Icelandic banks gain investment grade ratings from S&P

Standard & Poor’s upgraded Iceland’s main banks into investment grade territory on Tuesday, saying it expectations operating conditions for Icelandic banks to improve on the back of measures proposed by the government to enable the eventual lifting of the country’s capital controls.

Iceland’s government on 8 June announced plans to finally unwind capital controls imposed during the financial crisis of 2008, outlining proposals to unfreeze Ikr1,200bn (Eu8.12bn) of assets, with withdrawals subject to a 39% tax to prevent a destabilising capital flight.

Stating that it now expects improving operating conditions for Iceland’s commercial banks, with lower credit losses, greater stability and a limited future impact on banks’ credit profiles from Iceland’s financial crisis, S&P upgraded Arion Bank, Íslandsbanki and Landsbankinn by one notch, from BB+ to BBB-.

Arion’s and Íslandsbanki’s ratings are on stable outlook, while Landsbankinn was maintained on positive outlook, given the potential for a further upgrade if the bank retains a relative capital advantage, as it is not initially expected to pay extraordinary dividends to its majority owner, the Icelandic government, S&P said.

“In our view, the proposals of the failed banks’ winding-up estates and the government, presented in June, would likely address the country’s sizable balance of payments overhang without materially hampering the value of the Icelandic krona or the country’s financial stability,” the rating agency said.

“If the current proposals are implemented, which is our base case, we believe this would reduce external risks associated with the lifting of capital controls, which in our view is positive for banks, households, and companies.”

In addition, S&P said parts of the proposals will have a direct positive impact on the banks, including measures to replace winding-up estates’ deposit funding with longer term funding, and agreements to refinance existing capital instruments.

However, the rating agency said the upside to the banks’ ratings is constrained based on funding and liquidity, because of their limited access to wholesale markets and international financing, and uncertainty on potential deposit outflows associated with the eventual removal of capital controls, despite their strong liquidity positions and relatively strong funding metrics.

S&P noted that the bank upgrades followed its reassignment of Iceland from group 7 to group 6 under its banking industry country risk methodology (on a scale of 1 to 10, with group 1 indicating the lowest risk banking systems).

Also a consideration, S&P said, is its recent upgrade of the Icelandic sovereign, which it described as a sign of improvement and normalisation in the banking sector. On 17 July, S&P raised its long term foreign and local currency sovereign credit rating of Iceland from BBB- to BBB, citing the government’s “credible” proposals.