DBRS Downgrades Greece to CCC (high) Negative Trend

DBRS, Inc. has today downgraded the Hellenic Republic’s long-term foreign and local currency issuer ratings to CCC (high) with a Negative trend from B, and downgraded the short-term foreign and local currency issuer ratings to R-5 with a Stable trend from R-4. The ratings are no longer Under Review with Negative Implications.

As defined in EU Regulation 462/2009, amending Regulation 1060/2009 on credit rating agencies, DBRS’s ratings on Greece are subject to certain publication restrictions, as set out in Article 8a of the Regulation, including publication in accordance with a pre-established calendar. (See "2015 Planned Publication Calendar for EU Sovereign Rating Reports,” which DBRS published on 19 December 2014). Under Article 8a, deviation of the publication of sovereign ratings from the calendar must be accompanied by a detailed explanation of the reasons for the deviation. The next scheduled publication date for our ratings on Greece is 12 June 2015.

The deviation of this review from the calendar is due to an increase in uncertainty over government policies and Greece’s capacity to remain current on its debt. DBRS placed the ratings Under Review on 4 February 2015 to reflect DBRS’s elevated concern over the potential for a deterioration in Greece’s creditworthiness as a result of actions by the Greek government following the general elections on 25 January 2015. In light of the change in government, and given the importance of financial assistance from the European Commission, European Central Bank and International Monetary Fund, DBRS’s concern over Greece’s ability to meet its financing needs had increased.

The current downgrade is due to a further increase in uncertainty over whether Greece and its creditors will reach an agreement on a program that restores macroeconomic stability and improves Greece’s cash position. In the absence of an agreement, financing sources appear to be insufficient to meet Greece’s financing needs over the foreseeable future. This shortfall is due to the lack of access to bond markets, as well as a delay in an agreement between Greece and its official sector creditors over the conditions that the creditors require in exchange for continuing the existing financial assistance program, or entering a new longer term lending program. DBRS’s view is that a new longer term program is likely to be necessary to restore macroeconomic stabilization. The delay in an agreement has had an adverse impact on the economic recovery, on financial stability, and on the fiscal stance.

The Negative trend reflects the risk of a missed payment to official creditors, or the further buildup of arrears to domestic agents. In the coming weeks Greece faces a series of payments to the IMF and the ECB. DBRS’s view is that a default to these official sector creditors would likely cause an acceleration in the withdrawal of deposits from Greek banks, and would further undermine growth prospects. This is turn would make it more difficult for Greece to generate primary fiscal surpluses. Such a default could also jeopardize ECB Emergency Liquidity Assistance (ELA), without which Greek banks could face lower liquidity buffers and run the risk of insolvency.

Downward pressure on the ratings would likely result if an agreement is not reached, or if the ECB ceases to provide liquidity support to Greek banks. Alternatively, DBRS could move the trend to Stable if Greece and its creditors agree on a financial assistance program that restores liquidity and bolsters macroeconomic stability. This in turn would likely stabilize bank deposits, improve fiscal sustainability and foster economic growth.

The existing financial assistance program, the second Economic Adjustment Program, was extended to 30 June 2015. If Greece meets the conditions of the program it would be eligible for a final tranche of €7.2 billion. This would help Greece’s cash position, but would be unlikely to remove uncertainty over future payments. As part of the existing program, the ECB and Single Supervisory Mechanism (SSM) could request from the European Financial Stability Facility (EFSF) an additional €10.9 billion, originally transferred to the Hellenic Financial Stability Fund (HFSF) in the form of EFSF bonds and subsequently returned to the EFSF, to be transferred back to the HFSF for the recapitalization and resolution of Greek banks, if necessary.

The policy conditionality of the existing program’s Memorandum of Understanding is threefold: to restore competitiveness and growth, fiscal sustainability, and financial stability. The current negotiations appear to be focused on two technical issues in the labor market and the social security system. Excessive restrictions in the Greek labor market maintain a high cost of doing business, and inhibit the establishment or expansion of large firms. Collective dismissals of workers are not allowed, and this forces firms to offer high severance packages or resort to bankruptcy. The second issue is over reducing social security contribution rates, eliminating loopholes, better targeting lower-end contributions to reduce the cost of doing business for firms and strengthen labor demand, and strengthening the pension system by improving efficiency, achieving actuarial balance over the coming decades, ensuring consistency with fiscal targets, and making other parametric improvements.

The Greek negotiators have allegedly agreed to harmonize value-added tax rates, improve tax collection, and privatize a number of state-owned entities. However, they have not agreed to make further changes to the labor market or social security system. The impact of the delay in an agreement has been a liquidity squeeze, deposit outflows from Greek banks, a setback in the economic recovery, and a slowdown in the fiscal adjustment. From July 2014 to March 2015, deposits declined by €33.7 billion, and are at their lowest level since September 2005. If deposit outflows continue, this could jeopardize financial stability and further lower prospects for economic growth, lead to a larger primary fiscal deficit, and impair debt sustainability.

For the remainder of 2015, Greece’s obligations are mainly in the form of principal and interest charges on IMF loans, principal and interest payments on bonds held mainly by the Eurosystem (the ECB and national central banks within the euro area), and interest payments on bilateral loans to Greece under the Greek Loan Facility (GLF). At the same time, Treasury bill redemptions and monthly public sector wages and pensions are sizeable. There are also minimal principal and interest payments on restructured bonds held by the private sector. The central government has also slipped into arrears with suppliers of goods and services to the public sector. To improve its cash position, the central government passed a decree on 20 April 2015 requiring local governments, state-owned companies and public pension funds to transfer their cash reserves to the Bank of Greece.

In the absence of an agreement with its creditors, DBRS’s view is that Greece’s cash position would fall short of that needed to meet its obligations. Although DBRS does not classify as a default a missed payment on any obligations other than the bonded debt held by the private sector, a missed payment to the IMF or ECB could nonetheless lead to further deposit outflows. This in turn could lead to government-imposed capital controls, or a cap on ELA.

Notes:
A rating committee was held on 13 November 2015. The following issues were discussed: options available to the Greek government; the possibility of an accident whereby Greece missed a payment to one of its creditors, assigns capital controls, prints a parallel currency, or exits the Euro area. The possibility of a referendum was also discussed. Much of the discussion focused on the possibility for an agreement between Greece and its official sector creditors, and the liquidity constraints Greece is facing.

All figures are in Euros unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

The sources of information used for this rating include Ministry of Finance, Bank of Greece, European Commission, EFSF, ESM, European Central Bank, Eurostat, OECD, BIS, IMF, Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Fergus McCormick
Rating Committee Chair: Roger Lister
Initial Rating Date: 16 August 2013
Most Recent Rating Update: 4 February 2015

For additional information on this rating, please refer to the linking document under Related Research.