S&P warns Malta’s ratings may be downgraded by two notches

Credit rating agency Standard & Poor's has warned Malta and 15 other eurozone member states - including AAA-rated France and Germany - that they have been placed under 'CreditWatch', implying the possibility of a downgrade.

The warning comes amid spiralling European debt turmoil that poses a threat to the very existence of the euro as a currency.

"CreditWatch placements are prompted by our belief that systemic stresses in the eurozone have risen in the recent weeks to the extent that they now put downward pressure on the credit standing of the euro zone as a whole," S&P Ratings Services said.

Malta's AA rating could fall back by two notches, S&P warned, while  Estonia, Ireland, Italy, Portugal, Slovak Republic, Slovenia, Spain and Cyprus, may also face the same fate.

S&P placed Malta's 'A' long- and 'A-1' short-term sovereign credit ratings on CreditWatch with negative implications.

The CreditWatch placement is prompted by S&P's concerns about the potential impact on Malta of what the agency views as the "deepening" political, financial, and monetary problems within the eurozone.

S&P believes that the lack of progress the European leaders have made so far in controlling the spread of the financial crisis may reflect structural weaknesses in the decision-making process within the eurozone and European Union.

This - the agency said - "informs our view about the ability of European policymakers to take the proactive and resolute measures needed in times of financial stress. We are therefore reassessing the eurozone's record of debt-crisis management and its implications for our view on the effectiveness of policymaking in Malta."

S&P's CreditWatch review will focus on three areas of its criteria:

The political score

In S&P's view, the overall consistency, predictability, and effectiveness of policy coordination among institutions within the eurozone has weakened at a time of severe ongoing fiscal and economic challenges to a degree more than we envisioned.

"For Malta, we believe this environment could offset recent successful efforts to consolidate public finances and detract from important structural measures, such as the reform of the pension system. Specifically, we will review the policy-making environment in terms of: the predictability of its overall policy framework and its policy responses to current developments," S&P said.

The external score

S&P points out that Malta is host to a number of foreign banking institutions whose assets total an estimated 750% of GDP.

While the majority of these banking institutions are not linked to the domestic economy, S&P believes that a deepening and prolonged financial crisis could complicate access to financing for Malta's banks and private sector entities.

"We note that the two main domestic banks, Bank of Valletta and HSBC, are predominantly funded by resident deposits and have a small reliance on interbank funding lines. However, liquidity concerns and the weakening asset quality of Malta's banks' securities and loan portfolios could in our view increase the risk of the need for capital injections by the government or similar interventions. In our view, this raises the possibility that contingent liabilities could materialize. However, we expect the government's appetite to support financial institutions, if needed, would likely be limited to systemically important domestic institutions."

Although Malta's domestic banks have so far maintained access to market liquidity, S&P said that it will review the risk of a sudden reduction of cross-border interbank lines resulting from perceptions of increasing financial-sector stress.

"We will also review Malta's fiscal capacity (at its current rating level) to provide additional support to its national banking system should further official assistance be required," it said.

The monetary score

S&P is also set to review the ECB's policy settings and their impact on financial market conditions, the real economy, and ultimately Malta's creditworthiness.

"If we were to conclude that the ECB's policy stance is unlikely to be effective in mitigating the economic and financial shocks that we believe Malta could be experiencing, we could lower this score," S&P has warned.