Europe’s effort to pull Greece back from the brink may result in a default rating by Standard & Poor’s, exposing a critical flaw in the drive to press creditors to assume a share of the bailout cost.
Standard & Poor’s said today a rollover plan serving as the basis for talks between investors and governments would qualify as a distressed exchange and prompt a “selective default” grade. That may leave the bondholders unwilling to complete the transaction and the European Central Bank unable to accept Greek government debt as collateral, impairing the lifeline it has provided the country’s banks.
“It sends all the officials and banks back to the drawing board to think of something new,” said Christoph Rieger, head of fixed-income strategy at Commerzbank AG in Frankfurt. “The ECB is saying it won’t accept debt in a default. Someone needs to give in -- either Germany or the ratings agencies or the ECB. One of three will have to compromise.”
The S&P statement came less than 48 hours after euro-area finance ministers authorized an 8.7 billion-euro ($12.6 billion) loan payout to Greece by mid-July and said they would aim to complete talks with banks on maintaining their Greek debt holdings within weeks. The International Monetary Fund indicated it would deliver its 3.3 billion-euro share of the payment.
The prospect of a default rating adds to policy makers’ concerns that Greek officials may fail to enact the 78 billion euros of austerity measures that lawmakers passed last week as a condition of receiving further aid.
Greek 10-year government bonds fell, sending the risk premium against benchmark German notes up by 12 basis points to 1,342 basis points at 2:05 p.m. in London. Two-year Greek yields dropped 70 basis points to 26.1 percent as the threat of immediate default waned.
Finance ministers from the 17 euro countries meet on July 11 to work on Greece’s next rescue, which Austria last week said may add as much as 85 billion euros to the bill for keeping the country financially sound.
Greece must roll over about 4 billion euros of bills maturing between July 15 and July 22, plus about 3 billion euros of coupon payments in the month, according to Bloomberg calculations. A bigger test looms Aug. 20 when 6.6 billion euros of bonds fall due.
Europe is inching toward a goal of getting banks to roll over 30 billion euros of Greek bonds, instead of opening a hole for the official lenders to fill. French banks, with the biggest exposure to Greece, worked out a rollover formula that is serving as an example elsewhere.
Their proposal depends on credit-rating firms not cutting Greece and existing or newly issued government securities to default, according to a draft of the plan.
“This does argue for possibly taking a step back and refraining from any kind of private-sector contribution at all,” said Marius Daheim, a senior fixed-income strategist at Bayerische Landesbank in Munich. “That’s the only way out if you want to avoid default then you have to keep the private sector uninvolved.”
A spokeswoman for the French banking association declined to comment, as did an ECB spokesman and Amadeu Altafaj, a spokesman for the European Commission. German Finance Ministry spokesman Martin Kotthaus said “exact details” are still being negotiated.
‘Very Good’ Proposal
Bank of France Governor Christian Noyer, a member of the European Central Bank council, said the proposal drafted by French banks is “very good” and may make Greece’s program more credible, according to an interview in yesterday’s Athens-based Proto Thema newspaper.
ECB President Jean-Claude Trichet reiterated last week that the bank opposes “all concepts that are not purely voluntary” and called for “the avoidance of credit events or selective default or default.” He declined to comment on the French proposal.
German banks, insurers and so-called bad banks pledged last week to buy 3.2 billion euros of maturing Greek bonds. Allianz SE, Europe’s largest insurer, puts its share at 300 million euros, spokesman Christian Kroos said yesterday.
Standard & Poor’s said its default rating may be temporary and that it would assign a new grade after the exchange.
Even if S&P or other rating companies determined that the rollover plan constituted a default, the ruling wouldn’t necessarily trigger credit swaps insuring Greek debt. That decision may be made by the determinations committee of the International Swaps & Derivatives Association.
S&P would assign a “D” rating to the maturing Greek government bonds “upon their refinancing in 2011,” it added. All debt issues would then “likely” be rated at the same level as the new Greek rating afterwards.
“It is our view that each of the two financing options described in the Federation Bancaire Francaise proposal would likely amount to a default,” S&P said in the statement. “But, once either option is implemented, we would assign a new issuer credit rating to Greece after a short time reflecting our forward-looking view of Greece’s sovereign credit risk.”
Under one option of the French plan, private investors would reinvest 70 percent of their original holdings in 30-year Greek bonds, with the remaining 30 percent paid in cash on maturity. Greece would use 50 percent of the original amount to meet its financing needs with the remaining 20 percent invested in zero-coupon bonds through a so-called special purpose vehicle to serve as collateral to insure the banks get their principal repaid. The second option of the plan is to reinvest at least 90 percent of the maturing securities into new 5-year bonds.
“They are clearly creating a problem with what has been discussed,” said Marc Ostwald, a fixed-income strategist at Monument Securities Ltd. in London. “It’s a risky exercise and it looks from S&P’s perspective that they’re going to take no prisoners on it. It will be a downer for the periphery, above all for Greece, and will give bunds a bit of support.”
Fitch Ratings said June 15 it would probably keep ratings of Greek government bonds above default level if European Union leaders go ahead with plans for investors to voluntarily roll over their debt, while lowering Greece’s issuer rating to ‘restricted default.”
Any such outcome would present a “surmountable” risk, as long as the ECB keeps accepting the debt as collateral, Steven Major, global head of fixed-income research at HSBC Holdings Plc in London.