Bk. Cyprus Hldg Regulatory News (BOCH)

Announcement

Group Financial Results for the nine months ended 30 September 2017

Nicosia, 21 November 2017

Group Chief Executive Statement

"The Bank continues to make steady and positive progress in its journey back to strength. Our results this quarter reflect our previously communicated strategy. In the third quarter, we continued to direct all operating profitability to further increase coverage levels on delinquent exposures to best position the Bank to present a more normal credit cycle charge in 2018. This strategy will continue into the fourth quarter.

Momentum in NPE reduction was maintained. This is the tenth consecutive quarter of material NPE reduction. We have reduced the stock of NPEs by c.€2 bn since the beginning of the year and by c.40% since December 2014. Coverage levels against non-performing exposures are now above the EU average and still increasing.

We expect the organic reduction of our NPE stock to continue its downward trajectory in the coming quarters. At the same time, we are actively exploring structured solutions to further accelerate reduction and further normalise the Bank.

Today we are pleased to announce the first of these accelerative non-organic balance sheet repair initiatives. Following approval by CySeC to register a real estate fund as an Alternative Investment Fund (AIF), the Bank is launching a Real Estate Fund to be listed on the Cyprus Stock Exchange, subject to meeting certain conditions. This c.€190 mn Fund is the first of its kind in Cyprus and adds further pace to our efforts to accelerate balance sheet de-risking.

Deposits increased by €731 mn or 4% in the quarter. The increase in our deposit base facilitates compliance with liquidity requirements. The re-shaping of deposit tenures to drive EU and local liquidity ratio compliance and the continued de-risking of higher margin delinquent exposures adds negative pressure on the Bank's Net Interest Margin. The profit-pressure created by this dynamic in the future should be more than offset by reduced provisioning and the positive contribution of new lending. In the near-term we expect to see continued headline margin pressure. However we are maintaining our 2018 EPS guidance of 40 cents and a return to profitability in 2018.

Capital levels are adequate. As at 30 September 2017 the Bank's CET1 ratio (transitional) was at 12.4% and the Total Capital Ratio was at 13.8%, both in excess of regulatory requirements. Following the Supervisory Review and Evaluation Process (SREP) performed by the ECB in 2017, based on the pre-notifications received, we expect an improvement to the SREP requirements of 75 bps in Pillar II which will be broadly offset by a 62.5 bps further phasing-in of the Capital Conservation Buffer effective from 1 January 2018.

We have now substantially completed our work in anticipation of the introduction of IFRS 9. The expected impact on the Bank's starting shareholders' equity for 2018, based on the Balance Sheet as at 30 September 2017 is estimated to be in the range of €250 mn - €300 mn. This is conservatively inside the range we previously expected.

We are proud to maintain a leading position in a fast growing Cyprus economy. The economy expanded by 3.9% in the third quarter. We continue to support the Cyprus economy through the provision of new lending. New lending in the nine months to 30 September 2017 was €1.7 bn and this exceeded lending in the entirety of 2016.

John Patrick Hourican

Financial Results

Interim Condensed Consolidated Income Statement

A. Analysis of Group Financial Results for the nine months ended 30 September 2017

A.1 Balance Sheet Analysis

A.1.1 Capital Base

Shareholders' equity totalled €2,562 mn at 30 September 2017, compared to €2,543 mn at 30 June 2017 and to €3,071 mn at 31 December 2016. The Common Equity Tier 1 capital (CET1) ratio (transitional basis) improved to 12.4% at 30 September 2017, compared to 12.3% at 30 June 2017 and 14.5% at 31 December 2016. During 9M2017 the CET1 ratio was negatively affected by the additional provision charge in 2Q2017 and the deferred tax asset phasing-in, despite the reduction in risk- weighted assets (RWA). Adjusting for Deferred Tax Assets, the CET1 ratio on a fully-loaded basis totalled 11.9% at 30 September 2017, compared to 11.8% at 30 June 2017 and 13.9% at 31 December 2016. As at 30 September 2017, the Total Capital ratio stood at 13.8%.

