as well as real estate properties with book value of approximately €120 million as at 30 September 2021, to funds affiliated with Pacific Investment Management Company LLC (PIMCO), known as Project Helix 3. This portfolio of loans had a contractual balance of €993 million as at the reference date of 31 May 2021 and comprises approximately 20,000 loans, mainly to retail clients. As at 30 June 2022 and 31 December 2021, this portfolio of loans, as well as the real estate properties included in Helix 3, were classified as a disposal group held for sale. At completion, currently expected to occur in the second half of 2022, BOC PCL will receive gross cash consideration of approximately €385 million.

This portfolio of loans (as well as the real estate properties included in Helix 3) will be transferred to a licensed Cypriot Credit Acquiring Company (the 'CyCAC') by BOC PCL. The shares of the CyCAC will then be acquired by certain funds affiliated with Pacific Investment Management Company LLC (PIMCO), the purchaser of the portfolio.

Following a transitional period where servicing will be retained by BOC PCL, it is intended that the servicing of the portfolio of loans and the real estate properties included in Helix 3 will be carried out by a third party servicer selected and appointed by the purchaser.

Group financial results on the underlying basis (continued)

Balance Sheet Analysis (continued)

Loan portfolio quality (continued)

Non-performing exposure reduction (continued)

Project Helix 3 (continued)

Project Helix 3 represents a milestone in the delivery of one of the Group's core strategic priorities of improving asset quality through the reduction of NPEs. Pro forma for HFS, the Group's NPE ratio is in mid-single digit. Helix 3 reduced the stock of NPEs by 50% to €600 million pro forma on the basis of 30 June 2022 figures, and its NPE ratio by 5 p.p., to 5.7% pro forma on the basis of 30 June 2022 figures.

All relevant figures and pro forma calculations are based on 30 June 2022 financial results, unless otherwise stated, and assume completion of the transaction, which remains subject to customary regulatory and other approvals.

Project Sinope

In December 2021, BOC PCL entered into an agreement for the sale of a portfolio of NPEs, with a contractual balance of €146 million and a gross book value of €12 million as at 31 December 2021, as well as properties in Romania with carrying value €0.6 million as at 31 December 2021 (known as 'Project Sinope'). The portfolio has been classified as held for sale since 31 December 2021.  Project Sinope was completed in August 2022.

O verall, since the peak in 2014 and pro forma for HFS, the stock of NPEs has been reduced by €14.4 billion or 96% to €0.6 billion and the NPE ratio by over 57 percentage points, from 63% to 5.7%.

The Group has already achieved a mid-single digit NPE ratio and is on track to achieve a target NPE ratio of approximately 5% by the end of 2022 and less than 3% by the end of 2025.

Real Estate Management Unit (REMU)

The Real Estate Management Unit (REMU) is focused on the disposal of on-boarded properties resulting from debt for asset swaps. Cumulative sales since the beginning of 2017 amount to €1.46 billion and exceed properties on-boarded in the same period of €1.35 billion.

During the six months ended 30 June 2022 the Group completed disposals of €87 million (compared to € 76 million in the six months ended 30 June 2021 ), resulting in a profit on disposal of €8 million (compared to a profit on disposal of € 7 million during the six months ended 30 June 2021 ). During the six months ended 30 June 2022 asset disposals are across all property classes, with over 60% of sales by value relating to land .

As at 30 June 2022 the carrying value of assets held by REMU classified as ' non-current assets and disposal groups held for sale' amounted to € 90 million (compared to € 98 million at 31 December 2021). They relate to Project Helix 3 and Project Sinope and comprise stock of property of € 85 million and investment property of € 5 million as at 30 June 2022 (compared to stock of property of € 93 million and investment properties of € 5 million as at 31 December 2021).

During the six months ended 30 June 2022, the Group executed sale-purchase agreements (SPAs) for disposals of 373 properties with contract value of approximately €99 million, compared to SPAs for disposals of 387 properties (with contract value of €85 million) for the six months ended 30 June 2021.

In addition, the Group had a strong pipeline of €81 million by contract value as at 30 June 2022, of which €41 million related to SPAs signed (compared to a pipeline of €85 million as at 30 June 2021, of which €48 million related to SPAs signed).

REMU on-boarded €26 million of assets in the six months ended 30 June 2022 (compared to additions of €21 million in the six months ended 30 June 2021), via the execution of debt for asset swaps and repossessed properties.

As at 30 June 2022, assets held by REMU (excluding assets classified as held for sale) had a carrying value of €1,146 million (comprising properties of €1,054 million classified as 'Stock of property' and €92 million as 'Investment properties'), compared to €1,215 million as at 31 December 2021 (comprising properties of €1,112 million classified as 'Stock of property' and €103 million as 'Investment properties').

Group financial results on the underlying basis (continued)

Balance Sheet Analysis (continued)

Real Estate Management Unit (REMU)

In addition to assets held by REMU, properties classified as 'Investment properties' with carrying value of €10 million as at 30 June 2022 (compared to €15 million as at 31 December 2021) are not managed by REMU. These relate mainly to legacy properties held by the Group before the set-up of REMU in January 2016 and to assets classified as 'Investment properties' following a change in use.

Income Statement Analysis

Total income

Net interest income (NII) for the six months ended 30 June 2022 amounted to €145 million, compared to € 152 million in the six months ended 30 June 2021. The decrease reflects the foregone NII on the Helix 2 portfolio (approximately € 15 million in the six months ended 30 June 2021), partially offset by the growth in the performing (non-legacy) loan book and loan yield improvement in line with the interest rate environment during the six months ended 30 June 2022.

Quarterly average interest earning assets (AIEA) for the six months ended 30 June 2022 amounted to €22,235 million, driven by the increase in liquid assets following the increase in deposits by €1.6 billion since 30 June 2021 .

Net interest margin (NIM) for the six months ended 30 June 2022 amounted to 1.32% (compared to 1.56% for the six months ended 30 June 2021) negatively impacted by the corresponding decrease in NII and the increase in average interest earning assets.

Non-interest income for the six months ended 30 June 2022 amounted to €154 million (compared to €136 million for the six months ended 30 June 2021), comprising net fee and commission income of €94 million, net foreign exchange gains and net gains/(losses) on financial instruments of €11 million, net insurance income of €33 million, net gains/(losses) from revaluation and disposal of investment properties and on disposal of stock of properties of €7 million and other income of €9 million. The increase compared to 30 June 2021 is mainly due to higher net fee and commission income, following the introduction of a revised price list and extension of liquidity fees to a wider customer group in the first quarter of 2022.

Net fee and commission income for the six months ended 30 June 2022 amounted to €94 million, compared to € 84 million for the six months ended 30 June 2021. The increase was driven mainly by the introduction of a revised price list in February 2022 and the extension of liquidity fees to a wider customer group in March 2022.

Net foreign exchange gains and net gains/(losses) on financial instruments of €11 million for the six months ended 30 June 2022 (comprising net foreign exchange gains of € 12 million and net losses on financial instruments of € 1 million), compared to €9 million for the six months ended 30 June 2021 (comprising net foreign exchange gains of € 7 million and net gains on financial instruments of €2 million). The increase in the six months ended 30 June 2022 is mainly due to the lower net foreign exchange gains in the six months ended 30 June 2021, which was impacted by the lockdown and the higher interest rates compared to previous years.

