Fitch ratings agency has cut Cyprus’ sovereign credit rating from AA- to A- and is warning of another possible downgrade because of its banking sector’s large exposure to Greece.
“The downgrade reflects the severity of the crisis in neighbouring Greece and the risk this poses for the Cypriot banking system and consequently the public finances of Cyprus,” said Chris Pryce, Director in Fitch’s Sovereign Group.
Cyprus is a small economy with a large banking system equivalent in terms of assets to approximately nine times its GDP. Exposure to Greece is a significant source of vulnerability that has intensified with successive downgrades of the Greek sovereign since January 2011, when Fitch put Cyprus on Rating Watch Negative citing fiscal and financial sector risks.
Roughly one third of the banking system’s assets are booked as Greek exposure, including that of Greek subsidiaries based in Cyprus. This exposure includes almost €14 billion of Greek sovereign bonds and an estimated €5 billion of Greek bank bonds. In addition, Cypriot-owned banks have lent through their substantial networks in Greece significant amounts to Greek companies and households.
Most Greek-related exposure is held by three major Cypriot banks: Bank of Cyprus, Marfin Popular Bank and Hellenic Bank. These “are relatively well placed to absorb the impact of a sovereign debt crisis in Greece that entailed an assumed 50% haircut to face value of Greek government bonds,” Fitch said.
But in a more severe scenario, in which “non-performing loans rose to 25%, Fitch estimates that the cost of recapitalizing the banks could rise to 25% of GDP, necessitating more extensive sovereign support.” The government likely “would be willing and able to provide effective support to Cypriot banks in a stress test of this magnitude,” but this “could materially alter the government’s debt profile in a manner that would be negative for the sovereign ratings.”
Fitch says developments in Greece will continue to have an important bearing on Cyprus’ ratings, underlining the importance of sound public finances and a robust, well-capitalised banking system.
The latest move by Fitch follows similar downgrades by ratings agencies Moody’s and Standard and Poor’s in recent months based on similar concerns.
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