Greece Inches Closer to a Messy Default (Update 1)

Updated to include additional CDS data and information on German vote.

NEW YORK (TheStreet) -- Standard & Poor's has cut the ratings on Greek debt to "selective default" as the European financial crisis continues its roller coaster ride in the markets.

The ratings downgrade comes just a week after the European Union, European Central Bank and International Monetary Fund approved $174 billion in new financing for the struggling county ahead of a March debt maturity. To be seen is whether the ratings cut will trigger a "credit event" payout on credit default swaps tied to the debt of Greece and held by many of Europe's largest banks.

In the bailout agreed on Feb. 21, creditors to Greece would receive a 53.5% haircut on the repayment of their holdings of Greek debt from the EU, ECB and IMF, which will then give Greece $174 billion that -- in tandem with financial reforms -- is expected to help the country lower its debt to GDP ratio to 121% by 2020 from current levels of 160%.

The aid package meant that bondholders would see a 74% cut on the net present value of their Greek holdings and is contingent on 95% of holders participating in the exchange. On Mar. 20, 14 billion euros of Greek bonds mature in a debt repayment may have precipitated a default without the February aid package.

The bonds subject to the exchange have a total face value of roughly 206 billion euros.

However, the deal announced by what's called the "troika" still needs the support bondholders in what's been deemed as "private sector involvement" in their voluntary agreement to receive a diminished repayment on their Greek debt holdings. To that end, a collective action clause (CAC) in the debt exchange offer to bind all bondholders on amended payout terms triggers a debt restructuring, according to a Monday Standard & Poor's opinion.

"In our opinion, Greece's retroactive insertion of CACs materially changes the original terms of the affected debt and constitutes the launch of what we consider to be a distressed debt restructuring. Under our criteria, either condition is grounds for us to lower our sovereign credit rating on Greece to 'SD' and our ratings on the affected debt issues to 'D'," wrote Standard & Poor's.

The next question is whether the debt exchange will create a "credit event" on credit default swaps tied to Greece, formally called the Hellenic Republic. The International Swaps and Derivatives Association a private organization that makes rules for over the counter swaps market hasn't yet said whether the debt exchange constitutes an event of default, which would trigger payouts to holders of protection on Greek bonds.

Banks and asset managers had net CDS exposure of $3.2 billion to Greek obligations as of Feb. 17, according to Bloomberg compilations of data from the Depository Trust & Clearing Corp.