Net insurance income for the six months ended 30 June 2022 amounted to €33 million, comprising of income from assets under insurance and reinsurance contracts of €30 million and a credit for expenses from liabilities under insurance and reinsurance contracts of €3 million, compared to €31 million for the six months ended 30 June 2021 (comprising of income from assets under insurance and reinsurance contracts of €104 million and expenses from liabilities under insurance and reinsurance contracts of €73 million respectively). The increase in net insurance income of  2 million, which corresponds to an increase of 6% compared to 30 June 2021, is mainly due to increased new business and the positive changes in valuation assumptions, partially offset by higher insurance claims. The decrease in income from assets under insurance and reinsurance contracts is impacted by the valuation on the unit-linked investments, which in turn has a positive impact on the respective technical reserves, whose movement is reported under expenses from liabilities under insurance and reinsurance contracts.

Group financial results on the underlying basis (continued)

Income Statement Analysis (continued)

Total income (continued)

Net gains/(losses) from revaluation and disposal of investment properties and on disposal of stock of properties for the six months ended 30 June 2022 amounted to € 7 million (comprising a profit on disposal of stock of properties of €8 million and net losses from revaluation and disposal of investment properties of €1 million), compared to € 6 million for the six months ended 30 June 2021 (comprising a profit on disposal of stock of properties of €7 million and net losses from revaluation of investment properties of €1 million).  REMU profit remains volatile.

Total income for the six months ended 30 June 2022 amounted to €299 million, compared to €288 million for the six months ended 30 June 2021, mainly driven by the changes in the non-interest income as explained above.

Total expenses

Total expenses for the six months ended 30 June 2022 were €190 million, compared to €186 million for the six months ended 30 June 2021. Of these, 53% related to staff costs (€100 million), 38% to other operating expenses (€73 million) and 9% to special levy on deposits and other levies/contributions (€17 million). The increase of 2% compared to 30 June 2021 is driven partly by the increase in other operating expenses and partly by the increase in special levy on deposits and other levies/contributions.

Total operating expenses amounted to €173 million for the six months ended 30 June 2022, compared to €171 million for the six months ended 30 June 2021.

Staff costs for the six months ended 30 June 2022 were €100 million, compared to € 101 million for the six months ended 30 June 2021, resulting from the combined impact of the voluntary staff exit plans that took place in the previous quarters, the renewal of the collective agreement, and despite rising inflation. The Group employed 3,422 persons as at 30 June 2022 compared to 3,438 persons as at 31 December 2021.

In July 2022, the Group completed a Voluntary Staff Exit Plan, through which approximately 550 applicants were approved to leave at a total cost of approximately € 99 million, expected to be recorded in the consolidated income statement in the third quarter of 2022. Following the completion of the VEP, the overall number of employees is reduced by approximately 16%, with an estimated annual saving of approximately € 37 million or approximately 19% of staff costs.

In addition, in January 2022 the Group , through one of its subsidiaries , completed a Voluntary Staff Exit Plan (VEP), through which a small number of its employees were approved to leave at a total cost of €3 million, recorded in the consolidated income statement in the first quarter of 2022 as a non-recurring item in the underlying basis. 

Other operating expenses for the six months ended 30 June 2022 were €73 million, compared to €70 million in the six months ended 30 June 2021 . The increase reflects the pandemic-related lockdown in the first quarter of 2021 and the seasonally higher marketing expenses.

Special levy on deposits and other levies/contributions for the six months ended 30 June 2022 amounted to €17 million, compared to €15 million for the six months ended 30 June 2021 driven by the increase in deposits of over € 1.6 billion since 30 June 2021.

The cost to income ratio excluding special levy on deposits and other levies/contributions for the six months ended 30 June 2022 was 58%, compared to 59% for the six months ended 30 June 2021.

The cost to income ratio excluding special levy on deposits and other levies/contributions for 2022 is revised downwards to around current levels from initial expectations of mid-60s , reflecting mainly the rising revenue on improving interest rate environment and management's ongoing efforts to contain costs. In 2023 the cost to income ratio excluding special levy on deposits and other levies/contributions is expected to decrease further to approximately 50%, as efficiency actions on staff and branch reduction unlock meaningful savings in 2023.

Group financial results on the underlying basis (continued)

Income Statement Analysis (continued)

Profit before tax and non-recurring items

Operating profit before credit losses and impairments for the six months ended 30 June 2022 was €109 million, compared to €102 million for the six months ended 30 June 2021.

Loan credit losses for the six months ended 30 June 2022 totaled €23 million, compared to €35 million for the six months ended 30 June 2021.

C ost of risk for the six months ended 30 June 2022 was 43 bps, compared to a cost of risk of 61 bps for the six months ended 30 June 2021, down by 18 bps mainly as the cost of risk for the six months ended 30 June 2021 included 21 bps credit losses related to COVID-19.

At 30 June 2022, the allowance for expected loan credit losses, including residual fair value adjustment on initial recognition and credit losses on off-balance sheet exposures (please refer to 'Definitions and explanations of Alternative Performance Measures Disclosures' of the Interim Financial Report 2022) totalled €677 million (compared to €792 million at 31 December 2021) and accounted for 6.1% of gross loans including portfolios held for sale (compared to 7.3% of gross loans including portfolios held for sale at 31 December 2021).

Impairments of other financial and non-financial assets for the six months ended 30 June 2022 amounted to €13 million, compared to € 11 million for the six months ended 30 June 2021, impacted mainly by higher impairment charges on net legacy overseas exposures.

Provisions for litigation, claims, regulatory and other matters for the six months ended 30 June 2022 amounted to € 1 million, compared to €4 million for the six months ended 30 June 2021.

Profit before tax and non-recurring items for the six months ended 30 June 2022 totalled €72 million, compared to €52 million for the six months ended 30 June 2021.

Profit after tax (attributable to the owners of the Company)

The tax charge for the six months ended 30 June 2022 amounted to €12 million, compared to € 1 million for the six months ended 30 June 2021.

Profit after tax and before non-recurring items (attributable to the owners of the Company) for the six months ended 30 June 2022 is €59 million, compared to €51 million for the six months ended 30 June 2021. Return on Tangible Equity (ROTE) before non-recurring items calculated using 'profit after tax and before non-recurring items (attributable to the owners of the Company)' amounts to 7.3% (on an annualised basis) for the six months ended 30 June 2022, compared to 6.1% for the six months ended 30 June 2021.

Advisory and other restructuring costs - organic for the six months ended 30 June 2022 amounted to €5 million, compared to €18 million for the six months ended 30 June 2021, down by 70% mainly due to ad-hoc cost related to the tender offer for Existing Tier 2 Capital Notes amounting to € 12 million in 2021. Advisory and other restructuring costs - organic relate to the transformation program of BOC PCL and other strategic projects of the Group.  

Profit after tax arising from the organic operations (attributable to the owners of the Company) for the six months ended 30 June 2022 amounted to €54 million, compared to €33 million for the six months ended 30 June 2021. 

Provisions/net loss relating to NPE sales for the six months ended 30 June 2022 amounted to less than € 1 million relating to Helix 3, compared to €16 million for the six months ended 30 June 2021 (relating to Helix 2).