The Group's minimum phased-in CET1 capital ratio stands at 9.50%, comprising of 4.50% Pillar I requirement, a 3.75% Pillar II requirement and the capital conservation buffer (CCB) of 1.25% applicable for 2017. Following the Supervisory Review and Evaluation Process (SREP) performed by the ECB in 2017, based on the pre-notification received in September 2017, the Pillar II requirement which will be applicable as from 1 January 2018, is expected to be 3.00% compared to current level of 3.75%. As a result, the Group's minimum phased-in CET1 capital ratio is expected to be reduced to 9.375% from 9.50%, comprising of a 4.50% Pillar I requirement, a 3.00% Pillar II requirement and the CCB of 1.875% applicable as from 1 January 2018. The ECB has also provided revised lower non-public guidance for an additional Pillar II CET1 buffer. The group CET1 ratio remains comfortably above this combined Pillar II requirement and guidance.

The overall Total Capital Requirement currently stands at 13.00%, comprising of a Pillar I requirement of 8.00% (of which up to 1.50% can be in the form of Additional Tier 1 capital and up to 2.00% in the form of Tier 2 capital), a Pillar II requirement of 3.75% (in the form of CET1), and the CCB of 1.25% applicable for 2017. Following the 2017 SREP pre-notification decision received, the overall Total Capital Requirement is expected to be reduced to 12.875% from 13.00%, comprising of 8.00% Pillar I requirement, a 3.00% Pillar II requirement and the CCB of 1.875% applicable as from 1 January 2018.

The new SREP requirements will be effective as from 1 January 2018, and as at the date of publication of this announcement these requirements remain subject to ECB final confirmation, which is expected by the end of 2017.  

The Group may explore opportunities, subject to market conditions, to raise up to 1.5% of Additional Tier 1 (AT1) and/or Tier 2 capital in the near term to further strengthen the Group's capital base. In preparation for a potential issuance of AT1 capital instruments, the Bank will proceed (subject to the approval of the Cypriot courts) with the full reduction of its capital reduction reserve (which, at 30 September 2017, amounted to €1.3 bn) in order to eliminate the Bank's accumulated losses of €0.6 bn at 30 September 2017 (the accumulated losses as at 30 September 2017 reflect the elimination of accumulated losses of €0.6 bn at 31 December 2016 through the reduction of the capital reduction reserve as approved by the Cypriot courts in July 2017), thus creating retained earnings of €0.8 bn on a 30 September 2017 pro-forma basis. The reduction of capital will not have any impact on regulatory capital or the total equity position of the Bank or the Group.

The retained earnings will provide the basis for the calculation of distributable items under the Capital Requirements Regulation (EU) No. 575/2013 ('CRR'). The CRR provides that coupons on AT1 capital instruments may only be paid out of distributable items. Distributable items for the purposes of the CRR are determined, in part, by reference to retained earnings. Assuming the capital reduction referred to above is effected, the Bank would have €0.8 bn in distributable items on a 30 September 2017 pro-forma basis. The Bank is currently under a dividend distribution prohibition which is expected to continue in 2018 following the 2017 SREP pre-notification received in September 2017 (subject to final confirmation upon issue of the final 2017 SREP decision by the ECB which is expected before the end of 2017). However, based on the pre-notification, such prohibition will not apply to the payment of coupons on any AT1 capital instruments issued by the Bank. Both the retained earnings and distributable items of the Bank will partly decrease as a result of the IFRS 9 implementation on 1 January 2018.

The Group continues to develop its processes to enable the implementation of IFRS 9 on 1 January 2018. The new accounting standard requires these changes on the implementation date, 1 January 2018, to be recognised through equity rather than the income statement. As a result, the impact on initial implementation of IFRS 9, as at 1 January 2018, will impact the equity of the Group and will not affect the income statement.

The Group's current estimated IFRS 9 impact based on the 30 September 2017 balance sheet is a decrease of shareholders' equity ranging between €250 mn and €300 mn and is primarily driven by credit impairment provisions. This estimated reduction in shareholders' equity equates to a decrease in the tangible net asset value at 30 September 2017 of €0.56 to €0.67 per share.

The Group expects to implement transitional arrangements for regulatory capital purposes currently being finalised by European regulators (http://data.consilium.europa.eu/doc/document/ST-13725-2017-INIT/en/pdf) which would result in only c.5% of the estimated IFRS 9 impact affecting the capital ratios during 2018. On a transitional basis and on a fully phased-in basis after the period of transition is complete, the impact of IFRS 9 is expected to be manageable and within the Group's capital plans. 

