DBRS Downgrades Greece to CC Under Review Negative

DBRS, Inc. has today downgraded the Hellenic Republic’s long-term foreign and local currency issuer ratings to CC from CCC (high), and placed the ratings Under Review with Negative Implications. The short-term foreign and local currency issuer ratings are confirmed at R-5 with a Stable trend.

The downgrade was prompted by the recent breakdown in negotiations between Greece and its creditors over the terms of a financial support program that could ease Greece’s acute liquidity crisis. In the absence of financial support with near unconditional terms, DBRS views a Greek departure from the Eurozone and default on private sector debt as increasingly probable. If Greece and its creditors agree on financial support that guarantees Greece’s financing needs in the context of a stabilization program, DBRS would likely remove the ratings from Under Review with Negative Implications. Alternatively, if Greece misses a payment on Treasury bills or bonded debt held by the private sector, or enters a distressed exchange, DBRS would assign a D (default) or an SD (selective default) to the long-term or short-term ratings.

Instead of continuing negotiations with its creditors on the terms of a financial support program, Prime Minister Alexis Tsipras called a referendum, to be held on July 5. This brought the negotiations to a standstill. The question to be posed in the referendum is whether Greeks support the creditors’ June 25 proposal for a staff level agreement. This proved to be problematic for the negotiations because the referendum is to take place after the June 30 expiration of the existing EU adjustment program. The referendum announcement also caught the creditors by surprise, suggesting that the two sides remain far apart in their respective positions. Prime Minister Tsipras appears to be willing to risk a departure of Greece from the Eurozone – which would likely be accompanied by a default on debt held by the private sector. The government is advising the public to vote ‘no’.

The second reason for the downgrade is that following the announcement of the referendum, the European Central Bank Governing Council announced, on June 27, that instead of raising the ceiling for the provision of emergency liquidity assistance (ELA) to Greek banks, it would maintain it at the level existing on June 26. In the presence of a run on Greek bank deposits, the ECB decision not to increase ELA forced the Greek government to declare a bank holiday from June 29 to July 7, and to impose withdrawal limits on deposits and controls on transfers abroad. The government also closed the stock market to reduce financial market volatility. The restrictions on bank transactions may delay pension payments, increase financial arrears to government suppliers, and have a severe negative knock-on effect on the real economy, the fiscal stance and the trajectory of public debt to GDP.

In the absence of a program, and lacking access to capital markets, financing sources available to the central government appear to be insufficient to meet its financing needs. Indeed, on June 30 Greece went into arrears on a loan repayment to the IMF of €1.6 billion. Unless new sources of financing materialize in the near term, DBRS expects Greece to miss additional payments. DBRS does not classify going into arrears on an official sector loan from institutions such as the IMF, the ECB or the European Financial Stability Facility (EFSF) as a default. Nor do we expect the missed IMF payment to trigger an acceleration of payments on EFSF loans to Greece. However, missing a payment signals a further deterioration in credit quality.

The results of the July 5 referendum will also be relevant for our ratings. If the majority of Greeks vote ‘no’, it will be viewed as a rejection of the creditors’ proposal, as well as a signal that Greece is no longer willing to remain in the Eurozone. Such an outcome would likely shut Greece off from official sector financing indefinitely, and force the government to print IOUs in order to pay public sector wages and pensions. The widening circulation of IOUs would likely precipitate an end to euro membership and a default on bonds held by the private sector. Specifically, on July 8 Greece plans to sell 26-week Treasury bills, on July 10 Greece must refinance €2 billion in Treasury bills, on July 14 it owes €85 million on a Japanese samurai bond, and on July 17 it owes €72 million in interest payments on a three-year bond.

A ‘yes’ vote would likely be viewed as a decision to remain in the Eurozone. However, even with a clear vote of support for the EU proposal, the challenges of remaining in the Eurozone would be formidable. The existing support program expired on June 30, and the missed payment to the IMF means that Greece can only receive new IMF financing once the arrears are cleared. Therefore, the July 5 referendum would already be somewhat discredited, and a new support program would need to be negotiated. If Greece and its creditors agreed to a new program, it would take time before confidence returned to the point that Greece could remove the restrictions on bank transactions. Meanwhile, the effect of the restrictions on real economic activity would be increasingly severe, and the printing of IOUs would become a necessity. Furthermore, whether Prime Minister Tsipras or the current Syriza-led coalition would survive a referendum is unclear. If new elections were held, this would take several weeks at the least.

As specified in EU Regulation 462/2009, amending Regulation 1060/2009 on credit rating agencies, DBRS’s ratings on Greece are subject to 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 December 19, 2014). Under Article 8a, a 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 pre-established calendar date for publication of our ratings on Greece is December 11, 2015. This review deviates from the calendar because of the recent breakdown in negotiations between Greece and its creditors.

Notes:
The main points discussed during the rating committee were the events since our last rating committee on June 12 that led to the decision to downgrade the ratings. These were: (1) the different proposals in the negotiations between Greece and its creditors, (2) the referendum and the possible outcomes of a ‘yes’ and ‘no’ vote, (3) the importance of Eurosystem support for Greek banks, (4) the effect of capital controls, and (5) the effect of these developments on the real economy, the fiscal stance and the trajectory of public sector debt to GDP. The committee also discussed the probability of an exit of Greece from the Eurozone, and the probability of default on official sector and private sector debt. The committee concluded that the risk of a Greek exit from the Eurozone, and a default on private sector debt, had significantly increased since the June 12 rating committee.

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, Public Debt Management Agency, Bank of Greece, ECB, European Commission, EFSF, ESM, 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: Alan G. Reid
Initial Rating Date: 16 August 2013
Most Recent Rating Update: 12 June 2015

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