From Moody's official statement:
The profound difficulties in the Cypriot banking sector, which are the result of deteriorating conditions in Greece and Cyprus, are the key driver of today's rating action. There are two aspects to this issue:
1.) In order to maintain appropriate domestic bank capital levels, the Cypriot government will likely need to provide financial support to the country's banks that could threaten the sustainability of the government's debt burden.
2.) The banking sector's difficulties will reduce domestic credit growth and severely constrain the country's growth potential, which will exacerbate existing economic and institutional weaknesses.
Moody's decision to assign a negative outlook to the rating reflects the adverse macroeconomic environment and policy uncertainty that poses further risks to the Cypriot government's credit strength. In particular, the Cypriot government has not yet reached an agreement on conditionality with the International Monetary Fund, the European Union and the European Central Bank, also known as the Troika, which is a precondition to receiving the financial support it will need to continue servicing its debt obligations beyond the end of 2012. Cyprus has lacked international market access for over one year, which is preventing the government from financing its own deficit or the banks' capital needs through the markets and therefore requires the sovereign to seek external assistance. In addition, the sovereign's credit strength would be greatly challenged if Greece were to exit the euro area, because of the severe impact it would have on Cypriot banks and more generally on the national economy.