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Moody's Investors Service has today downgraded Cyprus's government bond ratings by two notches to Ba3 from Ba1, and has placed the ratings on review for further possible downgrade.
The key driver for today's rating action is the material increase in the likelihood of a Greek exit from the euro area, and the resulting increase in the likely amount of support that the government may have to extend to Cypriot banks. The two-notch downgrade reflects Moody's assessment that this risk is exacerbated by the fact that the country's finances are already strained and access to the international markets is still denied.
Moody's decision to maintain Cyprus's sovereign bond ratings on review for further downgrade reflects the need to assess the substantial downside risks to the banking sector and the sovereign as a result of a Greek euro exit. These risks have the potential to rise in the aftermath of the Greek elections on 17 June 2012.
RATINGS RATIONALE
The key driver of Moody's two-notch downgrade of Cyprus's government bond rating is the significant deterioration in the country's outlook as a result of the material increase in the likelihood of a Greek exit from the euro area. The immediate result is a further increase in the likely amount of government support that the Cypriot banks may require due to their exposure to the Greek government and economy as well as the deterioration in domestic macroeconomic conditions.
Moody's prior Ba1 rating for Cyprus incorporated an assumption that the Cypriot government would need to contribute capital support equivalent to around 5-10% of GDP to the country's banks. The rating agency now expects this to be materially higher. For Cyprus Popular Bank alone, Moody's expects most, if not all, of the €1.8 billion in recapitalisation costs to be borne by the government, which will increase debt levels by just over 10 percentage points of GDP.
Moody's has reflected the increased risks emanating from the increased likelihood of a Greek exit in the ratings of the three largest Cypriot banks, two of which were downgraded on 12 June 2012, with all banks being placed on review for further downgrade. The close linkage between the government and the banking sector means that these increased risks for the banks may lead to much larger recapitalisation costs to the government, and Moody's needs to reflect these in the Cypriot sovereign's ratings.
FACTORS TO BE CONSIDERED IN THE REVIEW
The review will primarily focus on developments in Greece and how these may translate into heightened risks for Cypriot banks' solvency and liquidity, as well as any contingency measures that the banks and the government of Cyprus may take to address these risks. The political situation in Greece remains fluid and Moody's considers that the risk of a Greek exit from the euro area may increase further following the Greek parliamentary elections on 17 June.
As part of the review, Moody's will also assess any plan by the government to seek external funding from the euro area to provide liquidity support to the sovereign, much of which may be used to provide systemic support to the banking sector. The extent of this support and the conditionality that is attached to it would also be considered in the review.
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.
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