Restructuring and other costs relating to NPE sales for the six months ended 30 June 2022 was €1 million, compared to €16 million for the six months ended 30 June 2021 (relating to the agreements for the sale of portfolios of NPEs).

Group financial results on the underlying basis (continued)

Income Statement Analysis (continued)

Profit after tax (attributable to the owners of the Company) (continued)

Restructuring costs relating to the Voluntary Staff Exit Plan (VEP) amounted to €3 million for the six months ended 30 June 2022, compared to nil for the six months ended 30 June 2021. For further details please refer to Section 'Total expenses'.

Profit after tax attributable to the owners of the Company for the six months ended 30 June 2022 was €50 million, compared to €1 million for the six months ended 30 June 2021.

Operating Environment

Real GDP increased by 6.1% in the second quarter 2022 on a seasonally adjusted basis, compared to 6% in the first quarter 2022, which was revised upwards from an initial estimate of 5.6%. Economic growth in the first six months of 2022 was 6.1% compared to 5.6% in 2021, facilitated mainly by the faster-than-expected recovery of tourism and the continuing expansion of exports of other services. The economic fallout of the war in Ukraine and Western sanctions on Russia was offset by strong economic activity broadly in the economy, but significant headwinds remain, as a result of higher inflation, the ongoing energy crisis and monetary tightening.

Tourism in Cyprus and in Europe in general, is expected to be stronger than in 2021. Governments have rolled back COVID-19-related travel restrictions and as a result entering countries does not require pre-departure tests. Airlines have increased capacity in anticipation of firmer passenger demand. Tourism-dependent economies like Cyprus are expected to benefit from a recovery in arrivals in 2022, although significant uncertainty remains regarding demand for tourism in 2023.

Tourist arrivals in the first seven months of 2022 reached 1.7 million people or 77% of the corresponding arrivals in 2019, recovering towards pre-pandemic levels. Likewise, receipts in the first six months of the year reached 83% of corresponding receipts in 2019. The prospects for the sector remain positive for the remainder of the tourist season, based on data on planned international flights and surveys on reservations for tourist accommodation, despite a sizeable loss of tourism from Russia (approximately 20% of 2019 levels).

Other short-term indicators are relatively mixed on the supply side and stronger on the demand side. Thus, retail sales in volume terms recovered strongly in May-June 2022, driven by non-food items except of automotive fuel, after a slump in March-April 2022. Total car registrations were down in January-July 2022, which may reflect global supply constraints in car manufacturing and export. In the construction sector the volume of building permits in the first five months of 2022 were down driven by drops in April and March after positive first three months.

Consumer inflation has been accelerating from the third quarter of 2021 onward, as a result mainly of supply chain disruptions, the resulting higher energy and food prices, and other shortages in commodities and industrial goods. The harmonised index of consumer prices increased by 7.4% in the Euro area on average in January-July, from one year earlier, rising by 8.9% in July alone according to the Eurostat. Respectively in Cyprus, the harmonised index of consumer prices increased by 7.7% in January-July and by 10.6% in July. Energy prices increased by 35% in Cyprus in January-July 2022. The overall index excluding energy increased by 4.9% and by 4.3% when food is also excluded. The all-services index was up 4.4% in the period. Thus, core inflation is considerably lower than headline inflation, but still higher than in previous periods.

Higher and more persistent inflation has driven the ECB to adopt a more aggressive monetary stance. In their last meeting of the policy setting governing council in July 2022, the ECB raised its main refinancing operations rate, by 50 basis points, the first interest rate increase in eleven years, and also approved a new policy tool, the Transmission Protection Instrument (TPI). This is a country specific bond purchasing instrument, designed to counter undue pressures on individual member countries' bond yields, that are not justified by their economic fundamentals and to prevent marked interest rate divergences in the euro area. By approving the new instrument, the ECB has signalled its resolve to intervene as necessary to keep market dynamics from disrupting its policy transmission mechanism.

Operating Environment (continued)

Rising inflation and interest rates do not pose any immediate threats to financial stability in the Eurozone provided highly indebted countries ensure debt sustainability in the medium term, which presupposes a series of reforms and restructuring. The debt-to-GDP ratio drops for a period of time, as inflation and nominal GDP rise in tandem.

The recovery in 2021 underpinned a significant increase in general government revenue and a relative drop in government spending. As a result, the budget deficit narrowed to 1.6% of GDP from a deficit of 5.7% of GDP in 2020 when the government implemented measures to support the economy amidst a deep recession induced from the COVID-19 pandemic. The public debt to GDP ratio dropped to 103.6% in 2021 from a bloated 115% in 2020. During the first six months of 2022 there has been a significant improvement in public finances. Driven by higher inflation and a higher nominal GDP, total revenues increased by 16.7% from the year before while total spending declined by 1%. As a result, the budget was near balanced in the period, and a small surplus may be expected for the year as a whole. The debt-to-GDP ratio is expected to decline further in 2022.

The underlying resilience of the banking system improved steadily in recent years, and starting positions are vastly different today than what they were more than ten years ago. Banks restructured their operations, shrunk their balance sheets, and bolstered liquidity and capital positions. They refocused their operations domestically and reduced markedly their overseas exposures. Prudential oversight has been strengthened within the EU supervisory framework. However, weaknesses persist evidenced in high cost to income, low profitability and concerns about a renewed rise in NPEs if problems in some sectors related with the COVID-19 pandemic and the Ukrainian crisis, persist. Banks managed to weather the pandemic crisis well, with their liquidity and capital buffers intact. Non-performing loans continued their declining trend attributed mostly to sales packages by the two largest banks. However, amidst uncertain condition asset quality remains a focal point for bank management and the supervisory authorities. The Russia-Ukraine war poses new challenges, and close monitoring of developments will be required. Total NPEs at the end of May 2022 amounted to €3 billion, unchanged since December 2021. The ratio to gross loans was 11.4% and the coverage ratio of provisions to non-performing exposures was 50.7%. Loans to residents excluding the government, dropped to €23.3 billion at the end of June 2022, or about 90% of expected nominal GDP at year end.

Cyprus received the first disbursement from the Recovery and Resilience Facility of €157 million in September 2021 and applied for the second disbursement of €85 million in July 2022. The allocation in grants and loans amount to €1.2 billion in total (€1 billion in grants and €200 million in loans) and will be conditional on the implementation of the reforms agreed in the national recovery plan. The plan allocates 41% of the funds to green investments and an additional 23% to digital investments. Reforms include increasing the efficiency of the public sector and local government; improving the governments of state-owned enterprises; improving the efficiency of the judicial system; and accelerating anti-corruption reforms.

Economic activity remained resilient in the year so far, despite the fallout of the war in Ukraine and Western sanctions on Russia. According to an announcement from the press office of the Minister of Finance, real GDP is expected to grow by over 5% in 2022, significantly outperforming the Euro area. Real GDP is expected to slow in 2023, as the external environment, particularly in Europe is expected to deteriorate.