A.1.2 Funding and Liquidity

Funding

Funding from Central Banks

At 30 September 2017, the Bank's funding from central banks totalled €830 mn, which relates wholly to ECB funding, compared to funding from the ECB at 30 June 2017 of €900 mn and funding from central banks at 31 December 2016 of €850 mn, which comprised ELA of €200 mn and ECB funding of €650 mn. The ECB funding of €830 mn at the quarter- end comprises wholly of funding through Targeted Longer-Term Refinancing Operations (TLTRO II).

The Bank fully repaid ELA in January 2017.

Deposits

Group customer deposits totalled €17,315 mn at 30 September 2017, compared to €16,584 mn at 30 June 2017 and €16,510 mn at 31 December 2016. Group customer deposits increased by €731 mn or 4%, during the quarter with customer deposits in Cyprus increasing by €579 mn or 4%. Cyprus deposits stood at €15,589 mn at 30 September 2017, accounting for 90% of Group customer deposits. The Bank's deposit market share in Cyprus reached 32.3% at 30 September 2017. Customer deposits accounted for 76% of total assets at 30 September 2017. The Loan to Deposit ratio (L/D) stood at 85% at 30 September 2017, down from 90% at 30 June 2017, compared to a high of 151% at 31 March 2014. The 5 p.p. reduction in L/D ratio mainly relates to the significant increase in deposits during the quarter.

Subordinated Loan Stock

In January 2017 the Bank tapped the debt capital markets and issued €250 mn unsecured and subordinated Tier 2 Capital Notes.

Liquidity

As at 30 September 2017 the Group Liquidity Coverage Ratio (LCR) stood at 141% (compared to 108% at 30 June 2017, and 49% at 31 December 2016) and is in compliance with the minimum regulatory requirement of 80% (which will increase to 100% by 1 January 2018). The Net Stable Funding Ratio (NSFR ratio) is expected to be introduced on 1 January 2018, with a minimum requirement of 100%. As at 30 September 2017 the Group's NSFR, on the basis of Basel ΙΙΙ standards, was 107% (compared to 102% at 30 June 2017 and 95% at 31 December 2016).

As at 30 September 2017, the Bank was not in compliance with all the local regulatory liquidity requirements set by the Central Bank of Cyprus (CBC) with respect to its operations in Cyprus. In September 2017, the CBC proceeded with a partial relaxation of the regulatory liquidity requirements. According to the Capital Requirements Regulation (CRR), the local liquidity requirements are expected to be abolished by the end of 2017. For the purposes of bridging the requirements gap between national prudential liquidity requirements currently in place and the LCR under the CRR framework, it is expected that the CBC will move in the direction of a measure in the form of a liquidity add-on that will be imposed on top of the LCR.

A.1.3 Loans

Group gross loans totalled €19,253 mn at 30 September 2017, compared to €19,505 mn at 30 June 2017 and €20,130 mn at 31 December 2016. Gross loans in Cyprus totalled €17,406 mn at 30 September 2017 and accounted for 90% of Group gross loans. The Bank is the single largest credit provider in Cyprus with a market share of 39.5% at 30 September 2017. Gross loans in the UK amounted to €1,510 mn at 30 September 2017 and accounted for 8% of Group total gross loans. New loan originations for the Group reached €1,725 mn for the 9M2017 (of which €1,301 mn were granted in Cyprus and €424 mn by the UK subsidiary), exceeding new lending in FY2016.

At 30 September 2017, Group net loans and advances to customers totalled €14,833 mn (30 June 2017: €14,913 mn; 31 December 2016: €15,649 mn), including net loans and advances to customers with carrying value of €374 mn which were classified as held for sale as at 30 September 2017 in line with IFRS 5.

A.1.4 Loan portfolio quality

Tackling the Group's loan portfolio quality remains the top priority for management. The Group continues to make steady progress across all asset quality metrics and the loan restructuring activity continues. The Group has been successful in engineering restructuring solutions across the spectrum of its loan portfolio.

Loans in arrears for more than 90 days (90+ DPD) were reduced by €379 mn or 5% qoq in 3Q2017 and by €1.1 bn or 14% in 9M2017. The decrease was the result of restructuring activity, debt for asset swaps and write offs. 90+ DPD stood at €7,182 mn at 30 September 2017, accounting for 37% of gross loans (90+ DPD ratio), compared to 39% at 30 June 2017 and 41% at 31 December 2016. The provisioning coverage ratio of 90+ DPD increased to 62% at 30 September 2017, compared to 61% at 30 June 2017 and 54% at 31 December 2016. When taking into account tangible collateral at fair value, 90+ DPD loans are fully covered. The provisioning coverage ratio of 90+ DPD, calculated with reference to the contractual balances of customers, totalled 74% at 30 September 2017, compared to 73% at 30 June 2017 and 67% at 31 December 2016.

