MOODY’S downgraded Cyprus’ bond ratings to B3 from Ba3, placing it six levels into junk territory, and has assigned a negative outlook to the ratings.
Moody’s also downgraded its ratings on three Cypriot banks to reflect the severity of the banks’ capital shortfalls owing to the firm’s expectations of acute asset-quality deterioration and funding pressures faced by the banks.
The Bank of Cyprus ratings were lowered by two notches to Caa1, placing it seven levels into junk territory, while the Cyprus Popular Bank ratings were cut by one notch to Caa1. The agency also downgraded the Hellenic Bank ratings by two notches to B3, six levels into junk territory. All three banks have negative outlooks.
Deteriorating conditions in Greece and Cyprus have weighed on the Cypriot banking sector. Moody’s said the main factor in its downgrade is the substantial increase in the amount of government support that Cypriot banks are likely to require.
Moody’s said the projected recapitalization costs have increased sharply in recent quarters due to the large asset quality deterioration that has been recorded in Cypriot banks’ domestic and Greek loan books, a trend that is expected to continue. The firm said the recapitalization needs of Cyprus’s three largest banks, should they materialize as projected in 2013, would raise the country’s debt to gross domestic product ratio to more than 140% of GDP. Moody’s said such a level may not be sustainable for a small economy with very weak expected GDP growth such as Cyprus.
The banking sector’s difficulties are also likely to reduce domestic credit growth and constrain the country’s growth potential over the next three to five years, Moody’s added. The firm said the Cypriot government, in order to address fiscal deterioration, will need to achieve substantial downward adjustments in its public-sector wage bill. However, the firm also noted the government’s previous record raises doubts about its ability to swiftly and vigorously implement such adjustments.
In June, Cyprus became the fifth member of the euro zone to formally request aid from its European partners and the International Monetary Fund to rescue its teetering bank system, which is heavily exposed to Greek debt.