July 5, 2013 / 4:36 PM / 4 years ago

Fitch Upgrades Cyprus's LC IDR to 'CCC' from 'Restricted Default'

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Link to Fitch Ratings' Report: Cyprus - Rating Action ReportLONDON, July 05 (Fitch) Fitch Ratings has upgraded Cyprus's Long-term local currency Issuer Default Rating (IDR) to 'CCC' from 'Restricted Default' (RD). Individual bonds affected by the exchange completed 1 July have been upgraded to 'CCC' from 'D'; unaffected domestic bonds have been affirmed at 'CCC'. The Long-term foreign currency IDR has been affirmed at 'B-' with a Negative Outlook. The Short-term foreign currency IDR has been affirmed at 'B' and the Country Ceiling affirmed at 'B'. KEY RATING DRIVERS The upgrade of Cyprus's local currency IDR reflects the following key rating drivers and their relative weights: - High The announcement of the completion of the government's domestic debt exchange and issue of the new bonds on 1 July marks the resolution of a default event. The government's exchange of EUR1bn of domestic laws bonds maturing during the IMF-EU programme period for new bonds maturing in 2019-23 was considered a distressed debt exchange (DDE) by Fitch. Although the new bonds have the same coupon and face value as those exchanged, the transaction represented a material reduction in terms for bondholders, who were not compensated for the longer duration against a backdrop of heightened credit risk over the medium term. - Medium The one-notch differential between the local currency IDR (CCC) over the foreign currency IDR (B-) reflects the agency's assessment of the greater vulnerability of bonds issued under domestic law relative to foreign law bonds, as demonstrated by the recent exchange, which reveals a preferential treatment of foreign law sovereign bonds. Domestic law bonds represent 26% of the stock of general government debt and foreign law bonds 14%. EUR670m (4% of GDP) domestic law bonds mature during the programme period, excluding the EUR1,987m 'recapitalisation bond'; EUR1,618bn (9% of GDP) of foreign law MTNs mature during the same period. Cyprus's 'B-' foreign currency IDR reflects the following key rating drivers: - External support under the auspices of the EU-IMF programme improves the immediate position of the sovereign from both a liquidity and solvency perspective, albeit with large downside risks. - There is a high risk of the agreed programme going off track, stemming from downside risks to economic performance and political commitment to the programme. - Lack of flexibility to deal with domestic or external shocks, with financing buffers potentially insufficient to absorb material fiscal and economic slippage, notwithstanding the recent maturity extensions of domestic debt. - High public debt, likely to peak above the 126% of GDP by 2015 assumed under the programme, reflecting Fitch's assumption of a deeper recession in the later years of the programme and a slower recovery than that assumed. - Capital controls pose an additional risk: a premature lifting of these controls triggering material capital flight would have negative economic consequences. RATING SENSITIVITIES The Negative Outlook on the Long-term foreign currency IDR reflects the following risk factors that may, individually or collectively, result in further pressure on the ratings:- - Implementation risk for the programme is high. The deep recession and sharply rising unemployment will make it more difficult to implement fiscal consolidation plans. Political will for implementing painful measures may weaken. Significant slippage from future programme targets, in particular fiscal deficits, would undermine the rating. - The recession could be materially deeper and last longer than assumed under the EU/IMF programme as has been the experience of other programme countries in the eurozone. This would have adverse consequences for the Cypriot debt dynamics. - Intensification of the banking crisis in Cyprus. There is a still high risk of capital flight from banks if capital controls are lifted prematurely, exacerbating the domestic credit contraction even assuming liquidity support from the ECB. - A further restructuring of Cyprus's marketable liabilities could, depending on the terms, trigger a second ratings default event. Fitch's sensitivity analysis does not currently anticipate developments with a material likelihood of leading to a rating upgrade in the near term. Much further in the future, the realisation of significant off shore gas and oil reserves could significantly help the financing of fiscal deficits and place upwards pressure on the rating. KEY ASSUMPTIONS There is considerable uncertainty over the near- and medium-term evolution of output, unemployment and the government deficit. The pressure on banks to de-lever is expected to exert considerable pressure on the economy with knock on effects to public finances. Fitch expects the recession to be deeper and last longer than assumed under the EU/IMF programme. Fitch also anticipates slippage from fiscal targets reflecting the weak macroeconomic outlook and implementation risks resulting in public debt to GDP ratios materially higher than projected by officials. Fitch currently assumes that the fiscal costs of bank recapitalisation will not exceed the EUR2.5bn specified under the EU-IMF programme, which includes a contingency buffer. Should the current banking sector instability result in a prolonged breakdown in the domestic payments system, this would lead to a surge in corporate bankruptcy and drive a deeper GDP contraction. However, it is Fitch's expectation that the residual banking system will be promptly recapitalised and that capital controls will seek to allow depositors to access funds for consumption and to pay suppliers. Fitch has not factored possible hydrocarbon receipts into its projections; these therefore represent an upside risk beyond the near term. While the authorities claim government revenues to range between EUR18.5bn (102.9% of GDP) to EUR29.5bn (164.1% of GDP) in Block 12 alone, the economic viability of extraction remains uncertain and beyond the horizon of the programme. Fitch assumes that there is no materialisation of severe tail-risks to eurozone financial stability that could trigger a sudden and material increase in investor risk aversion and financial market stress. Fitch also assumes that Cyprus remains a member of the eurozone. Contact: Primary Analyst Enam Ahmed Director +44 20 3530 1624 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Douglas Renwick Senior Director +44 20 3530 1045 Committee Chairperson Ed Parker Managing Director +44 20 3530 1176 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com Applicable criteria, 'Sovereign Rating Methodology' and 'Country Ceilings' dated 13 August 2012, and 'Distressed Debt Exchange' dated 8 August 2012 are available at www.fitchratings.com. Applicable Criteria andALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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