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Global Credit Research - 20 Apr 2011
London, 20 April 2011 -- Moody's Investors Service has today affirmed Iceland's Baa3 local
and foreign currency government bond ratings and their negative outlook,
as well as the Prime-3 rating for the country's short-term
Today's announcement comes despite the recent majority "no"
vote in the country's referendum on the revised Icesave agreement,
which Moody's had previously said (February 2011) would most likely
result in a negative rating action. However, today's
affirmation of the rating recognizes the following developments that led
Moody's to reach a more benign assessment of the referendum outcome:
(1) Despite the rejection of the revised agreement to resolve the dispute
over the Icesave offshore bank deposit scheme, the British and Dutch
governments are now expected to receive initial payments from the Landsbanki
estate soon for the costs they incurred in covering their citizens'
Icesave deposits. In addition, the Landsbanki estate now
expects to be able to make significantly higher payments to priority claimholders
as asset recoveries have been much higher than expected earlier.
The outstanding Icesave obligation and potential liability to the government
might therefore be reduced significantly in the coming months regardless
of the referendum outcome.
(2) Moody's also expects Iceland's programme of support from
the International Monetary Fund (IMF) to remain on track. The fifth
review was scheduled for 27th April and there will certainly be a delay
while the IMF assesses the implications of the referendum outcome.
However, it seems unlikely that there will be a significant delay
or blockage of the programme as occurred in 2009.
(3) Public statements indicate that the Nordic governments will likely
continue to provide funding to the Icelandic authorities under their loan
agreements. Apart from the IMF, the Nordic governments'
financing has been an essential external funding source for the Icelandic
The outlook on the rating remains negative given the ongoing uncertainty.
Moody's understands that the underlying issue of whether the Icelandic
government has a liability under the EU directive on deposit-guarantee
schemes will now most likely be resolved through the court of the European
Free Trade Association (EFTA). This legal process may take at least
a year. There are also uncertainties regarding the timetable for
the relaxation of the capital controls and the economic outlook,
in particular related to investment.
RATIONALE FOR AFFIRMATION OF CURRENT RATING
The primary driver of today's affirmation of Iceland's ratings
is Moody's recognition that the size and importance of the government's
liability related to the Icesave dispute will likely decline substantially
in the coming months. This is because the Landsbanki Resolution
Committee now estimates that asset recoveries will ultimately amount to
approximately 90% of priority deposit claims, which is significantly
higher than earlier estimates. The Resolution Committee is expected
to start paying out to priority claimants (such as the UK and Netherlands
governments) after the summer. Given the substantial cash reserves
that the estate has accumulated, the potential liability to the
government (if found liable) might well have declined to less than half
by the time the legal process has run its course. However,
Moody's continues to view the full resolution of the Icesave issue
-- most likely through further legal proceedings -- to be an
important pre-requisite for normalizing Iceland's relations
with the international investor community.
The second driver underlying the rating affirmation is Moody's expectation
that the IMF programme will not undergo any material changes and remain
on track, despite a short delay while the IMF re-assesses
its macroeconomic framework. Overall, Moody's considers
the IMF programme to be a crucial anchor for Iceland's economic
and financial recovery, especially in terms of the ongoing fiscal
consolidation. A related third driver is the rating agency's
expectation that the Nordic governments will also continue to provide
funding to Iceland under their loan agreements (EUR888 million still available).
The deadline for draw-downs has recently been extended until December
These drivers address Moody's previous concerns that a possible
rejection of the Icesave agreement might put the external funding from
the Nordics (and consequently the IMF) at risk, thereby undermining
Iceland's economic recovery, fiscal sustainability and the
ability of the Icelandic authorities to relax the strict capital controls
that are in place.
Additionally, Moody's notes that the government recently announced
a buyback offer at par for all holders of the two Eurobonds maturing in
December 2011 and April 2012. The government has already bought
back a significant amount of these bonds but approximately EUR800 million
worth remain outstanding. The May 5 auction will provide a good
indication of the sentiment of non-resident investors towards Iceland
and will probably influence the timing of the first steps to relax capital
RATIONALE FOR MAINTAINING A NEGATIVE OUTLOOK
Moody's notes that there are still significant risks that warrant
maintaining a negative outlook on the rating. While the size of
the Icesave liability will shrink, the government could still be
found liable for accrued interest and any uncovered portion of the principal,
the amount of which is unclear at this point in time. Litigation
risks relating to the Emergency Act and the priority status of deposits
claims are another source of uncertainty, but Moody's expects
these lawsuits to be resolved in the coming months.
Moreover, the risks to Iceland's economic recovery are significant.
In particular, Moody's believes that the economy might be
negatively affected due to lower capital inflows because of possible delays
to the liberalization of the strict capital controls that are currently
in place. The positive GDP growth, which Moody's expects
Iceland to record in 2011, relies mainly on a strong rebound in
investment -- but this may not materialize if foreign investors delay
investment decisions, pending a full resolution of the Icesave issue.
A longer-term question is whether the rejection of the Icesave
agreement will have more fundamental implications for the outlook for
FDI and the attractiveness of Iceland as a place of doing business.
WHAT COULD CHANGE THE RATING DOWN
Moody's would downgrade Iceland's rating if the above-mentioned
legal risks related to the priority status of deposits were to materialize.
This would result in a much higher liability for the government because
of lower payouts from the Landsbanki estate to the British and Dutch governments.
The rating would also come under downward pressure if Nordic funding was
disrupted against our expectations or the economic recovery turns out
to be slower than Moody's is expecting, possibly due to delays
to important investment projects or slower-than-expected
corporate and household debt restructuring. Indications of a declining
commitment to fiscal consolidation would also be negative for the rating.
The speed and sequencing of capital account liberalization will become
a more important ratings driver going forward, and Moody's
will closely monitor the impact of the steps the Icelandic government
will take on the exchange rate.
WHAT COULD CHANGE THE RATING UP
Moody's would consider returning the rating outlook to stable and
potentially upgrading the ratings if the economy were to recover much
faster than is currently expected and if the foreign exchange rate were
to remain stable following the gradual relaxation of capital controls.
PREVIOUS RATING ACTION AND METHODOLOGY
Moody's last rating action affecting Iceland was implemented on
29 July 2010, when the rating agency assigned a negative outlook
to Iceland's Baa3 rating. The rating action prior to that
was taken on 23 April 2010, when the rating agency returned the
outlook on the Baa3 rating to stable from negative.
The principal methodology used in rating the government of Iceland is
Moody's "Sovereign Bond Methodology", published in 2008.
Vice President - Senior Analyst
Financial Institutions Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
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MD - Sovereign Risk
Financial Institutions Group
Moody's Investors Service
Moody's Investors Service Ltd.
Moody's affirms Iceland's Baa3/P-3 ratings and maintains negative outlook
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London E14 5FA
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