Greece downgraded as bailout creates negative investment sentiment

Ratings agency Moody's cut Greece's sovereign debt by three notches today (Monday July 25) to Ca, just one notch above default, saying the new bailout set a negative precedent for creditors of other debt burdened countries.

Euro zone leaders agreed last week to offer Greece debt relief through a new rescue package of easier loan terms, with private creditors shouldering part of the burden via a debt exchange.

The downgrade means Greece now has the lowest rating of any country in the world covered by Moody's, which, like Fitch last week, said it would offer a new rating after the debt swap was completed. Standard & Poor's and Fitch have downgraded Greece to CCC.

‘Once the distressed exchange has been completed, Moody's will reassess Greece's rating to ensure that it reflects the risk associated with the country's new credit profile, including the potential for further debt restructurings,’ it said in a statement.

Last Friday, Fitch Ratings said Greece would be declared in restricted default due to the steps taken in the new euro zone rescue package but that new ratings of a low speculative grade would likely be assigned once the bond exchange is completed.

Moody's said the combination of the announced European Union support programme and debt exchange proposals by major financial institutions implied that private creditors would incur hefty losses on their Greek government debt holdings.

It said that while the overall package carried a number of benefits for Greece, including lower debt-servicing costs and reduced reliance on financial markets for years to come, the impact on its debt burden would be limited.

The rating agency also warned that despite some debt reduction thanks to the new rescue package, the country still faced medium term solvency challenges and significant implementation risks.

‘The announced EU programme along with the Institute of International Finance's statement implies that the probability of a distressed exchange, and hence a default, on Greek government bonds is virtually 100%,’ Moody's said.

The IIF said that the bond exchange deal would help reduce Greece's debt pile by €13.5 billion and by offering a menu of new instruments it aims to attract 90% investor participation in the plan. But Moody's noted that Greece would still have a mountain of debt to service after that.

‘Greece's stock of debt will still be well in excess of 100% of GDP for many years and it will still face very significant implementation risks to fiscal and economic reform,’ it said.

Moody's added that while the rescue package for Greece benefited all euro zone countries by containing near term contagion risks, the deal set a negative precedent.

‘The support package sets a precedent for future restructurings should the finances of another euro area sovereign become as problematic as those of Greece. The impact of Thursday's announcement for creditors of Ireland and Portugal is therefore likely to be credit neutral,’ Moody’s added.

Derivatives body ISDA told Reuters that the IIF's plans for voluntary debt swaps and buybacks to help rescue Greece wouldn't trigger a credit event and payment of CDS contracts, limiting the fallout of any default rating.

One condition for a credit event affecting CDS is that changes in the terms of debt must be binding on all holders, which ISDA said was not the case.