Moody’s downgrades Cyprus’ bond ratings

MOODY’S Investors Service has downgraded Cyprus’s government bond ratings to Baa3 from Baa1 and placed the ratings on review for further possible downgrade.

This is the Island’s third rating downgrade by Moody’s this year after a two-notch cut in February and a second in July. It comes after losses on Greek bonds have been raised since last month’s revised deal on greater public sector involvement in Greece.

In yesterday’s statement, Moody’s said that the key drivers for its two-notch downgrade were:

1. The high likelihood that the Cypriot banking system will require state support in 2012 as a result of the large expected write-downs on its exposures to Greek government bonds. (The Island’s largest banks, the Bank of Cyprus and the Marfin Popular Bank are estimated to have an exposure of €5 billion to Greek government bonds – and both have substantial retail operations in Greece)
2. The Cypriot government’s loss of international market access and the resulting likelihood that the government will need to seek emergency funding from official sources.
3. Cyprus’ weaker-than-expected institutional capacity to approve and implement the budgetary and structural changes that are needed to correct the government’s rising debt trajectory and improve the longer-term sustainability of its public finances.

Moody’s believes that the combined impact, and the links between, these three factors on the government’s balance sheet is, at best, consistent with the lower end of the Baa rating range. The structural rigidities in the government budget are not being decisively addressed, increasing risks to the fiscal consolidation plans.

These vulnerabilities have also substantially reduced the government’s ability to absorb an increase in debt stemming from the crystallisation of contingent banking liabilities. The potential size of these liabilities, along with the rapid deterioration of conditions in Greece, and the government’s weak response to these adverse developments have resulted in a loss of international market access.

The decision to maintain the ratings on review for further downgrade reflects the need to assess the substantial downside risks to the government’s fiscal performance, the Cypriot banking sector, and the state’s future funding plans. A rising probability that these risks will crystallise would likely cause the government to lose its investment grade debt rating.

The rating agency has also downgraded Cyprus’s short-term rating to Prime-3 from Prime-2 and placed it on review for further possible downgrade.

Last month, Standard & Poor’s cut Cyprus one notch to BBB, due to concerns over the Island’s banks and delays in bolstering its public finances. Fitch recently downgraded Cyprus to BBB.

(Yesterday the Marfin Popular Bank Executive Chairman, Andreas Vgenopoulos, announced his resignation from the Board of the bank).