D is for Default: Greece Warned Rollover Tantamount to Default

The good news is that with the approval of an 8.7 billion euro loan payment Greece will make its debt responsibilities later this month thereby avoiding an outright default. The bad news is that even with this rescue package, the intended debt relief plan may still be considered a default by the ratings agencies.

The European Union – with the tacit approval of the French banking system – has suggested a plan that would see financial institutions “roll over” the repayment of debt owed to many the region’s largest banks. Referred to as “re-profiling” it is hoped that deferring payment will give Greece the breathing room it needs to get its affairs in order without being considered an outright default. It appears however, that at lease one of the ratings agencies is not prepared to go along with the scheme.

Standard & Poor’s advised EU officials that a debt rollover is simply another form of default and would be reflected in a downgrading of Greece’s credit rating. A default designation would also make it impossible for the European Central Bank to accept Greek government debt as collateral essentially banishing the rescue plan to the trash heap.

French Banks Argue in Favor of Deferment

For several weeks talk of deferring payment as an acceptable workaround have gathered in intensity. Last week French banks which collectively hold US$93 billion in Greek debt were the first to agree to a plan that would see much of the debt rolled over. German banks have an estimated US$23 billion invested in Greece, and are less enthusiastic about deferring the payments claiming more information is needed before they can endorse the plan.

Ultimately, the German Banks are expected to come onside but the real issue remains; is a roll over an actual default event? And if it is, will it activate the corresponding credit default swaps?

Credit default swaps are used extensively by large financial institutions as a form of insurance to protect themselves from losses arising from non-payment due to default. The entity buying the swap pays a fee for the protection against a default while the seller assumes the risk in exchange for the fee. If a default does occur, the seller is responsible for paying the full amount of the loan to the buyer.

While rating agencies such as Standard & Poor’s obviously carry weight with respect to lending spreads, it is the determination of the International Swaps & Derivatives Association (ISDA) that determines if a default has taken place for the purposes of triggering credit default swaps. According to a statement from the ISDA’s General Counsel on Monday, a voluntary roll over where banks agree to defer payment, is not likely to result in the paying of default insurance. This would change however, if a haircut in any form were forced on lenders and it is this distinction upon which the ISDA is basing its assessment.

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