Sanctions and Russia's retaliation by cutting supplies, will exacerbate Europe's energy crisis in the coming winter. Gas shortages can be expected, and rationing may become necessary in the industrial sectors. Households will be affected, and industrial activity may be disrupted. All countries will be impacted by soaring energy prices, fall in confidence and weaker external trade. Europe's efforts to decouple from Russia and secure alternative sources of gas supply will continue but will face limitations. In these conditions the risk of disruption increases, and confidence is undermined. The agreement reached in the EU for the voluntary reduction of gas usage by 15% will be helpful in reducing disruption but sharing across member states may become necessary in some cases. Higher prices will likely persist which will have real income effects.

Sovereign ratings

The sovereign risk ratings of the Cyprus Government improved considerably in recent years reflecting reduced banking sector risks, and improvements in economic resilience and consistent fiscal outperformance. Cyprus demonstrated policy commitment to correcting fiscal imbalances through reform and restructuring of its banking system. Public debt remains high in relation to GDP but large-scale asset purchases from the ECB ensure favourable funding costs for Cyprus and ample liquidity in the sovereign bond market.

Operating Environment (continued)

Sovereign ratings (continued)

Most recently in August 2022, Moody's Investors Service affirmed the Government of Cyprus' long-term issuer and senior  unsecured ratings to Ba1 and changed the outlook from stable to positive. The key drivers reflecting the affirmation are the strong reduction in Cyprus' public debt ratio in 2022, stronger-than expected economic resilience to Russia's invasion of Ukraine and the COVID-19 pandemic as well the ongoing strengthening of the banking sector.

In March 2022, Fitch Ratings affirmed Cyprus' Long-Term Issuer Default rating at investment grade BBB- since November 2018 and stable outlook. The stable outlook reflects the view that despite Cyprus' exposure to Russia through its tourism and investment linkages, near-term risks are mitigated by a strengthened government fiscal position, and continued normalisation of spending after the pandemic shock. Meanwhile, medium-term growth prospects remain positive on the back of the government's Recovery and Resilience Plan (RRP).

Also in March 2022, S&P Global Ratings affirmed Cyprus' investment grade rating of BBB- and positive outlook. The positive outlook reflects the view that Cyprus' sovereign rating could be upgraded within the next 24 months if the country's economic and budgetary performance continues to strengthen, supported by the Government's implementation of structural reforms. While the crisis in Ukraine weighs on Cyprus' economic performances via the sanctions imposed on Russia, medium-term economic prospects remain solid according to S&P.

In April 2022, DBRS Morningstar upgraded the Republic of Cyprus's Long-Term Foreign and Local Currency - Issuer Ratings from BBB (low) to BBB and changed the trend from Positive to Stable. The rating upgrades reflect Cyprus' stronger-than-anticipated economic and public finance performance during 2021 and the expectation of DBRS Morningstar that medium term conditions remain supportive of Cyprus' debt reduction efforts, despite risks posed by Russia's invasion of Ukraine and the pandemic.

Business Overview

Credit ratings

The Group's financial performance is highly correlated to the economic and operating conditions in Cyprus. In June 2022, Standard and Poor's affirmed their long-term issuer credit rating on BOC PCL of B+, maintaining the positive outlook, despite the deteriorating macroeconomic environment and escalating inflation. In December 2021, Moody's Investors Service upgraded BOC PCL' s long-term deposit rating to Ba3 from B1, maintaining the positive outlook. The upgrade reflects significant ongoing improvement in BOC PCL's asset quality following the agreement reached for Project Helix 3 in November 2021. In December 2021, Fitch Ratings affirmed BOC PCL's long-term issuer default rating of B- and revised the outlook to positive from negative. The revision of the outlook reflects significant improvement in asset quality following the agreement reached for Project Helix 3, as well as in organically reducing problem assets since the end of 2019, despite an adverse operating environment in Cyprus, together with an expectation that this trend will continue in the near future.

Strategic priorities for the medium term

The Group is a diversified, leading, financial and technology hub in Cyprus. In February 2022, the Group updated its medium term strategic targets with an increased focus on creating shareholder value and increased its medium term return on tangible equity (ROTE) target to over 10% (2025), providing the foundations for a return to dividend distributions, subject to performance and relevant approvals. The prolonged geopolitical crisis in Ukraine has changed the economic landscape, reflecting potential slowdown in economic growth impacted by the escalating inflationary pressures and rising interest rate outlook. As a result of the changing and dynamic economic outlook, the Group will benefit substantially from the interest rate increases, setting NII to growth trajectory and outweighing potential pressures on total operating costs and cost of risk. Overall, return on tangible equity (ROTE) is now expected to reach to over 10% in 2023, supporting the ability to make meaningful dividend distributions from 2023 onwards, subject to regulatory approvals and market conditions. A ROTE in excess of 10% for 2024-2025 is reaffirmed.

Business Overview (continued)

Strategic priorities for the medium term (continued)

Favourable interest rate environment

The structure of the Group's balance sheet is geared towards higher interest rates. As at 30 June 2022, cash balances with ECB (including TLTRO of approximately €3.0 billion and Exempt Tier of approximately €1.0 billion) amounted to approximately €9.9 billion and following the uplift of 50 bps of ECB deposit rate in July 2022, the Group will have an immediate NII benefit of approximately € 12 million.  The repricing of the reference rates will gradually benefit the interest income on loans, as around 50% of the loan book is priced on Euribor. Overall, the rising interest rate environment facilitates faster growth in net interest income, with Financial Year 2022 NII expected to reach to approximately €320 million. NII is expected to increase further in 2023 by a range of € 100 million to €120 million on a yearly basis. These improvements in NII demonstrate faster repricing of loans and liquids than funding costs and incorporate assumptions on partial pass-through to deposits, gradual change in deposit mix, and higher wholesale funding costs.

Growing revenues in a more capital efficient way

The Group has a renewed focus on growing revenues in a more capital efficient way. It aims to grow its high quality new lending, drive growth in niche areas for further market penetration and diversify through non-banking services, such as insurance and digital products.

The Group has continued to provide high quality new loans in the six months ended 30 June 2022 via prudent underwriting standards. Growth in new lending in Cyprus has been focused on selected industries more in line with BOC PCL 's target risk profile .

During the six months ended 30 June 2022, new lending amounted to €1.2 billion, increased by 30% year-on-year, returning to pre-pandemic levels, whilst maintaining strict lending criteria . The year-on-year increase is driven by increased activity across all sectors. As a result, the net performing loan book expanded further to € 9.7 billion reflecting an increase of 4% during the six months ended 30 June 2022. Aiming at supporting investments by SMEs and Mid-Caps, BOC PCL continues its collaboration with the European Investment Bank (EIB), the European Investment Fund (EIF) and the Cyprus Government.

Separately, the Group aims to increase revenues over the medium term through multiple less capital-intensive initiatives, with a focus on fees and commissions, insurance and non-banking opportunities, leveraging on the Group's digital capabilities. In the first quarter of 2022, a revised price list for charges and fees was implemented and liquidity fees were extended to a wider customer group. As a result, net fee and commission income for the six months ended 30 June 2022 remained strong at €94 million, reflecting an increase of 12% year-on-year. Net fee and commission income is likely to be under pressure in the near term mainly due to the phasing out of liquidity fees in 2023.