Non-performing exposures (NPEs) as defined by the European Banking Authority (EBA) were reduced by €588 mn or 6% during 3Q2017 and by €1.9 bn or 17% during 9M2017 to €9,164 mn at 30 September 2017, accounting for 48% of gross loans, compared to 50% at 30 June 2017 and 55% at 31 December 2016. This is the fifth consecutive quarter during which the quarterly reduction of NPEs exceeded the reduction of 90+ DPD mainly due to the curing of restructured performing NPEs that met the exit criteria following satisfactory performance post their restructuring. The provisioning coverage ratio of NPEs improved to 49% at 30 September 2017, up from 48% at 30 June 2017 and 41% at 31 December 2016. When taking into account tangible collateral at fair value, NPEs are fully covered. The provisioning coverage ratio of NPEs, calculated with reference to the contractual balances of customers, stood at 62% at 30 September 2017, compared to 60% at 30 June 2017 and 54% at 31 December 2016.

The Group has recorded significant NPE reductions for ten consecutive quarters and expects the organic reduction of NPEs to continue in the coming quarters. In parallel the Group is actively exploring alternative avenues to accelerate this reduction. The gross value of c.€450 mn of the loan portfolio classified as held for sale as at 30 September 2017, in line with IFRS 5, includes NPEs of c.€370 mn, mainly corporate and SMEs. The Bank is continuing to explore other structured solutions to accelerate de-risking potentially in the near term, in one or more transactions.

A.1.5 Real Estate Management Unit

The Real Estate Management Unit (REMU) on-boarded €127 mn of assets, via the execution of debt for asset swaps, in 3Q2017 (up by 26% qoq) and €356 mn of assets in 9M2017. The focus for REMU is increasingly shifting from on-boarding of assets resulting from debt for asset swaps towards the disposal of these assets. The Group completed disposals of €64 mn in 3Q2017, compared to €30 mn in 2Q2017 and disposals of €204 mn in 9M2017. In addition, in 2Q2017 the Group disposed of a property with carrying value €10 mn, previously classified as investment property. Post 30 September 2017, the Group completed additional disposals of €9 mn. Since the beginning of the year, the Group executed sale-purchase agreements (SPAs) with contract value of €270 mn and in addition signed SPAs for disposals of assets with contract value of €27 mn.

The Bank has received approval by the Cyprus Securities and Exchange Commission ('CySEC') to register a Real Estate Fund in Cyprus, CYREIT Variable Capital Investment Company PLC (the 'Fund'), subject to meeting certain conditions. The Fund is structured as an Alternative Investment Fund (AIF) with an anticipated size of c.€190 mn. The Fund will follow a core and core+ strategy by acquiring a diversified portfolio of high-quality income yielding commercial real estate assets in Cyprus with stable lease roll. These properties are located throughout Cyprus and are currently rented to various tenants offering gross average rental yield returns of over 6% per annum on a 5 to 10 year horizon. The Fund will be distributing, in the form of cash dividends, at least 80% of all distributable net proceeds on an annual basis. Upon satisfaction of CySEC's conditions and the Fund receiving final authorisation from CySEC for commencing its operations, the Bank shall proceed with the offering of all or part of its shares in the Fund to qualifying local and international institutional and well-informed investors. The shares of the Fund will be listed on the Non-Tradable Investment Schemes Market of the Cyprus Stock Exchange (CSE).

As at 30 September 2017, assets held by REMU had a carrying value of €1.5 bn.

A.1.6 Non-core overseas exposures

The remaining non-core overseas net exposures (including both on-balance sheet and off-balance sheet exposures) at 30 September 2017 are as follows:

The Group continues its efforts for further deleveraging and disposal of non-essential assets and operations in Greece, Romania and Russia. In accordance with the Group's strategy to exit from overseas non-core operations, the operations of the Bank's branch in Romania are expected to be terminated by the end of 2017.

In addition to the above, at 30 September 2017 there were overseas exposures of €169 mn in Greece (compared to exposures of €173 mn in Greece as at 30 June 2017), not identified as non-core exposures, since they are considered by management as exposures arising in the normal course of business.

