S&P Declared Default on Greece

More than half of debt is to be written off on bond swap deal in second European Union bailout

February 28, 2012

Ratings agency Standard & Poor's (S&P's) on Monday downgraded Greece's long-term credit rating to selective default from already junk-level CC grade. It is a result of a more than half of Greek debt write-off deal with private creditors that is an integral part of a second EU bailout of the country. Once the swap deal is carried out next month, the agencies are expected to upgrade Greece.

Greece became the first Euro-zone country officially to be rated in default, 13 years after the single European currency was adopted to strengthen the European Union.

S&P’s had said this month that it would consider Greece in default if it added "collective-action" clauses to its sovereign debt, effectively forcing all bondholders to accept a bond-swap offering. Greece has been seeking to avoid an outright default on its massive debt by negotiating a "voluntary" debt exchange with creditors.

The rating firm says their move was triggered by the terms Greece put in the tentative deal agreed last Tuesday, which amounts to a 53.5 percent write-down. Following the February 21 debt deal, Greece amends its sovereign bond documentation with collective action clauses (CACs). 

A CAC binds all bondholders of a certain series to amended payment terms in the event that a certain quorum of creditors has agreed to the terms, S&P explained. If a large majority of creditors accept the new terms then all the creditors need to agree, which would have consequences for bondholders. 

Greece's retroactive insertion of CACs materially changes the original terms of the affected debt and constitutes the launch of what is considered to be a distressed debt restructuring. The retroactive insertion of CACs will diminish bondholders' bargaining power in an upcoming debt exchange, according to S&P.

The European Union agreed to provide Greece with 130 billion in new financing in the 237 billion Euro ($320 billion) bailout deal last Tuesday. Meanwhile representatives of private investors, mostly banks, agreed to write off 107 billion euros worth of Greek debt via a bond swap. The bond swap was launched on Friday, and is scheduled to be completed about next month on March 12. 

The government hopes that almost all of its private creditors will sign up to the bond swap deal, allowing Greece to impose the collective action clause to force hold-outs to accept the swap and losses as well. 

Under the Greek legislation approved Thursday, the debt exchange becomes binding for bonds governed by Greek law "if at least two thirds by face amount of a quorum of these bonds... approve the proposed amendments." 

At issue is whether the debt swap can be deemed 'voluntary' if just two-thirds of creditors sign up. If it cannot be classed as voluntary, then creditors could invoke their credit default swaps -- insurance claims against investment losses on the bonds -- which would not only lead to heavy costs for the counterparties of the swaps, but could also possibly cause the entire Greek debt deal to unravel.