Greece is expected to announce a bond swap deal with private sector creditors that will see at least half the value of their investments in its debt written off. We look at what this means for investors, the wider market, and Greece itself.
Greece’s current ratings
The three big credit rating agencies – Fitch, Moody’s and Standard & Poor’s – downgraded Greece in July after the debt swap plan was unveiled, assigning it “highly speculative” status and warning that losses for private creditors would imply a default.
S&P said in July it would revise Greece’s sovereign rating to “selective default” when any debt restructuring is implemented, with the affected bonds being cut to D, its lowest rating, denoting a default.
Fitch’s lead analyst for Greece, Paul Rawkins, said on Wednesday that Greece would be assigned its “restricted default” rating when the bond exchange period closes.
Moody’s does not make a similar distinction but its lowest rating of C implies a default with little prospect for recovery of principal or interest.
What happens afterwards?
S&P and Moody’s each said in July that once a restructuring is completed they will reassess Greece’s creditworthiness in light of its reduced debt burden, which is likely to mean its ratings are upgraded. S&P said it expected to assign “a low speculative-grade rating” to Greece, reflecting its still-high debt and uncertain growth prospects.
New bonds issued under the debt swap will also be rated, possibly – since some will be collateralised – at a higher level than unsecured Greek government bonds.
Fitch’s Rawkins said Greece’s restricted default rating would be maintained “for a short period” before it was reassessed, taking into account changes to the country’s debt profile.
An outright default would be seen as a sign politicians had lost control of the single currency, and markets would immediately take aim at other weak countries such as Italy, Spain and Portugal.
Will there be a credit event?
The International Swaps and Derivatives Association (ISDA), has the final say on whether a “credit event” has occurred, triggering the payment of default insurance taken out on Greek bonds via the credit default swap (CDS) market.
In October, when Greece’s second bail-out was initially agreed, the ISDA said that the voluntary nature of the deal meant that it would not trigger payments under existing CDS contracts.
This week, talk of retrospectively applying collective action clauses (CACs), which would prevent a minority of investors from blocking any restructuring deal, sparked talk of disorderly default.
The ISDA concluded that “the inclusion of a CAC would not, in and of itself, be expected to trigger a Credit Event. On the other hand, the use of such a clause to effect a reduction in coupon or principal or one of the other events set out in the definition of the Restructuring Credit Event could trigger if the other requirements of the Restructuring Credit Event were met (for example decline in creditworthiness), as its effect would be to bind all holders of the relevant debt.”
According to the latest data from DTCC, outstanding credit default swaps on Greek debt total $70.8bn gross and $3.2bn net. Forced losses for investors would almost certainly be considered a credit event, even as part of an “orderly” default.
Greek prime minister Lucas Papademos told the New York Times this week he will consider legislation forcing creditors to take losses if no agreement can be reached.
An outright default, where Greece does not meet interest payments or repay principal, would prompt ISDA to declare a credit event as grace periods expire.