S&P says Greece’s problems is an effective default of its debt obligations’

The credit rating agency warned at the beginning of this week that the French proposal to address Greece’s problems (which was proposed last week) is just “an effective default of its debt obligations”. On June 13, Standard & Poor’s Ratings Services lowered the long-term rating on the Hellenic Republic (Greece) to ‘CCC’ from ‘B’. In part, the downgrade reflected our view of the rising risk that an enhanced official financing package addressing the Greek government’s 2011-2014 financing needs could require private sector debt restructuring in a form that we would view as an effective default of its debt obligations under our ratings criteria. In recent weeks, a number of proposals relating to this topic have surfaced, and the particulars in some cases are evidently still in flux. This credit comment looks at the most prominent of the recent proposals, put forward by the Federation Bancaire Francaise (FBF) on June 24, 2011, in the context of our criteria for evaluating distressed debt exchanges and similar debt restructurings. In brief, it is our view that each of the two financing options described in the FBF proposal would likely amount to a default under our criteria.

The FBF proposal currently envisions French-regulated financial institutions agreeing to either of two options regarding their reinvestment of proceeds from Greek government debt maturing between July 2011 and June 2014. Based on recent public statements by European policy makers and bank executives, we believe the options FBF has put forward on the refinancing of Greece’s maturing debt were made at the behest of Greece’s eurozone official creditors.

We broadly summarize these options below.

  • Under the first option, French financial institutions would invest at least 70% of the proceeds of their maturing Greek government bonds in newly-issued 30-year Greek government bonds (New Thirty-Year Bonds). The transferability of the New Thirty-Year Bonds would be restricted for the first 10 years of their tenor (but eligible collateral for ECB repo operations). They would bear interest at 5.5% plus a margin equal to the percentage of real annual growth of the Greek economy, capped at 2.5% and floored at 0%. The Greek government, in turn, would be required to apply a portion of the issuance proceeds to the purchase of zero-coupon 30-year ‘AAA’-rated bonds issued by one or more sovereigns, supranational institutions, or European agencies, with the principal and interest from such ‘AAA’ debt calculated to repay in full the principal amount of the New Thirty-Year Bonds. 
  • Under the second option, French financial institutions would invest at least 90% of the proceeds of their maturing Greek government bonds in newly-issued five-year Greek government bonds (New Five-Year Bonds). The New Five-Year Bonds would also include restrictions on their transferability, and the interest rate coupon would be the same as on the New Thirty-Year Bonds described in option one. We understand there would be no investment of any part of issuance proceeds in ‘AAA’ debt under the second option.

The relevant Standard & Poor’s criteria pertaining to the financing options described in the FBF proposal are found in “General Criteria: Rating Implications of Exchange Offers and Similar Restructurings, Update,” published on RatingsDirect on May 12, 2009. This criteria describes the principles Standard & Poor’s follows when analyzing the credit effects when distressed entities attempt to restructure their obligations. Depending on the circumstances, Standard & Poor’s views certain types of debt exchanges and similar restructurings as equivalent to a payment default. Under our criteria, two conditions must be met for a debt exchange or similar restructuring to qualify as an effective default: (i) the transaction is viewed by us as distressed rather than purely opportunistic, and (ii) we take the view that the “exchange or similar restructuring” will result in investors receiving less value than the promise of the original securities.

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