London, 10 January 2013 -- Moody's Investors Service has today downgraded Cyprus's government
bond rating to Caa3 from B3, and the outlook on the rating is negative.
The rating action concludes the review for possible downgrade initiated
on 16 November 2012. Cyprus's short-term government
bond rating of Not Prime has been affirmed.
The key driver of today's rating action is the anticipated rise
in the Cypriot government's debt burden, driven principally
by the increased recapitalisation needs of its banking system following
distressed exchanges on Greek government debt and rising delinquencies
on loans to Greek and Cypriot obligors. Given that the resulting
increase in the debt burden is likely to be unsustainable, Moody's
believes there is a significantly increased likelihood that the Cypriot
government may eventually default outright or press for a distressed exchange,
although Moody's base case does not assume a default or distressed
exchange in 2013.
The negative outlook assigned to the rating reflects Moody's view
that the situation could significantly deteriorate over the next 12 to
18 months because of three factors: (1) ongoing liquidity concerns;
(2) uncertainty about the exact size of the necessary bank recapitalisations,
which may exceed the rating agency's current projections; and
(3) uncertainty about the upcoming finalisation and signing of a Memorandum
of Understanding (MoU) with the International Monetary Fund, the
European Union and the European Central Bank, also collectively
known as the Troika.
RATIONALE FOR DOWNGRADE
The main driver of Moody's three-notch downgrade of Cyprus's
government bond rating is the further increase in the amount of government
support that the rating agency believes Cypriot banks are likely to require.
Previously, Moody's forecasts of bank recapitalisation costs
had not included the credit cooperative sector. However,
our updated stress test analysis suggests that the recapitalisation cost
for the three largest banks is higher than originally anticipated which,
when combined with the likely needs of the cooperative sector, translates
into a bank recapitalisation cost of about EUR 10 billion, which
equates to over 50% of GDP. This estimate is consistent
with the Troika's provisional bank recapitalisation estimates.
Moody's has therefore incorporated its higher forecasts for bank
recapitalisation costs in its revised projections of the Cypriot general
government debt for 2013. However, the rating agency may,
over time, undertake further upward revisions of these recapitalisation
cost estimates given the rapid ongoing deterioration of the three largest
Cypriot banks' asset quality, as reflected in the rise in
non-performing loans to 26% in September 2012 from 19%
in March 2012.
As a result of these changed forecasts and assumptions, Moody's
currently estimates that the capital needs of the Cypriot financial sector
are likely to push the sovereign's debt-to-GDP ratio
to 150% in 2013 -- which would be one of the highest levels
in Moody's rating universe. More importantly, Moody's
believes that these debt levels could continue to rise to above 154%
by 2015 in view of the uncertainties regarding the cost of recapitalising
the banks and the implementation risks facing the country's fiscal
consolidation plan given the uncertain depth and length of the economic
downturn. This upward adjustment in Moody's forecast for
Cyprus's debt levels has in turn led to an assessment of a heightened
probability of default, given that debt levels of this magnitude
are unlikely to be sustainable for a small country with very weak expected
nominal GDP growth.
Moody's recognises that there is a strong political will among euro
area countries to avoid private sector involvement (PSI) and/or distressed
exchanges for any country in the monetary union, notwithstanding
Greece's default. Moody's also acknowledges that the
Cypriot banking system's exposure to its own government's
debt would limit the debt relief that the sovereign could obtain from
a restructuring. However, even though a debt restructuring
would increase the required bank recapitalisation costs, Cyprus
could obtain some debt relief through a restructuring with a large haircut.
Moreover, in Moody's opinion, there is a probability
of around 50% that the sheer size of Cyprus's anticipated
debt load will eventually compel the authorities to pursue every avenue
for debt reduction, including PSI. Given the very high projected
debt burden relative to the size of the economy, Moody's expects
investors to record large losses in such an event, and that a Caa3
rating is therefore warranted.
RATIONALE FOR NEGATIVE OUTLOOK
Moody's has assigned a negative outlook to Cyprus's Caa3 government
bond rating because of three significant uncertainties regarding events
that might prompt a rating downgrade and a possible default over the near
term:
1.) Liquidity concerns. Although Moody's base assumption
continues to be that access to short-term funding will remain sufficient
for the Cypriot government to meet its funding needs, the rating
agency notes that, in the absence of a disbursement from the Troika,
the government may face a severe crisis.
2.) Bank recapitalisation needs. The government has employed
a US asset manager, Pimco, to estimate the banks' recapitalisation
needs. Until its report is finalised later in January, there
will be lingering uncertainty about the amount of support that the government
will need to provide to Cyprus's banking sector in 2013.
3.) Progress of negotiations with the Troika. While Moody's
believes that the current agreement in principle between Cyprus and the
Troika on an MoU represents significant progress, the rating agency
notes that the finalisation of an agreement and disbursement of funds
have been delayed and that an assessment of debt sustainability has also
not been completed. Moody's base assumption continues to
be that the Cypriot government will be able to reach an agreement with
the Troika that will result in the provision of official assistance to
the Cypriot government until at least 2016 -- however, questions
about debt sustainability remain central to Moody's views on the
probability of a default event for Cyprus.
WHAT COULD CHANGE THE RATING UP/DOWN
Moody's considers a material upward movement in Cyprus's government
bond rating to be unlikely as long as debt levels continue to rise and
remain at very high levels. The magnitude of the government's fiscal
challenge is unlikely to change materially even following an agreement
on conditionality because of the sheer size of the financial support that
is needed for the banking sector.
