Moody’s rating upgrade ‘positive’ for structured finance transactions

Moody’s Investors Service upgraded Greece’s government bond rating by two notches to Caa1 from Caa3 last Friday on the expectation of an i mprovement in the country’s economic outlook, the significant improvement in Greece’s fiscal position over the past year and the government’s reduced interest burden and lengthened maturities of the debt triggered the positive rating action.

The rating agency also raised Greece’s local and foreign currency bond and deposit ceilings to Ba3 from B3 to reflect the country’s reduced economic, legal and political risks.

Consequently, the maximum achievable rating for Greek structured finance rated transactions increased to Ba3(sf) from B3(sf).

Moody’s said it is assessing the impact of the government bond rating action and the corresponding increase in the local-currency country ceiling on all outstanding Greek structured finance rated transactions. For this purpose, the rating agency said it also considers (i) the performance of the underlying asset portfolios in line with Moody’s collateral assumptions and (ii) the counterparty risks imbedded in the transactions, including servicers, account banks and swap counterparties exposures, in accordance with Moody’s methodologies.

In it’s rating upgrade, Moody’s said the the first factor is the expectation that the general government debt to GDP ratio will start declining in 2015, after peaking this year to around 179% of GDP. The rating agency said it expects the government will reach its primary surplus Troika target of around 1.6% of GDP this year and that the headline budget deficit will decline to 2.9% in 2014. Last year, the government registered its first primary surplus since 2002, one year before it was scheduled to do so, and was able to deliver it in a decelerating economic growth environment. The budget deficit shrank to 3.2% (under the Troika support programme definition) and 12.7% of GDP according to Eurostat’s definition (which includes bank recapitalisation costs, among other items).

Moreover, future budget targets and debt reduction could fall to around 166% of GDP by 2018.

The second factor supporting the upgrade is greater certainty regarding the prospect of continued improvements in the fiscal and debt trends offered by Greece’s improving economic environment, with the recovery showing signs of broadening from net exports to domestic demand. Investment continued to decline, but at a much lower rate (7.9%), supported by the absorption of EU funds, especially following the restart of large infrastructure projects.

While Greece’s ambitious structural reform agenda has had mixed results to date, the Government has made good progress on labour market reforms and in liberalising some areas of the product markets. These reforms have led to wage and price adjustments, which far outstrip adjustments elsewhere in the euro area periphery, the rating agency said.

Moreover, the government recently passed legislation that should help the country’s medium-term growth outlook, because it will further deregulate the food processing, retail, building materials and tourism sectors. Based on these trends and high frequency data, Moody’s forecasts real GDP growth of +0.4% in 2014 and +1.2% in 2015.

The third driver of the upgrade decision is that the predominantly official creditor structure of the government debt has allowed the reduction of the government’s interest burden and lengthened maturities following previous private-sector debt restructurings and official sector assistance.

The creditor structure, where 82% of general government debt is held by the official sector (mainly the IMF, EC, ECB and other euro area governments), and the debt profile that has evolved in consequence, adds to the government’s fiscal flexibility and reduces refinancing risks.

Moody’s considers that Greece’s fiscal outlook is more resilient than in the past, given the improvement in the debt affordability (interest expenses-to-revenues) to 10.1% in 2014 from 17.0% in 2011.

At 4% of GDP in 2013, interest-to-GDP is also in line with the euro area average. Greece’s debt-maturity profile has also been lengthened to around 18 years in 2014, up from around 6.5 years in 2011.

Negative factors include the high level of political uncertainty with a high probability of early parliamentary elections by Q1 2015, prompted by (1) the eroding majority of the coalition government; and (2) the constitutional rules surrounding the Presidential appointment, which is due by February 2015.

This uncertainty is heightened by the ambiguity associated with the end of European Commission and IMF programmes in December 2014 and Q1 2016, respectively.

Important decisions will be made over the coming months related to the financing of the government’s funding needs for 2015, the shape of the structural adjustment programme post 2016 and the structure of further officialsector debt relief.

Moody’s base case is that external support will still be forthcoming in some form; however, the rating agency believes that the primary surplus targets under the current Troika programme are ambitious and would prove demanding in the current social and political environment. Consequently, Moody’s expects that the forthcoming negotiations with the official creditors will be challenging and the risk that these tensions imply for creditors are incorporated in the current rating level.

These credit challenges include an ambitious structural adjustment programme; a very high level of public debt and a banking system that has high levels of non-performing loans (NPLs) and is unsupportive to economic growth; a track record of default; and a challenging political and social environment, which complicates the implementation of structural reforms.