Iceland's Credit Outlook Cut to Negative at Moody's on Foreign Loan Ruling
Iceland’s rating outlook was cut to negative at Moody’s Investors Service after a court ruling on foreign currency loans threatened to trigger bank losses that may require a government cash injection to offset.
Iceland’s Baa3 sovereign rating, the lowest investment grade, may be lowered to junk if the bank ruling hurts the island’s economic recovery and forces the government to raise its debt levels by bailing out the banks, Moody’s said in a statement.
“The magnitude of the banking system losses that will result from the recent court ruling is not known at this time but it is clear that Iceland still faces significant risks to its economic and financial recovery,” said Kathrin Muehlbronner, a Moody’s vice president and lead analyst for Iceland, in the statement.
The June 16 decision by Iceland’s Supreme Court, which banned loans indexed to foreign-exchange rates, may require the government to step in a second time since 2008 to bail out the island’s banks, Moody’s said. At the same time, the government has yet to resolve a dispute with the U.K. and Dutch on how to cover depositor claims worth about $5.1 billion. Failure to settle the claims may prompt the International Monetary Fund and other lenders to withhold future disbursements, Moody’s said.
“Although banks have some buffer to absorb losses due to their currently high capitalization levels, Moody’s does not rule out that Iceland’s banks will be faced with further losses following the Supreme Court decision,” Muehlbronner said. “This could in turn require the government to inject further capital into the banks as the only realistic provider of additional capital.”
FSA Rules
Some of Iceland’s lenders may be unable to meet the regulator’s 16 percent capital adequacy requirement, Financial Supervisory Authority Director Gunnar Andersen said in a July 14 interview. Economy Minister Gylfi Magnusson said then his government would suffer a “severe blow” if called on to support the banks with additional capital, though he didn’t rule out financial support.
Iceland, which targets the removal of capital controls when its IMF-led program expires in August next year, may be forced to keep the restrictions longer following the court ruling, Magnusson said in an interview yesterday.
“Undeniably, the removal of capital controls is based on the premise that people have faith in the Icelandic economy and the Icelandic krona,” he said. “This news doesn’t make that easier.”
Converted Claims
The June ruling threatens to derail Iceland’s efforts to rebuild relations with international investors almost two years after the island’s financial system collapsed. Iceland, the fifth-richest nation per capita as recently as 2007, faces litigation from creditors in the island’s banks, who sought to limit their losses last year by converting some of their claims to equity, according to Arni Tomasson, the head of Glitnir Bank hf’s winding up committee.
Fitch Ratings grades Iceland’s government debt one level below investment grade at BB+ with a negative outlook. Standard & Poor’s rates the island’s debt BBB-, one level above junk, with a negative outlook.
“Doubts are likely to persist over the restoration of Iceland’s access to international capital markets and the liberalization of capital controls,” Fitch Senior Director Paul Rawkins said in a July 19 interview.
The IMF on June 28 delayed its third review of Iceland’s program until the beginning of September, following the court’s decision. The review had been planned to take place in July or August.
Yen, Francs
Iceland’s financial crisis was exacerbated by banks that borrowed in currencies such as Japanese yen and Swiss francs to take advantage of lower interest rates, then repackaged them as kronur loans for clients. The krona has lost 38 percent against the yen and 30 percent against the franc since Sept. 15, 2008. The government is struggling to pay down a gross debt burden that will swell to 150 percent of economic output this year, Moody’s estimates.
Arion Bank, the successor to failed Kaupthing Bank hf, Islandsbanki, which was created out of Glitnir, and NBI, the successor to Landsbanki Islands hf, said this month the impact the June court decision will have on their assets is as yet unclear.
A July 23 ruling at the District Court of Reykjavik found that lenders could charge borrowers higher Icelandic rates instead of the contractual rates linked to foreign currency rates that the loans were originally indexed to. That ruling was based on a retail car loan. It is unclear whether mortgage and corporate debt affected by the June 16 ruling will be able to charge higher interest rates.
To contact the reporter on this story: Omar Valdimarsson in London at valdimarsson@bloomberg.net
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