What Impact Will Greek Troubles Have on Corporate Bonds?
Corporate credit spreads may widen out a bit in the near term, but Greece's troubles should not lead to a systemic financial crisis, says Morningstar's Dave Sekera.
Dave Sekera: The four-year-running Greek debt tragedy is rapidly nearing its end. The negotiations to refinance Greece's bailout financing have broken down, and Greece's prime minister has called for a national referendum. The intent of this referendum is to ask voters whether the country should accept the EU's conditions to extend further financing. As a result, Greece was unable to meet its debt payment due at the end of June, and the ECB will not increase the size of its emergency lending-assistance program. As a result, Greece has shut down its banking system for six days until July 6.
While this will certainly negatively impact Greek citizens and cast a shadow over Europe's struggle to stimulate stronger economic growth in the eurozone, we do not think a Greek default and possible exit from the eurozone will significantly impact credit spreads in the corporate bond markets.
When the Greek debt crisis first emerged several years ago, the situation was much different. The economies of several peripheral eurozone countries were in perilous conditions and the banking systems within those countries were experiencing large and growing nonperforming loans. Greek debt was widely held across numerous banks in Europe, and analysts were concerned that losses incurred from a Greek default at that time could lead to insolvency among those banks. As corporate credit spreads widened out to account for increasing default risk, the banking system began to reduce lending between banks due to jump-to-default concerns among credit counterparties. As default risk increased in the banking system, sovereign credit spreads on the peripheral countries rose as investors priced in the risk that the countries would need to raise debt to bail out their banking systems. Similar to the contagion in the U.S. during the 2008-09 credit crisis, this process fed upon itself and continuously pushed corporate credit spreads wider. This lasted until ECB President Draghi gave his famous "whatever it takes" remarks to support the eurozone.
What's different now is that real GDP in the eurozone has been expanding, albeit at a very modest pace, and the banking system has been able to shore up its capital levels. In addition, 75% to 80% of Greece's debt is now owed to official creditors such as the IMF, ECB, EU, and other financial-bailout vehicles. If, in default, Greece does reduce the principal value of its outstanding debt, the amount of losses that will be absorbed by the banking system will be pretty low. It will be the taxpayers in the EU who will indirectly absorb the impact of those losses. In addition, the ECB is only three months into its asset-purchase program, which is providing additional liquidity into the banking system, and the ECB had created the European Stability Mechanism in 2012 to handle such situations. As such, while we might see corporate credit spreads widen out in the near term, credit spreads should not widen significantly, as this event will not lead to fears of a systemic financial crisis.