The rating agency says that further downward movement in Cyprus's sovereign
rating would be likely if the likelihood of default were to become more
certain. Moreover, a downgrade would be likely if a Greek
exit from monetary union were to become more probable.
COUNTRY CEILINGS
As a consequence of today's rating action on the Cypriot sovereign,
Moody's has today also lowered the maximum rating that can be assigned
to a domestic issuer in Cyprus, including structured finance securities
backed by Cypriot receivables, by three notches to Caa1 from B1.
The lower ceiling reflects the increased risk of economic and financial
dislocations. The short-term foreign-currency country
and deposit ceilings remain at Not Prime.
Cyprus's adjusted country ceiling reflects Moody's assessment that the
risk of economic and financial instability in the country has increased.
The weakness of the economy and the sovereign's lack of access to international
markets constitutes a substantial risk factor to other (non-government)
issuers in Cyprus as income and access to liquidity and funding could
be sharply curtailed for all classes of borrowers. Moody's
cannot exclude a further deterioration in the financial sector,
which could lead to potentially severe systemic economic disruption and
reduced access to credit. Finally, the ceiling reflects the
risk of Cyprus's exit from the euro area and a redenomination in
the event of a default by the sovereign. If the Cypriot government's
rating were to fall further from its current Caa3 level, Moody's
might reassess the country ceiling and lower it at that time. Moody's
would also reassess the country ceiling in the event of an upgrade of
the Cypriot government's bond rating.
Moody's country ceilings capture externalities and event risks that arise
unavoidably as a consequence of locating a business in a particular country
and that ultimately constrain domestic issuers' ability to service their
debt obligations. As such, the ceiling encapsulates elements
of economic, financial, political and legal risks in a country,
including political instability, the risk of government intervention,
the risk of systemic economic disruption, severe financial instability
risks, currency redenomination and natural disasters, among
other factors, that need to be incorporated into the ratings of
the strongest issuers. The ceiling caps the credit rating of all
issuers and transactions with material exposure to those risks --
in other words, it affects all domestic issuers and transactions
other than those whose assets and revenues are predominantly sourced from
or located outside of the country, or which benefit from an external
credit support.
The principal methodology used in this rating was Sovereign Bond Ratings
published in September 2008. Please see the Credit Policy page
on www.moodys.com for a copy of this methodology.
REGULATORY DISCLOSURES
For ratings issued on a program, series or category/class of debt,
this announcement provides relevant regulatory disclosures in relation
to each rating of a subsequently issued bond or note of the same series
or category/class of debt or pursuant to a program for which the ratings
are derived exclusively from existing ratings in accordance with Moody's
rating practices. For ratings issued on a support provider,
this announcement provides relevant regulatory disclosures in relation
to the rating action on the support provider and in relation to each particular
rating action for securities that derive their credit ratings from the
support provider's credit rating. For provisional ratings,
this announcement provides relevant regulatory disclosures in relation
to the provisional rating assigned, and in relation to a definitive
rating that may be assigned subsequent to the final issuance of the debt,
in each case where the transaction structure and terms have not changed
prior to the assignment of the definitive rating in a manner that would
have affected the rating. For further information please see the
ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
The rating has been disclosed to the rated entity or its designated agent(s)
and issued with no amendment resulting from that disclosure.
Information sources used to prepare the rating are the following :
parties involved in the ratings, parties not involved in the ratings,
public information, and confidential and proprietary Moody's
Investors Service information.
Moody's considers the quality of information available on the rated
entity, obligation or credit satisfactory for the purposes of issuing
a rating.
Moody's adopts all necessary measures so that the information it
uses in assigning a rating is of sufficient quality and from sources Moody's
considers to be reliable including, when appropriate, independent
third-party sources. However, Moody's is not
an auditor and cannot in every instance independently verify or validate
information received in the rating process.
Moody's Investors Service may have provided Ancillary or Other Permissible
Service(s) to the rated entity or its related third parties within the
two years preceding the credit rating action. Please see the special
report "Ancillary or other permissible services provided to entities
rated by MIS's EU credit rating agencies" on the ratings disclosure
page on our website www.moodys.com for further information.
Please see the ratings disclosure page on www.moodys.com
for general disclosure on potential conflicts of interests.
Please see the ratings disclosure page on www.moodys.com
for information on (A) MCO's major shareholders (above 5%) and
for (B) further information regarding certain affiliations that may exist
between directors of MCO and rated entities as well as (C) the names of
entities that hold ratings from MIS that have also publicly reported to
the SEC an ownership interest in MCO of more than 5%. A
member of the board of directors of this rated entity may also be a member
of the board of directors of a shareholder of Moody's Corporation;
however, Moody's has not independently verified this matter.
Please see Moody's Rating Symbols and Definitions on the Rating Process
page on www.moodys.com for further information on the meaning
of each rating category and the definition of default and recovery.
Please see ratings tab on the issuer/entity page on www.moodys.com
for the last rating action and the rating history.
The date on which some ratings were first released goes back to a time
before Moody's ratings were fully digitized and accurate data may not
be available. Consequently, Moody's provides a date that
it believes is the most reliable and accurate based on the information
that is available to it. Please see the ratings disclosure page
on our website www.moodys.com for further information.
Please see www.moodys.com for any updates on changes to
the lead rating analyst and to the Moody's legal entity that has issued
the rating.
Sarah Carlson
VP - Senior Credit Officer
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454
Bart Oosterveld
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653
Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454
Moody's downgrades Cyprus's government bond ratings to Caa3 from B3; negative outlook
