Fitch: Prolonged Greece Deal Talks Heighten Key Risks

The continuing talks between the Greek government and the country's official creditors are testament to the political will to secure an agreement, but the time-consuming and often confrontational nature of the discussions heightens key risks to the credit profile of the Greek sovereign and its banks, Fitch Ratings says.

Thursday's Eurogroup meeting ended without an agreement, and another meeting will be held on Saturday. A deal would alleviate near-term risk of an uncontrolled Greek default and possible eurozone exit, but would come just days before the expiry of Greece's existing programme on 30 June.

Translating an initial agreement into a formal deal - and another programme extension - would require the approval of the Greek and some other eurozone parliaments (notably the German Bundestag), as well as rapid legislation of reforms by the Greek government. Elements in Syriza and its junior coalition partner have voiced their opposition to parts of this week's proposals, for example on pensions, VAT changes, and public sector wages. A Greek government split, a referendum on any proposed deal, or early elections, could further delay disbursements.

The lack of a deal to date has increased the risk that Greece fails to make its bundled IMF payments on 30 June, and the risk of capital controls. Fitch's sovereign ratings reflect the risk of default to private rather than official sector creditors, so missing the IMF payment would not constitute a sovereign ratings default, but it would be credit negative. Arrears to the IMF by a high-income economy are unprecedented and would indicate extreme liquidity stress.

Implications for Greece's sovereign rating would depend on the country's ability and willingness to cure the missed IMF payment, and the institutions' response. For example, if an outline deal were agreed or appeared imminent, it is possible that the European Central Bank would maintain Emergency Liquidity Assistance (ELA) to Greece's banks. Without ELA, Fitch believes capital controls would likely be imposed.

Even assuming a deal is struck, it is unlikely that Greece would regain market access by the end of an extended second programme. The struggle to agree tax and pension reforms, the heated rhetoric that has at times accompanied this week's discussions, and popular opposition to austerity in Greece, suggest that negotiating a third programme (or equivalent) will be challenging, with recurrent risks of a loss of trust between Greece and its official creditors.

Prolonged uncertainty has done lasting damage to the Greek economy. The hit to investor, consumer, and depositor confidence could push the economy from stagnation to contraction (we forecast no growth this year).

We believe the financial standing of Greek banks has deteriorated further during 2Q15 and anticipate that end-June financial statements will show negative trends in asset quality, liquidity and most key financial ratios. Funding and liquidity profiles will have worsened considerably due to deposit withdrawals, and the banking system is completely dependent on continued ELA.

The Bank of Greece reported EUR38bn of sector deposit withdrawals between end-November 2014 and end-May 2015, and withdrawals have escalated. Press reports indicated that they hit daily highs of EUR1bn-EUR2bn at times in the last fortnight. ELA is the sole source of new funding for the banks. Concentration and dependency risks for the banks are high, and any move by the ECB to cancel or limit ELA use could force the banks to place limitations on deposit withdrawals. We would likely view this as a restricted default by the banks. We expect to see a spike in impaired loans at end-June as borrowers, both retail and corporate, may have withheld loan repayments as they await news on sovereign negotiations.

Our 'CCC' Greek sovereign Long-Term Issuer Default rating indicates that default on privately held sovereign bonds is a real possibility. Similarly our 'CCC' Greek bank IDRs and our 'ccc' Viability Ratings reflect pressures on funding and liquidity, and material risk to asset quality and solvency, and our view that failure risk at these banks is a real possibility.