Net fee and commission income is also enhanced by transaction fees from the Group's subsidiary, JCC Payment Systems Ltd (JCC), a leading player in the card processing business, 75% owned by BOC PCL. JCC's net fee and commission income contributed 9% of non-interest income and amounted to €12 million for the six months ended 30 June 2022, backed by strong transaction volume.

Management is placing emphasis on diversifying income streams by optimising fee income from international transaction services, wealth management and insurance. The Group's insurance companies, EuroLife Ltd and General Insurance of Cyprus Ltd (GIC) operating in the sectors of life and general insurance respectively, are leading players in the insurance business in Cyprus, and have been providing a stable, recurring income,  diversifying the Group's income streams.

The insurance income net of claims and commissions for the six months ended 30 June 2022 contributed to 21% of non-interest income and amounted to €33 million, up 6% compared to the six months ended 30 June 2021, driven by increased new business and the positive changes in valuation assumptions, partially offset by higher insurance claims. Specifically, Eurolife increased its total regular income by 19% year-on-year, whilst GIC increased its gross written premiums by 8% year-on-year. Furthermore, there are initiatives underway to further enhance the value of the insurance companies by business growth supported by digitisation and a lean operating structure. For information on IFRS 17 please refer to the relevant subsection below.

Business Overview (continued)

Strategic priorities for the medium term (continued)

Growing revenues in a more capital efficient way (continued)

Finally, the Group through the Digital Economy Platform (Jinius) aims to generate new revenue sources over the medium term, leveraging on BOC PCL 's market position, knowledge and digital infrastructure. The Platform aims to bring stakeholders together, link businesses with each other and with consumers and to drive opportunities in lifestyle banking and beyond. The Platform is expected to allow BOC PCL to enhance the engagement of its customer base, attract new customers, optimise the cost of BOC PLC's own processes, and position BOC PCL next to the customer at the point and time of need.

Lean operating model

Striving for a lean operating model is a key strategic pillar for the Group in order to deliver shareholder value in the medium term, whilst funding its digital transformation and investing in the business. Management also expects that restructuring costs will be effectively eliminated as balance sheet de-risking is largely complete.

Management remains focused on further improvement in efficiency, through for example further branch footprint optimisation and substantial streamline of workforce. In July 2022 the Group successfully completed a voluntary staff exit plan (VEP) through which approximately 550 applicants were approved to leave at a total cost of approximately € 99 million. Following the completion of the Plan, the overall number of employees is reduced by approximately 16% whilst the annual savings are estimated at approximately € 37 million or 19% of staff costs. Additionally in January 2022 one of BOC PCL's subsidiaries completed a small-scale targeted voluntary staff exit plan (VEP), through which a small number of full-time employees were approved to leave at a total cost of €3 million. In relation to branch restructuring, the Group has reduced its number of branches by 20 year-to-date to 60, a reduction of 25%. Through these two successful initiatives, the Group has delivered ahead of schedule on its commitment to reduce its workforce by approximately 15% and its number of branches by 25%.

The cost to income ratio excluding special levy on deposits and other levies/contributions in 2022 is revised downwards to around current levels compared to initial expectations of mid-60%, reflecting mainly the rising revenue on improving interest rate environment and management's ongoing efforts to contain costs. In 2023 the cost to income ratio excluding special levy on deposits and other levies/contributions is expected to decrease further to approximately 50%, as efficiency actions on staff and branch reduction unlock meaningful savings in 2023.

Transformation plan

The Group continues to work towards becoming a more customer centric organisation. A transformation plan is already in progress and aims to enable the shift to modern banking by digitally transforming customer service, as well as internal operations. The holistic transformation aims to (i) shift to a more customer-centric operating model by defining customer segment strategies, (ii) redefine its distribution model across existing and new channels, (iii) digitally transform the way the Group serves its customers and operate internally, and (iv) improve employee engagement through a robust set of organisational health initiatives.

Digital transformation

BOC PCL 's digital transformation focuses on developing digital services and products that improve the customer experience, streamlining internal processes, and introducing new ways of working to improve the workplace environment.

During the second quarter of the year, BOC PCL continued to enrich and improve its digital portfolio launching a new innovative service to its customers, the mobile cheque deposit functionality, which allows BOC PCL 's retail customers to deposit their cheques through BOC mobile app without the need to visit a branch for this service. This solution further differentiates BOC PCL within the Cypriot market and enhances its status as a digital leader in banking. 

Business Overview (continued)

Strategic priorities for the medium term (continued)

Lean operating model (continued)

Digital transformation ( continued)

The adoption of digital products and services continued to grow and gained momentum in the second quarter of 2022 and beyond. As at the end of July 2022, 93.0% of the number of transactions involving deposits, cash withdrawals and internal/external transfers were performed through digital channels (up by 26.6 p.p. from 66.4% in September 2017 when the digital transformation programme was initiated). In addition, 79.9% of individual customers were digitally engaged (up by 19.7 p.p. from 60.2% in September 2017), choosing digital channels over branches to perform their transactions. As at the end of July 2022, active mobile banking users and active QuickPay users have grown by 17.4% and 37.4% respectively in the last 12 months. The highest number of QuickPay users to date was recorded in July 2022 with 154 thousand active users. Likewise, the highest number of QuickPay payments was recorded in July 2022 with 470 thousand transactions. New features, such as managing fixed deposits accounts, as well as the opening of new lending products entirely through the Group's digital channels will soon be available to customers.

Strengthening asset quality

Ensuring BOC PCL 's loan portfolio quality remains healthy is a priority for the Group and is aiming to maintain high quality of new lending and complete legacy de-risking.

Balance sheet normalisation continued in the first six months of 2022 with approximately a further €170 million of organic NPE reduction, reducing the Group's NPE ratio to 5.7%, pro forma for NPE sales. During 2021, the Group completed Project Helix 2 and reached an agreement for Project Helix 3. Overall, since the beginning of 2021, and including organic NPE reductions of approximately €570 million, the Group reduced its NPEs by 81% and its NPE ratio from 25.2% to 5.7%, on a pro forma basis. For further information please refer to Section 'Loan portfolio quality'.

The Group has already achieved a mid-single digit NPE ratio and is on track to achieve a target ratio of approximately 5% by the end of 2022 and less than 3% by the end of 2025.

In 2022 the cost of risk is expected to reach to approximately 50 bps. The cost of risk is expected to range between 50-80 bps in 2023, reflecting the prevailing uncertainty on macroeconomic outlook. The normalised cost of risk target of 40-50 bps, remains unchanged.

Enhancing organisational resilience and ESG (Environmental, Social and Governance) agenda

Moving to a sustainable economy is the challenge of our time. As part of its vision to be the leading financial hub in Cyprus, BOC PCL is determined to lead the transition of Cyprus to a sustainable future.

The Group has set the foundations to enhance its organisational resilience and ESG (Environmental, Social and Governance) agenda and continues to work towards building a forward-looking organisation with a clear strategy supported by effective corporate governance aligned with ESG agenda priorities.

In 2022, the Company received a rating of AA (on a scale of AAA-CCC) in the MSCI ESG Ratings assessment. In 2020, BOC PCL received a rating of A in the MSCI ESG Ratings assessment.

