Credit rating agency Moody's Investors Service said on March 8 that the credit outlook for the Bulgarian banking system was negative, primarily reflecting the adverse impact of the domestic economic recession on the credit quality and net profits of the country's banks.

Moody's said that the opinion was not a projection of rating changes, rather the credit agency's view on the likely future direction of fundamental credit conditions in the industry over the next 12 to 18 months.

"Following several years of strong economic growth, the Bulgarian economy was significantly affected by the global economic and financial crisis and entered recession in 2009. From the end of 2008, credit activity started to slow down, largely as a result of sluggish credit demand, the more cautious lending practices adopted by credit institutions and tighter financing conditions both domestically and in the international markets," Moody's analyst Elena Panayiotou said in a statement.

Negative trends in Bulgaria's banking industry, which showed on the lenders' bottom-line profitability in 2009, would continue over the next 12 to 18 months, Moody's said.

"We recognise that the banking system remains adequately profitable and has strong capital buffers that were built up during the good macroeconomic conditions in light of the prudent regulation adopted by the Bulgarian National Bank. Hence, the larger and higher-rated banks typically have strong capital levels and a high loss-absorption capacity," Panayiotou said.

Nevertheless, the system's non-performing loans grew at a very rapid pace during 2009, resulting in high provisioning expenses and reduced net profitability for most banks.

Bulgarian banks improved risk management systems and procedures as a result of predominantly foreign ownership, but the downturn would test such systems, Moody's said, given that foreign parent banks could provide only incremental support for their subsidiaries because of problems in their own domestic markets. The cost of support would also be high because of the inherent risks of the Bulgarian market.

"As regards profitability, on the one hand, we expect revenue generation to be constrained by low growth in business volumes, despite good interest rate margins, while net profitability will continue to be affected by elevated provisioning expenses. On the other hand, we expect managements' efforts to rationalise the banks' operations and rein in costs to partly alleviate the pressure on profits," Panayiotou said.

Moody's viewed the borrower risk concentration in some banks' loan portfolios as giving rise to particular concerns with regard to increased credit losses in case of some corporate defaults. Going forward, the rating agency said that the modest recovery in the economy in 2010 and expectations of a continued rise in unemployment levels suggested that delinquencies will continue to grow, albeit at a slower pace.