A.2 Income Statement Analysis

A.2.1 Total income

* p.p. = percentage points, bps = basis points, 100 basis points (bps) = 1 percentage point

Net interest income (NII) and net interest margin (NIM) for 9M2017 amounted to €454 mn and 3.18% respectively, down by 13% compared to €524 mn a year earlier. The NII and NIM for 3Q2017 amounted to €138 mn and 2.86% respectively, compared to €160 mn and 3.38% in 2Q2017. The decline reflects primarily lower cash collections of interest on delinquent exposures not previously recognised usually arising on the curing of NPEs, lower volumes of loans, the low interest rate environment and the cost of liquidity compliance.

Average interest earning assets for 9M2017 amounted to €19,089 mn, down by 4% yoy, largely due to debt for asset swaps and the elevated provision charges in 2Q2017. Average interest earning assets for 3Q2017 amounted to €19,150 mn, up by 1%, compared to €18,996 mn the previous quarter, due to increased liquid assets.

Non-interest income for 9M2017 amounted to €239 mn, mainly comprising of net fee and commission income of €133 mn, net insurance income of €39 mn and net foreign exchange income and net gains on financial instruments of €32 mn. Non-interest income for 9M2017 increased by 24% yoy, largely driven by the new and increased commission charges introduced in 4Q2016. Non-interest income for 3Q2017 was €85 mn, up by 11% qoq, comprising primarily net fee and commission income of €45 mn and net insurance income of €14 mn. The remaining component of non-interest income for 3Q2017 was a profit of €26 mn (compared to €17 mn for the previous quarter), which includes a net gain of €12 mn on the disposal of assets by REMU (compared to €1 mn for the previous quarter).

Total income for 9M2017 amounted to €693 mn, compared to €717 mn for 9M2016 (3% decrease yoy), with the reduction primarily reflecting the yoy reduction in NII. Total income for 3Q2017 amounted to €223 mn, compared to €237 mn for 2Q2017.

A.2.2 Total expenses

Total expenses for 9M2017 were €313 mn, 54% of which related to staff costs (€168 mn), 41% to other operating expenses (€128 mn) and 5% to special levy and contribution to SRF. Total expenses for 3Q2017 were €99 mn, down by 7% qoq, mainly due to the reversal of the SRF contribution. Staff costs and other operating expenses amounted to €57 mn and €43 mn respectively, at similar levels with the previous quarter. During the quarter, special levy and SRF contribution amounted to (€1 mn) as there was a reversal of the 2017 annual SRF contribution of c.€6 mn, following the amendment of the Law on the Imposition of a Special Tax Credit Law to allow the offsetting of the SRF contribution with the special levy charge.

The cost to income ratio for 9M2017 was 45%, compared to 46% for 1H2017. Cost to income for 1H2017 was negatively affected by the SRF contribution. The cost to income ratio for 3Q2017 was 44%, compared to 45% in 2Q2017.

A.2.3 (Loss)/profit before tax and restructuring costs

Operating profit for 9M2017 was €380 mn, compared to €418 mn for 9M2016 (down by 9% yoy). The decrease mainly reflects the lower net interest income and higher non-staff costs. Operating profit for 3Q2017 was €124 mn, compared to €130 mn the previous quarter.

Provisions for 9M2017 totalled €729 mn, up by 173% yoy, following the additional provisions of c.€500 mn in 2Q2017. The elevated provisioning levels in 2Q2017 reflect changes in the Bank's provisioning assumptions as a result of the Group's reconsideration of its strategy to more actively explore other innovative strategic solutions to further accelerate balance sheet de-risking. It also concludes the active and on-going regulatory dialogue with the ECB on this matter. Provisions for 3Q2017 amounted to €73 mn, down by 88% qoq.

The annualised provisioning charge for 9M2017 accounted for 4.1% of gross loans, compared to an annualised provisioning charge of 4.2% for 1H2017. An amount of c.€500 mn reflecting the one-off effect of the change in the provisioning assumptions is included in the cost of risk, but is not annualised.

At 30 September 2017, accumulated provisions, including fair value adjustment on initial recognition and provisions for off-balance sheet exposures, totalled €4,470 mn (compared to €4,638 mn at 30 June 2017 and €4,519 mn at 31 December 2016) and accounted for 23.2% of gross loans (compared to 23.8% at 30 June 2017 and to 22.4% at 31 December 2016). The decrease of accumulated provisions in 3Q2017 of €168 mn is mainly affected by write offs during the quarter. The increase of accumulated provisions in the previous quarter amounted to €304 mn largely driven by the incremental provisions of c.€500 mn.