In 2021, the first ESG strategy of the Group was formulated, whereby, in addition to maintaining its leading role in the social and governance pillars, there will be a shift of focus on increasing BOC PCL 's positive impact on the environment by transforming not only its own operations, but also the operations of its client chain.

BOC PCL has committed to the following primary ESG targets, which reflect the pivotal role of ESG in BOC PCL 's strategy:

● Become carbon neutral by 2030

● Become Net Zero by 2050

● Steadily increase Green Asset Ratio

● Steadily increase Green Mortgage Ratio

● ≥30% women in Group's management bodies (defined as the Executive Committee (EXCO) and the Extended EXCO) by 2030

Business Overview (continued)

Strategic priorities for the medium term (continued)

Strengthening asset quality (continued)

The Board composition of the Company and BOC PCL is diverse, with one third of the Board members being female as at 30 June 2022. The Board displays a strong skill set stemming from broad international experience. Moreover, BOC PCL aspires to achieve a representation of at least 30% women in Group's management bodies (defined as the EXCO and the Extended EXCO) by 2030. As at 30 June 2022, there is a 26% representation of women in Group's management bodies and 38% representation of women at key positions below the Extended EXCO level (defined as positions between Assistant Manager and Manager).

Ukrainian crisis

The economic environment has evolved rapidly since February 2022 following Russia's invasion in Ukraine. In response to the war in Ukraine, the EU, the UK and the US, in a coordinated effort joined by several other countries imposed a variety of financial sanctions and export controls on Russia, Belarus and certain regions of Ukraine as well as various related entities and individuals. As the war is prolonged, geopolitical tension persists and inflation accelerates, impacted by the soaring energy prices and disruptions in supply chains. The escalating inflation weighs on business confidence and consumers' purchasing power. In this context the Group is closely monitoring the developments, utilising dedicated governance structures including a Crisis Management Committee as required and has assessed the impact it has on the Group's operations and financial performance.

Direct impact

The Group does not have any banking operations in Russia or Ukraine, following the sale of its operations in Ukraine in 2014 and in Russia in 2015. The Group has run down its legacy net exposure to less than €1 million as at 30 June 2022 in Russia through write-offs and provisions.

The Group has no exposure to Russian bonds or banks which are the subject of sanctions.

The Group has limited direct exposure with loans related to Ukraine, Russia and Belarus, representing 0.4% of total assets or 1% of net loans as at 30 June 2022. The net book value of these loans stood at €108 million as at 30 June 2022, of which €95 million are performing, whilst the remaining were classified as NPEs well before the current crisis. The portfolio is granular and secured mainly by real estate properties in Cyprus.

Customer deposits related to Ukrainian, Russian and Belarusian customers account for only 5% of total customer deposits as at 30 June 2022. This exposure is not material, given the Group's strong liquidity position. The Group operates with a significant surplus liquidity of €6.7 billion (LCR ratio of 299%) as at 30 June 2022.

Only approximately 3% of the Group's 2021 net fee and commission income is derived from Ultimate Beneficiary Owners (UBOs) from Ukraine, Russia or Belarus.

Indirect impact

Although the Group's direct exposure to Ukraine, Russia or Belarus is limited, the crisis in Ukraine may have an adverse impact on the Cypriot economy, mainly due to a negative impact on the tourism and professional services sectors, increasing energy prices resulting in inflationary pressures, and disruptions to global supply chains.

At this stage, it is considered that the impact on the Cypriot economy is expected to come from higher inflation and a consequential slowdown in economic activity. The performance of tourism sector in the first seven months of 2022 is better than initially anticipated and represents 77% of 2019 respective levels, despite the loss from Russia and Ukraine. The Group continues to monitor the exposures in sectors likely impacted by the prolonged geopolitical uncertainty and persistent inflationary pressures and remains in close contact with customers to offer solutions as necessary. 

Cyprus has no energy dependence on Russia as it imports oil from Greece, Italy and the Netherlands; however it is indirectly affected by pricing pressures in the international energy markets.

Professional services account for approximately 10% of GDP (based on financial year 2020) of which some relate to Russia or Ukraine and thus expected to be adversely impacted. There is however no credit risk exposure as the sector is not levered.

Business Overview (continued)

Ukrainian crisis (continued)

Between 2018-2020, Cyprus recorded net foreign direct investment (FDI) outflow to Russia. While Russian gross FDI flows in and out of Cyprus may be quite large, these often reflect the typical set-up of Special Purpose Entities, with limited actual impact on the Cypriot economy, hence likely to have limited impact on domestic activity levels.

Conclusion

Overall, the Group expects limited impact from its direct exposure, while any indirect impact will depend on the duration and severity of the crisis and its impact on the Cypriot economy, which remains uncertain at this stage.

The Group will continue to closely monitor the situation, taking all necessary and appropriate measures to minimise the impact on its operations and financial performance, as well as to manage all related risks and comply with the applicable sanctions.

IFRS 17

IFRS 17, an accounting standard that will be effective from 1 January 2023, impacts the phasing of profit recognition for insurance contracts. Upon implementation, the Group's insurance-related retained earnings will be restated and the reporting of insurance new business revenue will be spread over time, as the Group provides service to its policyholders (versus recognised up-front under current accounting standards), with the quantum and timing of the impact dependent on, inter alia, the amount and mix of new business and extent of assumption changes in any given year following implementation. As highlighted in the 2021 Annual Financial Report, IFRS 17 requires a number of key changes compared with the Group's current accounting policies for insurance.

· Under IFRS 17, there will be no present value of in-force insurance contracts ('PVIF') asset recognised. Instead, the estimated future profit will be included in the measurement of the insurance contract liability as the contractual service margin ('CSM') and this will be gradually recognised in revenue as services are provided over the duration of the insurance contract. While the profit over the life of an individual contract will be unchanged, its emergence will be later under IFRS 17.

· IFRS 17 requires the increased use of current market values in the measurement of insurance assets and liabilities hence insurance liabilities and related assets will be adjusted to reflect IFRS 17 measurement requirements.

· In accordance with IFRS 17, directly attributable costs will be incorporated in the CSM and, as recognised, will be presented as a deduction to reported revenue. This will result in a reduction in operating expenses.

The Group continues to make progress on the implementation of IFRS 17 and preliminary management estimate on the impact is as previously communicated and included below. However, industry practice and interpretation of the standard are still developing, hence uncertainty remains as to the final transition impact .  Additionally, the impact on the forecast future returns of the Group's insurance business is dependent on the growth, duration and composition of its insurance contract portfolio. These estimates are therefore subject to change in the period up to adoption of the standard.

For the purposes of planning the Group's financial resources, the initial estimate is that the accounting changes will result in:

a)   the removal of value in force from the insurance business (including associated deferred tax liability) of approximately €105 million as per the Group's consolidated balance sheet as at 30 June 2022, which will reduce Group accounting equity by a respective amount (with no impact on the Group regulatory capital or tangible equity), and

b)   the remeasurement of insurance assets and liabilities and the creation of a contractual service margin (CSM) liability, which will increase both the insurance business' and the Group's equity by an amount of approximately €50 million, predominantly relating to the life business of the Group.  

Business Overview (continued)

IFRS 17 (continued)

The adoption of IFRS 17 may result in a modest annual negative impact on the contribution to profits of the Group's insurance business in the near term which has been incorporated in the Group business plan.

