Credit-ratings agency Standard & Poor's says it will regard any attempt by European Union to renegotiate debt as a default
The ratings agency Standard & Poor's (S&P) promised on Friday to take a tough line if the European Union attempts to disguise a default by Greece on its debts to save French and German banks from suffering losses.
The warning comes ahead of an announcement by Jean-Claude Juncker, head of the Euro Group finance ministers, that Athens will receive its next €12bn (£10.6bn) of bailout funds after an agreement for further spending cuts and a faster programme of state asset sell-offs.
However, the Greek prime minister, George Papandreou, is facing mounting domestic opposition to further austerity and has lobbied for concessions that include some forgiveness on loans made to Greece by EU banks.
There are several ways that Athens could ease its debt burden by renegotiating some of its $280bn (£170bn) of outstanding bank loans. Under one plan, the debts could be "re-profiled", which would allow Greece to repay debts over a longer period or at lower rates of interest. A voluntary exchange of debt would mean swapping existing loans for new ones with different terms.
Each would reduce the pace of repayments and cut the total amount of loans, giving Athens an easier time until 2013 when the EU expects to have an all-embracing package of loans for Greece, Ireland and Portugal.
S&P warned that the re-profiling of loans would almost certainly be considered a default and lead to a further downgrading of Greece's debt. "Such a lengthening of maturities would constitute a default under our criteria because the sovereign debtor will pay less than under the original terms of the obligation," it said.
A further downgrade would increase Greece's already sky-high borrowing costs. The yields on 10-year bonds are already in excess of 16%.
S&P said that testing the effect of a voluntary exchange would be a tougher challenge but any hint of the word voluntary being used to disguise an imposed cut in loan valuations would also trigger a default notice from the ratings agency and a subsequent downgrade.
Jim Reid, a credit strategist at Deutsche Bank, warned that a technical downgrade was unlikely to stop the EU going ahead with a restructuring of Greece's loan book. He said that EU banks could maintain the nominal value of the loans on their balance sheets despite the view of S&P and other ratings agencies that the loans were worth less after the restructuring.
He said the banks and the EU would disguise the real effect of the restructuring. Without a material cut in loan values, hedging instruments, known as credit default swaps (CDS), can remain untouched. CDSs act as a form of insurance against a bond default by a company or country.
Reid said: "The most important thing is whether a restructuring of Greek debt constitutes a credit default swap trigger. Among the biggest buyers of CDSs are Greek banks as well as French and German ones. So the authorities are not going to let a downgrade hit them, even if S&P goes ahead. The deal will be crafted so the values of the loans remains at par, which means there won't be a CDS trigger."
A cut of 20% in the value of Greek loans would leave some French banks facing losses of about $17bn. Without an injection of investor funds or a rescue package by the Paris administration, they in turn would default.