Impairments of other financial and non-financial assets for 9M2017 totalled €38 mn, compared to €34 mn for 9M2016 (up by 11% yoy), primarily affected by impairment charges relating to legacy exposures and legacy stock of properties in Greece and Romania. The 3Q2017 charge of €2 mn (compared to a charge of €4 mn in 2Q2017), reflects a €17 mn impairment loss on legacy properties in Greece reflecting additional haircuts taken to the carrying value in light of the stabilisation of property prices in Greece and the Group's strategy to accelerate disposals of legacy assets and exit from overseas non-core operations. This was partly offset by a reversal of €15 mn of impairment charges relating to legacy exposures following recent developments.

Provisions for litigation and regulatory matters for 9M2017 amounted to €73 mn. Provisions for litigation and regulatory matters for 3Q2017 amounted to €38 mn, primarily relating to redress provisions for the UK operations, following further analysis of the customer remediation from a pilot exercise which completed in 3Q2017. The charge for 2Q2017 amounted to €18 mn comprising €13 mn relating to litigations for securities issued by the Bank between 2007 and 2011 and €5 mn relating to redress provisions for the UK operations.

A.2.4 (Loss)/profit after tax

The tax charge for 9M2017 totalled €76 mn compared to €16 mn in 9M2016. The tax charge for 3Q2017 totalled €4 mn compared to €66 mn in 2Q2017. The elevated tax charge in 2Q2017 reflects the reduction of Deferred Tax Assets (DTA) of €62 mn, following the increase in provisions for impairment of loans and advances to customers and evaluation of the recoverability assessment of the DTA balance.

Loss after tax and before restructuring costs for 9M2017 totalled €532 mn, compared to a profit after tax and before restructuring costs of €101 mn for 9M2016. Profit after tax and before restructuring costs for 3Q2017 was €8 mn, compared to a loss after tax and before restructuring costs of €549 mn for 2Q2017.

Advisory, VEP and other restructuring costs for 9M2017 totalled €21 mn, compared to €98 mn for 9M2016 (down by 79% yoy). The elevated levels in the previous year relate mainly to the Voluntary Exit Plan (VEP). Advisory and other restructuring costs for 3Q2017 were €7 mn, at the same level as the previous quarter.

Net gain on disposal of non-core assets for 9M2016 of €59 mn related mainly to the gain on disposal of the investment in Visa Europe.

Loss after tax attributable to the owners of the Company for 9M2017 was €553 mn, compared to a profit after tax of €62 mn for 9M2016. Profit after tax attributable to the owners of the Company for 3Q2017 was €1 mn, compared to a loss after tax of €556 mn for 2Q2017.

B. Operating Environment

The Cyprus economy continued to perform well with the recovery strengthening into the first three quarters of 2017. Rising economic activity has, in turn, led to improved employment conditions and significant reductions in the unemployment rate whilst price inflation turned positive for the first time in five years. In public finances, the general government budget remained in surplus in the first half of the year whilst the current account deteriorated, driven by a widening of the gap in the goods and services balance. In the banking sector, non-performing loans continued to decline with significant improvements in the relevant metrics whilst funding conditions remain comfortable. The outlook over the medium term remains positive and risks are fairly balanced.

Real GDP increased by 3.9% year-on-year in the third quarter of the year on a seasonally adjusted basis, compared with an average increase of 3.8% in the first half, and an average increase of 3% in the whole of the previous year, according to data from the Cyprus Statistical Service. Economic activity remained broadly based mainly driven by tourism, trade, transportation and professional services. Manufacturing activity and particularly construction, made important contributions in the period.

Tourism continues to grow significantly benefiting from regional demand diversion. Total arrivals increased by 14.7% in the year to September and revenues by 13.5% to August, according to the Cyprus Statistical Service. In the labour market, the unemployment rate declined significantly in the year dropping to 11.3% in the second quarter on a seasonally adjusted basis compared with a 13% yearly average in 2016 according to Eurostat. After falling for the previous four years consumer prices increased by 0.7% in the year to September driven almost exclusively by higher costs for electricity and fuels. In property markets demand has been rising as evidenced in an increasing number of sales contracts. The Central Bank's Residential Property Price Index increased for the second consecutive time in the second quarter of the year rising by 1.1% year-on-year.

