Research Roundup: Iceland’s Sovereign Debt
Concern over Iceland’s sovereign debt increased today as Fitch Ratings put the country’s three largest banks on Ratings Watch Negative and cut its Outlook for the country’s Long-term foreign and local currency Issuer Default ratings (IDR) to Negative from Stable.
The Outlook revisions follow Fitch’s placement today of Iceland’s three largest banks, Glitnir Banki, Kaupthing Bank, and Landsbanki Islands, on Rating Watch Negative (RWN).
Should Fitch decide that the credit profile of Iceland’s major banks has deteriorated, downward pressure on Iceland’s sovereign ratings could result, if Fitch judges that the risks to macroeconomic stability and sovereign creditworthiness arising from distress in the banking system have materially increased.
The rating agency reiterates that the sovereign’s credit fundamentals remain strong, with net general government debt of just 8% of GDP, a succession of budget surpluses since 2004 and a very low debt service burden. In addition to this favourable credit profile, the authorities have a range of financial options open to them, including the issuance of foreign as well as domestic debt and draw downs of committed credit lines from major international financial institutions.
Nonetheless, the sheer size of the Icelandic financial system - close to 900% of GDP on a consolidated basis at end-June 2007 - underscores the importance of appropriate and measured policy responses to banking distress that will provide support and restore confidence in the banks without imperilling sovereign creditworthiness.
Moody’s has a Negative Outlook on Iceland’s banking system, but believes it can withstand tests to its liquidity. “Although Icelandic banks have had no direct exposure to the sub-prime market, their rapid loan growth, resulting in unseasoned loan portfolios and loan concentrations, is a concern, ” Moody’s said in a March Banking System Outlook.
Moody’s has conducted stress tests on the banks’ loan portfolios subjecting them to different default, asset growth and revenue assumptions as well as scenarios in which problem loans increased sharply. Moody’s said that Kaupthing’s liquidity profile is strong while Glitnir and Landsbanki exhibited solid liquidity profiles.
…the outlook takes into account the strong likelihood of systemic support in the event of financial difficulties, which raises each bank’s debt/deposit ratings by three notches compared to Moody’s assessment of their intrinsic credit strengh.
CreditSights says it would be difficult for Iceland’s central bank, with its international reserves of only $2.6 billion, to overcome a full-blown crisis in Iceland’s banks if it were operating alone. But Iceland is a member of the informal club of Nordic Central banks, a group whose combined international reserves total $129.4 billion, and most of whose members are not part of the Eurosystem and still retain their monetary tools.
Having been among the sternest critics of Icelandic banks in the past two years, we now find ourselves in the unaccustomed position of defending them. As we have said previously, we still think they are higher risk than other single-A rated European banks, but not to the extent implied by CDS spreads.
Meanwhile the Financial Times reports that Iceland’s Financial Supervisory Authority has begun an official investigation into alleged speculative attacks by international hedge funds on the country’s currency and stock market, according to people close to the probe. Simultaneously, Kaupthing, one of Iceland’s leading banks, is considering legal action against Bear Stearns, the troubled US bank, for the role it played in a trip to Iceland by a group of hedge funds last January.
The double moves highlight Iceland’s exasperation with the alleged role professional international investors are playing in undermining its currency, the krona, and its stock market, the FT says.
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