FX.co ★ Fitch Statement on Potential Implications on Greece's Rating of the "vienna" Initiative

Fitch Statement on Potential Implications on Greece's Rating of the "vienna" Initiative

"Fitch Outlines Rating Approach to a Sovereign Debt Exchange," public debate on potential options for a restructuring of Greek (B+/RWN) sovereign debt has progressed, with alternatives to a "traditional" debt exchange being considered to avoid a potential ratings default or credit event.
These alternatives centre on a "Vienna" initiative approach, involving the issuance of new securities to replace existing securities as they reach maturity which would effectively result in a roll-over of existing debt. The agency comments further below on the potential rating implications of the Greek restructuring options being debated by policymakers.
Fitch reiterates that it would view as a Distressed Debt Exchange (DDE) any mechanism that meets two guiding principles as outlined in the agency's 'Coercive Debt Exchange Criteria'. The first is an assessment of the terms of the new securities offered in the exchange and whether they are materially less advantageous to bondholders than the existing securities. The second guiding principle is whether the exchange is, or appears to be, necessary to avoid insolvency and/or illiquidity. Thus a debt exchange or similar mechanism that offers new securities with terms that are - on the whole - worse than the
original contractual terms of the existing debt and where the sovereign is subject to financial distress (which can be reflected in low issuer ratings, or ratings which have seen a sharp downward migration, or both) would be judged by Fitch to constitute a DDE and hence a default event, even if bondholders' participation was deemed to be 'voluntary.'
Fitch's current understanding of the 'Vienna' idea is that it envisages existing securities running to their scheduled maturity, at which time they would be repaid in full by the issue of new securities of the same principal amount with maturities of up to seven years and the same interest rates as the original maturing bonds (ie. below current market rates). There have been suggestions that this would be a voluntary arrangement among certain private sector creditors, with binding pre-commitments being signed as evidence of their intention to participate as their existing bonds mature.
Fitch would likely view such an operation as a DDE in the context of its Coercive Debt Exchange rating criteria. This reflects the agency's view that the substance of such a transaction would amount to a DDE, given that it would likely result in a material reduction in economic terms for the participating bondholders - taking into account various factors including underlying credit fundamentals, maturity and pricing - and that in Fitch's assessment it would be utilised to avoid or postpone the occurrence of a potential default event. The motivation for participation of any bondholders that pre-commit to this operation would not be the primary focus of Fitch's analysis, as this is inherently difficult to judge. Fitch has not currently been asked to review any proposal in this regard and is hence making a number of assumptions about the workings of the structure, but the migration of Fitch's ratings in such a scenario would likely proceed as follows:-
(i) Assuming there is an announcement of the Vienna initiative ahead of the pre-commitment formalities being completed, Fitch would likely downgrade the Greek sovereign Issuer Default Rating (IDR) to 'C' at this time, reflecting an imminent default event, notwithstanding the fact that the affected securities would theoretically be repaid, albeit with a commitment to roll-over the
principal immediately into new securities. The instrument ratings on the affected securities would be downgraded to a low non-investment grade rating - probably in the region of 'CCC' - reflecting Fitch's initial assessment of the post-operation credit profile of the issuer. Existing bonds not covered by the agreement would likely also be downgraded to the same level as the affected securities, assuming no subordination existed between the affected and the unaffected securities.
(ii) On completion of the pre-commitment formalities, Fitch would downgrade Greece's IDR to 'RD' but would leave the instrument ratings on both affected and unaffected bonds at their then existing level (probably in the region of 'CCC' - see (i) above). Fitch would not likely assign a default 'D' rating to the instrument ratings of the affected bonds, reflecting the fact that they will be repaid in line with their original terms, albeit with a commitment to roll-over the principal immediately into new securities. The default event would instead be recorded by the restricted default 'RD' rating assigned to the issuer.
(iii) In this scenario, Fitch would assess the effective date of completion of the transaction as the earlier of: (a) the first maturity of the affected bonds subject to the agreement and their replacement with the new securities (if such date is made public); or (b) 14 days from the date of the announcement that all pre-commitment formalities had been completed. At that time Fitch would move the IDR out of 'RD' and back up to a level commensurate with its forward-looking assessment of the issuer's credit profile, reflecting the risks of future distress and/or a more fundamental restructuring event. The new and existing securities would likely be rated at the same level as the IDR and no further changes would be required purely as a result of each individual bond series reaching maturity and being replaced by new securities.
In the event that a more traditional debt exchange is instead pursued and, in Fitch's opinion, any announced exchange offer does constitute a DDE, the Greek sovereign IDR will be lowered to 'C' indicating that default is highly likely in the near-term. The ratings of the securities subject to the exchange will also be lowered to 'C'.
On the closing of the exchange offer and following confirmation that the exchange will be completed (for example because the minimum threshold for participation has been met), Fitch will place the IDR of the sovereign into default, specifically 'Restricted Default' ('RD'). The ratings of the tendered securities will be lowered to 'D' and will remain at that level for as long as the sovereign is rated 'RD'. The ratings of eligible securities that are not tendered and continue to be serviced will remain at 'C' until the exchange is completed with the issue of new securities.
Finally, Fitch also notes the distinction between a 'credit event' and potential ratings default - whilst the latter relates to actions taken by Fitch or any other credit rating agency, only the ISDA Determination Committee can determine a 'credit event' which triggers credit default swap (CDS) contracts."

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