In the area of public finance, the government budget has been near balance or in surplus since 2014 when recapitalisation costs for the cooperative sector are excluded. Cyprus has consistently outperformed its fiscal targets during and after the economic adjustment programme. According to Eurostat the government budget was in surplus of 0.4% of GDP in 2016 and the corresponding primary surplus was 3%.

The overall outlook thus remains positive provided the external environment remains favourable. Real GDP growth is expected to average between 2.2% and 3% a year in the medium term according to most available forecasts, and the unemployment rate is expected to decline significantly. Inflation is expected to remain low aided by modest wage increases and low energy costs. The positive growth environment is expected to support a balanced budget and significant reductions in the stock public debt, both in absolute terms and in relation to GDP, and to also facilitate loan restructuring and a significant reduction in non-performing loans. Continued growth in the economy, debt sustainability and reductions in the stock of non-performing loans in the banking sector, remain the cornerstones for macroeconomic stability and further gains in competitiveness.

Downside risks to the outlook are associated with the still high levels of non-performing loans, and public debt ratio, and with a possible deterioration of the external environment for Cyprus. This may involve slower growth in the UK with a weakening of the pound as a result of uncertainty resulting from Brexit. The direct consequences on Cyprus from Brexit, will mostly emanate from tourist activity. The possible loss of UK tourist arrivals may be mitigated at least in part, by increases in arrivals of tourists from other destinations as airline connectivity improves. Political uncertainty in Europe triggered by a British exit or by the refugee crisis could also lead to increased economic uncertainty and undermine economic confidence.

In this context of a strengthening economy and narrowing imbalances, the Cyprus government benefited from a series of rating upgrades. Most recently in October 2017, Fitch Ratings upgraded its Long-Term Issuer Default ratings to 'BB' from 'BB-' with positive outlook. In September 2017, S&P Global Ratings affirmed its long term sovereign rating on Cyprus at 'BB' and upgraded its outlook to 'positive' from 'stable'. In July 2017, Moody's Investors Service upgraded the long-term issuer rating of the Cyprus sovereign to Ba3 from B1 and maintained its outlook to positive. The key drivers for rating upgrades have been stronger economic performance than expected, progress in the banking sector and consistent fiscal outperformance.

C. Business Overview

With the Cypriot operations accounting for 90% of gross loans and 90% of customer deposits, the Group's financial performance is highly correlated to the economic and operating conditions in Cyprus and will consequently benefit from the country's recovery. Most recently in October 2017, Standard and Poor's assigned a 'B/B' long- and short-term issuer credit ratings with positive outlook. The Bank currently has a long-term deposit rating from Moody's Investors Service Cyprus Limited of Caa1 with a positive outlook and a long-term issuer default rating from Fitch Ratings Limited of B- with stable outlook. The key drivers for the ratings were the improvement in the bank's financial fundamentals mainly in asset quality, and its funding position.

Tackling the Bank's loan portfolio quality is of utmost importance for the Group. Recently an internal reorganisation of the Restructuring and Recoveries Division (RRD) was executed with the aim of boosting resources on both the Retail and SME portfolios of RRD in order to further improve pace and sustainability in these portfolios. Additionally, the Group  is proceeding with the creation of an incremental servicing engine powered by an external party.

The strategic focus of the Group is to reshape its business model to grow in the core Cypriot market through prudent new lending and carefully developing the UK franchise. The Bank's capital position is sufficient and the Group expects to continue to be able to support the recovery of the Cyprus economy through the provision of new lending. Growth in new lending in Cyprus is focused on selected industries that are more in line with the Bank's target risk profile, such as tourism, trade, professional services, information/communication technologies, energy, education and green projects. The Bank is currently looking to carefully expand its UK operations, remaining consistent with the Group's overall credit appetite and regulatory environment. With selective presences in London and Birmingham and a predominantly retail funded franchise, the UK strategy is to support its core proposition in the property market, specifically targeting the professional buy-to-let market and further expanding its mortgage business and its savings, current accounts and trade-related products for SMEs, professionals and Cypriot residents.

Aiming at supporting investments by SMEs and mid-caps to boost the Cypriot economy and create new jobs for young people, the Bank continues to provide joint financed schemes. The Bank continues its partnership with the European Investment Bank (EIB), the European Investment Fund (EIF), the European Bank for Reconstruction and Development (EBRD) and the Cyprus Government.

