RPT-SCENARIOS-Impact of selective default ratings on Greek debt
Fri Jul 22, 2011 5:43am EDT
(Repeats, without changes, story first published on Thursday)
By Ana Nicolaci da Costa
LONDON, July 21 (Reuters) - As
euro zone officials make a last-ditch attempt at resolving the Greek debt crisis and stemming contagion, the options on the table are increasingly pointing to a likely downgrade of Greece's debt ratings to "selective default."
The crisis plan would give the euro zone financial rescue fund sweeping new powers to prevent contagion, according to the draft conclusion of an emergency summit meeting on Thursday. It would also involve a bond buyback, longer official loans at cheaper rates and a debt swap but no new tax on banks. For more see [ID:nL6E7IK2VL].
Key to the ratings impact on financial
markets is whether the European Central Bank abandons its recent position and decides to accept Greek debt as collateral in its lending operations even if it is downgraded to selective default.
The ECB signaled it would be willing to let
Greece default temporarily as part of a crisis response, according to sources.
S&P defines its "selective default" status as one where the issuer, in this case Greece, has defaulted on a specific issue, but will continue to meet its payments on other obligations. Fitch Ratings has a similar category, "restricted default."
Moody's has said that any private sector involvement that it deems to have an element of compulsion could prompt it to classify the move as a default.
CONTAGION
While a default rating would drive yields on peripheral
bonds sharply higher making it more difficult for countries to raise funds in commercial markets, analysts expect a "selective default" rating to have a more muted effect.
"If it's a selective default, it is a restructuring, and shows you're being pro-active about the mess that Greece is in," said Brian Barry, fixed income analyst at Evolution Securities.
"If they were to let Greece default that would be seen as a more hardline approach, and would have a knock-on effect to other highly indebted sovereigns' ability to fund, particularly in Spain and
Italy."
Analysts also said financial markets were already working with the prospect of some form of restructuring of Greek debt. Indeed 10-year Greek bonds yielded more than 16 percent and Irish and Portuguese bonds yielded in the region of 13 percent each.
Italian and Spanish 10-year bond yields meanwhile last week rose above 6 percent, towards the 7 percent level beyond which funding costs are perceived to be unsustainable.
"(Greece is) already priced for a default or a big restructuring ... so I don't think that will create a lot of contagion for Spanish and Italian bonds. Even the Irish or Portuguese bonds, if you see the level, it already implies some kind of restructuring (for those countries)," Alessandro Giansanti, strategist at ING said.
COLLATERAL
Greek banks currently borrow money from the ECB by using Greek bonds as a safeguard that they will pay back the loans.
If a ratings agency cuts Greece's debt ratings to default or selective default, the ECB has repeatedly said it would refuse to accept Greek bonds as a safeguard in its lending operations, cutting off funding to much of Greece's financial sector.
But in a policy reversal, the bank signalled it was willing to let Greece default temporarily as part of a broader bond swap plan, according to sources.
Under this bond swap, new bonds issued for Greece could be accompanied with collateral provided by other euro zone states, or the EFSF, to ensure Greece can receive funds from the ECB after the ratings agencies declare a short-term default. [ID:nLDE76K0ZB]
If this position materializes, it means Greek banks will continue to have access to ECB funding, limiting the strain on peripheral bond yields and money markets.
"If the final result of the summit is that there is a default but anyone holding the bonds that are rolled over can still use them, that they are still acceptable as collateral, then this is Europe getting ahead of the curve," said John Ventre, portfolio manager at Skandia Investment Group.
"It is saying 'look, we are going to solve the Greek debt issue, introduce measures that help us to help other countries in trouble and yes, there will be some private sector involvement but the capital you get back will still be acceptable'."
MIXED ASSET FUNDS
Any Greek ratings downgrade is not expected to trigger any significant sell-off by mixed asset funds, since many of them would already have dumped Greek holdings as they were reviewed to junk, analysts said.
Out of 2,098 bond and mixed asset funds registered for sale in the UK, 141 have fixed-income investments in Greece, data from Lipper, a Thomson Reuters Unit, showed. Their exposure to Greek debt averages 0.72 percent per fund.
Tactical funds rather than long-term "buy and hold" funds are more likely to be holding Greek debt, according to Tamara Burnell, head of financial and sovereign research at M&G, which runs almost 200 billion pounds in assets. She said she would be "very surprised" if many investment grade funds still held onto it, she said.
"We do not use ratings to invest. We do our own research on anyone we lend money to, and that includes sovereigns," she said.
"But even those investors who do, I think they are really more ratings-sensitive up the ratings spectrum, so a move from A to BB potentially is a very significant one, but a move from CCC to D is going to have far less impact." ($1 = 0.613 sterling