The day 1 benefit from IFRS 17 arising from the net remeasurement of insurance liabilities of approximately €50 million (including the creation of the CSM liability), referred to in (b) above, enables an equivalent dividend distribution to BOC PCL which would benefit Group regulatory capital by an equivalent amount (upon the payment of dividend by the subsidiary), enhancing CET1 ratio by approximately 50 bps.

Strategy and Outlook

The strategic objectives for the Group are to become a stronger, safer and a more efficient institution capable of supporting the recovery of the Cypriot economy and delivering appropriate shareholder returns in the medium term.

The key pillars of the Group's strategy are to:

· Grow revenues in a more capital efficient way; by enhancing revenue generation via growth in performing book and less capital-intensive banking and financial services operations (Insurance and Digital Economy)

· Improve operating efficiency; by achieving leaner operations through digitisation and automation

· Strengthen asset quality; maintaining high quality new lending, completing legacy de-risking, normalising cost of risk and reducing (other) impairments

· Enhance organisational resilience and ESG (Environmental, Social and Governance) agenda; by continuing to work towards building a forward-looking organisation with a clear strategy supported by effective corporate governance aligned with ESG agenda priorities

Strategy and Outlook (continued)

KEY STRATEGIC PILLARS	ACTION TAKEN IN THE FIRST HALF 2022 AND TO DATE	PLAN OF ACTION
Growing revenues in a more capital efficient way; by enhancing revenue generation via growth in performing book, and less capital-intensive banking and financial services operations (Insurance and Digital Economy)	• A revised price list for charges and fees was implemented in February 2022 • Liquidity fees were extended to a wider customer group in March 2022 • Net performing loan book grew to €9.7 billion, an increase of 4% in the six months ended 30 June 2022 For further information, please refer to Section 'Loan portfolio quality' and Section 'Business Overview'	• Grow net performing book and increase in new lending over the medium term • Enhance fee and commission income , e.g. on-going review of price list for charges and fees, increase average product holding through cross selling, new sources of revenue through introduction of Digital Economy Platform • Phasing out of liquidity fees in 2023 • Profitable insurance business with further opportunities to grow, e.g. focus on high margin products, leverage on Bank's strong franchise and customer base for more targeted cross selling enabled by digital transformation
Improving operating efficiency; by achieving leaner operations through digitisation and automation	• Completion of a Voluntary staff exit plan in July 2022, through which approximately 550 applicants were approved to leave at a total cost of approximately € 99 million; estimated annual saving of approximately € 37 million (19%) of staff costs • Rationalisation of branch footprint as 15 branches closed down in July 2022; a reduction of 25% year-to-date • Completion of a small-scale targeted voluntary staff exit plan (VEP) in the first quarter 2022, by one of BOC PCL's subsidiaries, through which a small number of the Group's full-time employees were approved to leave at a total cost of €3 million • Further developments in the Transformation Plan and the digitisation of BOC PCL	• Effectively eliminate restructuring costs as de-risking is largely complete • Enhance procurement control • Cost to income ratio (excluding special levy on deposits and other levies/contributions) revised downwards to around current levels for 2022, compared to initial expectations of mid-60s

Strategy and Outlook (continued)

KEY STRATEGIC PILLARS	ACTION TAKEN IN THE FIRST HALF 2022 AND TO DATE	PLAN OF ACTION
Strengthening asset quality	• Balance sheet normalisation continued in the six months ended 30 June 2022 with further approximately €170 million of organic NPE reduction • NPE ratio (pro forma for HFS) reduced to mid-single digit of 5.7% as at 30 June 2022 For further information, please refer to Section 'Loan portfolio quality' and Section 'Business Overview'	• The Group is on track to achieve a target NPE ratio of approximately 5% by the end of 2022 and of less than 3% by the end of 2025.
Enhancing organisational resilience and ESG (Environmental, Social and Governance) agenda; by continuing to work towards building a forward-looking organisation with a clear strategy supported by effective corporate governance aligned with ESG agenda priorities	• Initiations of ESG training to Board of Directors and staff to increase awareness • Initiation of decarbonisation of the Group's operations and portfolio • Approval of Green Lending Policy based on the Green Loan Principles (GLPs) • Environmental products launched e.g. under the Fil-eco product scheme For further information, please refer to Section 'Business Overview'	• Implement ESG strategy with a shift of focus on environment • Embed ESG sustainability in BOC PCL's culture • Continuous enhancement of structure and corporate governance Invest in people and promote talent

In November 2020 the Group , after a considerable period of change, announced for the first time its medium -term targets and its priorities to set the Group on a path for sustainable profitability. These included completion on balance sheet de-risking, delivery of sustainable profitability, enhancement on operating efficiency, modernisation of BOC PCL's franchise, including IT and digital investment, addressing challenges from low rates and surplus liquidity, initiation of MREL issuance and Tier 2 refinancing and optimisation on capital management. Since then, the Group's progress was remarkable, delivering on all fronts. In summary the key achievements were:

· 81% NPE reduction through organic and inorganic actions; NPE ratio is approaching to 5% and is on track with 2022 target

· Completion of several Voluntary Staff Exit Plans and branch footprint rationalisation

· 26% increase in active digital users

· Net interest income bottomed out and now is reverting to growth

· Inaugural MREL issuance and Tier 2 refinancing, regaining market access

The medium-term recurring ROTE target of approximately 7% (annualised) was achieved in the first half 2022, two years ahead of schedule and the Group is on path to achieve a double-digit ROTE in 2023. The CET1 ratio since September 2020 remained broadly flat, absorbing in full the restructurings and is now positioned for dividend resumptions. 

As a result the medium- term strategic targets have evolved, reflecting a dynamic strategy, capitalising on the changed macroeconomic outlook and the Group's strong performance.

Overall, a return on tangible equity (ROTE) over 10% is now expected to be achieved in 2023 and to be sustained for the following years 2024 and 2025, supporting the ability to make meaningful dividend distributions from 2023 onwards, subject to regulatory approvals and market conditions.

Strategy and Outlook (continued)

Also, higher profitability will be positive for the Group's CET1 ratio, which is expected to be further increased following the adoption of IFRS 17 on 1 January 2023. Specifically, a day 1 benefit from IFRS 17 on Group regulatory capital by approximately €50 million is estimated , thereby enhancing Group CET1 ratio by approximately 50 bps.

The Group's progress is being noticed. In an announcement on 19 August 2022 the Board noted the announcement made by LSF XI Investments LLC ('Lone Star') and confirmed that it has received and unanimously rejected three unsolicited, conditional, non-binding proposals from Lone Star relating to a possible cash offer for the entire issued, and to be issued, share capital of the Company.

The Board expressed its confidence in the Group's strategy and remains committed to delivering its strategy of becoming a stronger, safer and a more focused institution capable of further supporting the recovery of the Cypriot economy. In addition, the Board remains confident in its ability to implement its strategic objectives, delivering strong shareholder returns in the medium and long term, and accordingly has unequivocally rejected the proposal from Lone Star.

The evolution of the Group's medium-term strategic targets are set out below

Key Metrics		November 2020	February 2022	May 2022	August 2022
		2024	2025	2025	2025
Profitability	Return on Tangible Equity (ROTE)1	approximately 7% in 2024	>10% in 2025	>10% from 2024	>10% from 2023 onwards
	Cost to income ratio2	Mid-50s	50-55%	50%-55%	<approximately 50%
Asset Quality	NPE ratio	Approximately 5%	< 3 %	<3%	<3%
	Cost of risk	70-80 bps	40-50 bps	40-50 bps	40-50 bps
Capital returns	Dividend	No guidance	Consider from 2023 onwards3	Consider meaningful from 2023 onwards3	Meaningful from 2023 onwards4
Capital	CET1 ratio	at least 13%	Supported by CET1 ratio of 13.5%-14.5%		Supported by CET1 ratio of 13.5%-14.5%
1.  Return on Tangible Equity (ROTE) is calculated as Profit after Tax (annualised) divided by Shareholders' equity minus intangible assets. 2.  Calculated using total operating expenses which comprise staff costs and other operating expenses. Total operating expenses do not include the special levy on deposits or other levies/contributions and do not include any advisory or other restructuring costs. 3.  Subject to performance and regulatory approvals 4.  Subject to regulatory approvals and market conditions

Going concern

The Directors have made an assessment of the Group's ability to continue as a going concern for a period of 12 months from the date of approval of these Consolidated Financial Statements.

The Directors have concluded that there are no material uncertainties which would cast significant doubt over the ability of the Group, the Company and BOC PCL to continue to operate as a going concern for a period of 12 months from the date of approval of these Consolidated Financial Statements.

In making this assessment, the Directors have considered a wide range of information relating to present and future conditions, including projections of profitability, cash flows, capital requirements and capital resources, taking also into consideration, the Group's Financial Plan approved by the Board in February 2022 (the 'Plan') and Reforecast exercises run and the operating environment (as set out in Section 'Operating Environment' in the Interim Management Report). The Group has sensitised its projection to cater for a downside scenario and has used reasonable economic inputs to develop its medium term strategy. The Group is working towards materialising its Strategy.

Capital

The Directors and Management have considered the Group's forecasted capital position, including the potential impact of a deterioration in economic conditions. The Group has developed capital projections under base and adverse scenario and the Directors believe that the Group has sufficient capital to meet its regulatory capital requirements throughout the period of assessment.

Funding and liquidity

The Directors and Management have considered the Group's funding and liquidity position and are satisfied that the Group has sufficient funding and liquidity throughout the period of assessment. The Group continues to hold a significant liquidity buffer at 30 June 2022 that can be easily and readily monetised in a period of stress.

Principal risks and uncertainties ‑ Risk management and mitigation

As part of its business activities, the Group faces a variety of risks. The Group monitors, manages and mitigates these risks through various control mechanisms. Credit risk, liquidity and funding risk, market risk (arising from adverse movements in exchange rates, interest rates, security prices and property prices) and insurance and re‑insurance risk, are some of the key significant risks the Group faces.  In addition, key risks facing the Group also include operational risk which includes also compliance, legal and reputational risk, regulatory risk, information security and cyber risk, digital transformation and technology risk as well as business model and strategic risk. 

Information relating to the principal risks the Group faces and risk management is set out in Notes 29 to 32 of the Consolidated Condensed Interim Financial Statements and in the 'Additional Risk and Capital Management Disclosures', both of which form part of the Interim Financial Report for the six months ended 30 June 2022 and in the 'Interim Pillar III disclosures 2022'. In addition, in relation to legal risk arising from litigations, investigations, claims and other matters, further information is disclosed in Note 25 of the Consolidated Condensed Interim Financial Statements.

Additionally, the Group is exposed to the risk of changes in the value of property which is held either for own use or as stock of property or as investment property. Stock of property is predominately acquired in exchange for debt and is intended to be disposed of in line with the Group's strategy. Further information is disclosed in Note 17 to the Consolidated Condensed Interim Financial Statements.

The Group activities are mainly in Cyprus therefore the Group's performance is impacted by changes in the Cyprus operating environment, as described in the 'Operating environment' section of this Interim Management Report and changes in the macroeconomic conditions and geopolitical developments as described in the 'Additional Risk and Capital Management Disclosures' which form part of the Interim Financial Report for the six months ended 30 June 2022.

In addition, details of the significant and other judgements, estimates and assumptions which may have a material impact on the Group's financial performance and position are set out in Note 6 to the Consolidated Condensed Interim Financial Statements.

Principal risks and uncertainties ‑ Risk management and mitigation (continued)

Details of the financial instruments and hedging activities of the Group are set out in Note 14 of the Consolidated Condensed Interim Financial Statements.

The Russian - Ukraine military conflict and the sanctions imposed on Russia rose new challenges for the Group and closed monitoring of developments will be required. The Group's direct exposure is limited, however any indirect impact will depend on the duration and severity of the crisis in Ukraine and its impact on the Cypriot economy, mainly due to a negative impact on the tourism sector, the increasing energy prices resulting in inflationary pressures and disruptions to global supply chains. Further disclosures are provided in 'Business Overview' and 'Operating Environment' sections of this Interim Management Report.

The risk factors discussed above and in the reports identified above should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties. There may be risks and uncertainties of which the Group is not aware or which the Group does not consider significant, but which may become significant. As a result of the uncertainty created by the Ukrainian crisis, the growing threat of cyber‑attack and unknown risks, the precise nature of all risks and uncertainties that the Group faces cannot be predicted as many of these risks are outside of the Group's control.

Events after the reporting date

Voluntary exit plan

In July 2022 the Group proceeded with a VEP for its employees, with a cost of approximately €99 million. In total around 550 employees accepted the VEP and are expected to leave the Group in the second half of 2022.

Statement of Directors' Responsibilities

The Directors are responsible for preparing the Interim Financial Report in accordance with International Accounting Standard (IAS) 34 on 'Interim Financial Reporting' as adopted by the European Union, the Transparency (Directive 2004/109/EC) Regulations 2007, as amended, Part 2 (Transparency Requirements) of the Central Bank (Investment Market Conduct) Rules 2019 and the applicable requirements of the Disclosure Guidance and Transparency Rules of the UK's Financial Conduct Authority.

Each of the Directors, whose names and functions are listed on page 1, confirms that to the best of each person's knowledge and belief:

· the Consolidated Condensed Interim Financial Statements, prepared in accordance with IAS 34 'Interim Financial Reporting' as adopted by the EU, give a true and fair view of the assets, liabilities and financial position of the Group at 30 June 2022, and its profit for the period then ended; and

· the Interim Financial Report includes a fair review of:

a.  important events that have occurred during the first six months of the year, and their impact on the Consolidated Condensed Interim Financial Statements;

b.  a description of the principal risks and uncertainties for the next six months of the financial year;

c.  details of any related party transactions that have materially affected the Group's financial position or performance in the six months ended 30 June 2022; and

d.  any changes in the related parties' transactions described in the last annual report that could have a material effect on the financial position or performance of the Group in the first six months of the current financial year.

The Directors are responsible for the maintenance and integrity of the corporate and financial information included in the Company's website. Legislation in Ireland governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

Efstratios‑Georgios Arapoglou

Chairman

Panicos Nicolaou

Chief Executive Officer

30 August 2022

 

END

 

 

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