Management is also placing emphasis on diversifying income streams by boosting fee income from international transaction services, wealth management and insurance. The Group's insurance companies, EuroLife Ltd and General Insurance of Cyprus Ltd operating in the sectors of life and general insurance respectively, constitute a leading player in the insurance business in Cyprus, with such businesses providing a recurring income, further diversifying the Group's income streams. The insurance income net of insurance claims for 9M2017 amounted to €39 mn, up by 13% yoy, compared to €35 mn for 9M2016 contributing to 16% of non-interest income.

The Bank proceeded with the set-up of a UCITS (Undertakings for Collective Investment in Transferrable Securities) Management Company, BOC Asset Management (BOCAM). BOCAM, a 100% owned subsidiary of the Group, will offer a broad spectrum of investment products and services to private and institutional clients. The primary services offered include the management, administration and safekeeping of UCITS units catering to the current and future investment needs of clients in Cyprus.

In order to further improve its funding structure, the Bank is stepping up its efforts to grow lower cost deposits, and take advantage of the increased customer confidence towards the Bank, as well as improving macroeconomic conditions.

On 19 January 2017, BOC Holdings was admitted to listing and trading on the London Stock Exchange ("LSE") and the Cyprus Stock Exchange ("CSE"). The listing on the LSE is another significant milestone in the execution of the Group's strategy. It is expected to improve the liquidity of the Group's stock, which will enhance the Group's visibility and lead to a broader base of investors capable of supporting the Group in the long-term. This will further enhance the confidence of all stakeholders in the Group. BOC Holdings continues to work towards a premium listing on the LSE, and intends to apply for a step up to the premium segment of the LSE at a future date, with the intention of becoming eligible for inclusion in the FTSE UK Index series.

The Bank has received approval by the Cyprus Securities and Exchange Commission ('CySEC') to register a Real Estate Fund in Cyprus, CYREIT Variable Capital Investment Company PLC (the 'Fund'), subject to meeting certain conditions. The Fund is structured as an Alternative Investment Fund (AIF) with an anticipated size of c.€190 mn. The Fund will follow a core and core+ strategy by acquiring a diversified portfolio of high-quality income yielding commercial real estate assets in Cyprus with stable lease roll. These properties are located throughout Cyprus and are currently rented to various tenants offering gross average rental yield returns of over 6% per annum on a 5 to 10 year horizon. The Fund will be distributing, in the form of cash dividends, at least 80% of all distributable net proceeds on an annual basis. Upon satisfaction of CySEC's conditions and the Fund receiving final authorisation from CySEC for commencing its operations, the Bank shall proceed with the offering of all or part of its shares in the Fund to qualifying local and international institutional and well-informed investors. The shares of the Fund will be listed on the Non-Tradable Investment Schemes Market of the Cyprus Stock Exchange (CSE).

D. Outlook

The Group remains on track for implementing its strategic objectives aiming to become a stronger, safer and a more focused 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:

· Materially reduce the level of delinquent loans

· Further improve the funding structure

· Maintain an appropriate capital position by internally generating capital

· Focus on the core Cyprus market and the UK operations

· Achieve a lean operating model

· Deliver value to shareholders and other stakeholders

D. Outlook (continued)

The table below shows the Group's performance against the Medium Term Targets.

* An amount of c.€500 mn reflecting the one-off effect of the change in the provisioning assumptions is included in the cost of risk, but is not annualised.

** On an IFRS 9 phased-in basis (per the proposal of the Council of the European Union).

*** The net fee and commission income over total income for December 2016 excludes non-recurring fees of approximately €7 mn.

**** The preliminary 2018 guidance for the earnings per share (EPS) does not include the impact of any unplanned or unforeseen risk reduction trades, or macro events.

E. Statutory Financial Results

Interim Consolidated Income Statement

Interim Consolidated Statement of Comprehensive Income

Interim Consolidated Balance Sheet

Interim Consolidated Statement of Changes in Equity

F. Notes

F.1 Reconciliation of income statement between statutory and underlying basis

The reclassification difference between the underlying and statutory bases relates to €94 mn expenses (€73 mn relate to Provisions for litigation and regulatory matters and €21 mn to Advisory and other restructuring costs), which for the purpose of management reporting are monitored and reported below the operating profit.

F.2 Customer deposits

Analysis of customer deposits is presented below:

F.3 Credit risk concentration of gross loans and advances to customers

Geographical and industry concentrations of Group gross loans and advances to customers are presented below: