Cyprus Ratings Lowered To 'BB+/B'; Outlook Negative

Standard & Poor's is lowering its long-term sovereign credit ratings on 
the Republic of Cyprus to 'BB+' from 'BBB', and its short-term rating to 
'B' from 'A-3'.
The downgrade reflects our opinion of the effect on Cyprus of deepening 
political, financial, and monetary problems within the European Economic 
and Monetary Union (eurozone), with which Cyprus is closely integrated.
The downgrade also reflects our view of Cypriot financial institutions' 
significant exposure to Greece, which we believe further exacerbates 
Cyprus' existing external vulnerabilities.
The outlook on the long-term rating is negative.

LONDON (Standard & Poor's) Jan. 13, 2012--Standard & Poor's Ratings Services 
today lowered its long-term and short-term sovereign credit ratings on Cyprus 
by two notches to 'BB+/B' from 'BBB/A-3'. The outlook is negative. We have 
removed the long- and short-term sovereign credit ratings on Cyprus from 
CreditWatch, where they were first placed with negative implications on Aug. 
12, 2011. We have assigned a recovery rating of '4'.

Our transfer and convertibility (T&C) assessment for Cyprus, as for all 
eurozone members, is 'AAA', reflecting Standard & Poor's view that the 
likelihood of the European Central Bank restricting nonsovereign access to 
foreign currency needed for debt service is extremely low. This reflects the 
full and open access to foreign currency that holders of euro currently enjoy 
and which we expect to remain the case in the foreseeable future.

The outcomes from the EU summit on Dec. 9, 2011, and subsequent statements 
from policymakers lead us to believe that the agreement reached has not 
produced a breakthrough of sufficient size and scope to fully address the 
eurozone's financial problems. In our opinion, the political agreement does 
not supply sufficient additional resources or operational flexibility to 
bolster European rescue operations, or extend enough support for those 
eurozone sovereigns subjected to heightened market pressures.

We also believe that the agreement is predicated on only a partial recognition 
of the source of the crisis: that the current financial turmoil stems 
primarily from fiscal profligacy at the periphery of the eurozone. In our 
view, however, the financial problems facing the eurozone are as much a 
consequence of rising external imbalances and divergences in competitiveness 
between the eurozone's core and the so-called "periphery". As such, we believe 
that a reform process based on a pillar of fiscal austerity alone risks 
becoming self-defeating, as domestic demand falls in line with consumers' 
rising concerns about job security and disposable incomes, eroding national 
tax revenues.

The downgrade reflects our view of the systemic stresses--emanating from the 
eurozone--we see on the large Cypriot financial sector and Cyprus' external 
asset position, which in our view remains susceptible to a write-down on its 
high lending exposure to Greece. Cyprus is in a net external liability 
position that has averaged nearly 10% of GDP between 2007 and 2011, noting 
that this excludes "brass plate" holding companies and financial institutions 
that do not have meaningful local operations. It has run a current account 
deficit averaging 11% of GDP over the same period. Besides increasing funding 
costs, we expect losses on Cypriot banks' loan books to Greek customers--along 
with the banks' holdings of Greek government and bank paper--will further 
worsen its net external liability position and increase narrow net external 
debt to levels above 100% of current account receipts. In our view, Cyprus' 
external financing costs may remain elevated for some time due to high gross 
external financing requirements and reduced financial market integration in 
the eurozone.

The ratings on Cyprus are constrained by what we view as a politically 
obstructive environment, a relatively concentrated economy, and very high 
contingent liabilities emanating mostly from its large financial sector. The 
ratings are supported by relatively high levels of prosperity and strong 
official institutions.

We have assigned a recovery rating of '4', indicating an expected recovery 
rate of 30% to 50% in the event of a default, however unlikely.

The negative outlook reflects our view that there is at least a one-in-three 
probability that we could lower Cyprus' long-term rating again in the next 12 
months. This could occur in a context of losses from a Greek restructuring 
that turn out to be higher than we currently anticipate. This could lead to 
lower economic growth and larger external vulnerabilities, which could give us 
cause to adjust our economic and external scores in accordance with our 
criteria. Additionally, we could reduce our fiscal score if the government 
significantly misses its revised fiscal deficit targets, for example due to a 
sustained decline in growth or if domestic banks were to require additional 
significant fiscal support from the state. 

Cyprus' long-term rating could stabilize at the current level if private 
creditors were to provide any needed capital to domestic banks. If 
public-sector access to market funding improves and government financing is 
assured, amid stabilizing growth prospects, the ratings could also stabilize.

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