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Credit FAQ: When Would A "Reprofiling" Of Sovereign Debt Constitute A Default?

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Policy discussions aimed at resolving the debt crises of certain countries on the periphery of the eurozone have been taking place for some time now. However, these discussions have taken a new turn in recent weeks as some European politicians have begun speaking more openly about solutions that might include a "soft" restructuring, rescheduling, or "reprofiling" of bonded eurozone government debt. While these terms are sometimes used loosely or even interchangeably, we've seen a sharp rise in market participants' interest in understanding whether, under Standard & Poor's published criteria, such a restructuring could amount to a default, with the consequence that Standard & Poor's might lower the relevant sovereign's issuer credit rating to "selective default" (SD).

A Standard & Poor's sovereign credit rating does not speak to the advisability from a policy perspective of sovereign debt restructuring. Rather, a Standard & Poor's sovereign credit rating provides a forward-looking opinion on the likelihood of default. In arriving at our credit opinion we analyze historical default data to the extent we believe it informs our forward-looking analysis of a sovereign's creditworthiness.

How does S&P define a sovereign default?

We generally define a sovereign default as the failure to meet interest or principal payments on the due date, or within the specified grace period, contained in the original terms of the rated obligation when issued. This definition generally includes exchange offers of new debt with less favorable terms than those of the original issue without what we view to be adequate offsetting compensation. "Less favorable terms" may include, for example, reduced principal amount, extended maturities, lower coupon, different currency of payment, or effective subordination.

Under Standard & Poor's criteria, a discrepancy between the terms of a sovereign's exchange offer and the original terms of the rated obligation--even if not necessarily significant--may be viewed as a de facto restructuring. In such circumstances, we may lower the rating on the obligation to 'D' (default), even if only a portion of the rated bonds is subject to the exchange offer. We would furthermore lower the sovereign's issuer credit rating to 'SD' (selective default) in such cases, indicating that the sovereign is proposing to pay less than what it had originally undertaken.

Rated obligations on which the sovereign is still making full and prompt payment are generally not affected by an exchange offer for another issuance, although we might lower the rating on the still-performing obligations if we concluded that the likelihood of a default had also increased for securities not (yet) restructured. However, under our criteria if an exchange offer so closely resembles to us the terms of the original obligation that it is hard to discern any shortfall, we would likely not characterize such an offer as a default.

Would a "reprofiling" also constitute a default?

The term "reprofiling" has no clearly defined meaning but in the context of sovereigns we understand it generally to mean an extension of maturities in order to allay concerns regarding the encumbered short-term liquidity situation of the issuer. 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.

Would a "voluntary exchange" of securities constitute a default?

Many sovereigns engage frequently in regular, voluntary, and market-based exchanges or buybacks of their own debt obligations. These voluntary exchanges are usually conducted in the context of conventional treasury management to provide liquidity in certain secondary market segments. These opportunistic transactions usually involve relatively small portions of the outstanding debt obligation. To the extent the terms of the exchanged obligations are honored, these voluntary exchanges do not constitute defaults under our criteria.

In contrast, we would likely analyze in a different light an exchange offer that we view as having the objective of materially changing the size and/or profile of the debt burden of a sovereign in financial distress. In situations where investors consider a default to be possible and where the rating has fallen, it becomes more difficult to conclude that investors are exchanging securities voluntarily. For example, while an exchange offer for longer-dated bonds may appear to be "voluntary", we may conclude that investors have been pressured into accepting because they fear more-adverse consequences were they to decline the exchange offer. In such a "distressed" exchange, holders accept less than the original promise because of the risk that the issuer will otherwise fail to meet its original obligations.

In establishing whether to view an exchange offer as "distressed", Standard & Poor's will evaluate whether, apart from the offer, we believe there is a realistic possibility of a conventional default (that is, of a payment default) on the obligation subject to the exchange, over the near to medium term. The existing issuer credit ratings, as well as rating outlooks or CreditWatch listings, can serve as proxies for that assessment. For example, we consider the following guidelines, in addition to other information, which are set out in our "General Criteria: Rating Implications Of Exchange Offers And Similar Restructurings, Update," published May 12, 2009:

  • If the issuer credit rating is 'B-' or lower, we would ordinarily view the exchange as distressed and, hence, as a de facto restructuring.
  • If the issuer credit rating is 'BB-' or higher, we would ordinarily not characterize the exchange as a de facto restructuring.
  • If the issuer credit rating is 'B+' or 'B', we would analyze market prices and other cues in determining whether an exchange is distressed.

In our view, trading prices of the securities under offer and/or the offering prices can also provide insight about the nature of the exchange offer. For example, prior to the exchange offer, an investor could have sold the to-be-exchanged, soon-maturing security in the secondary market and purchased a longer-maturity obligation similar to the new security offered in the context of the exchange offer. Had the investor been able, relatively close to the exchange date, to purchase more long-dated paper in the market-based transaction than he would receive in the exchange offer, we would, other things being equal, likely consider the exchange as "distressed".

Extracted from http://img.en25.com/Web/StandardandPoors/2011-06-03_CreditFAQ_Reprofiling_SovDebt_Default.pdf

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