Grexit what if? Don t expect any solution before the summer crunch time

Investment Research General Market Conditions 22 April 2015 Grexit what if? Don t expect any solution before the summer crunch time Main scenario: Greece remains in the euro We still expect Greece will remain in the euro although the intensified chicken game between Greece and its creditors has implied an increasing risk of Grexit. The current situation with prevailing harsh negotiations was unavoidable, in our view. The Greek government needs to show that it fights until the very end seeking an easing of the Greek programme conditions. We have been in this situation before with Greece normally blinking eventually. This was also the case under the most recent stand-off in February. The reaction function reflects that 82% of the Greeks still want to remain in the euro, while Tsipras at the same time has promised his electorate more favourable conditions. Higher Grexit risk but no euro break-up risk Key dates 11 May: Eurogroup meeting 12 May: EUR0.8bn IMF repayment 18 June: Eurogroup meeting 22 June: EU Summit Ult. June: End of current bailout prg. 20 July: EUR3.5bn ECB repayment 20 Aug.: EUR3.2bn ECB repayment What could trigger a Greek default and a Grexit? Greece is close to running out of money as the last EUR7.2bn tranche has not been released, as the government has not come up with the comprehensive economic reforms required under the current bail-out programme. Both Greece and its creditors repeatedly state that neither favours a Grexit. However, it could still happen. A continuation of the ongoing chicken game could result in a Greek incident, ending with Greece leaving the euro ( Grexident ). But a Greek default will not necessarily imply a Grexit. Greece has already been through an orderly default with the PSI in February 2012 and is to this day still a member of the euro. In this paper, we consider the implications of what if. Greek 2015 payments schedule help needed to meet summer payments 9 EUR bn 8 7 6 5 Payment to the ECB not likely without furhter assistance *20 Jul 3.5bn *20 Aug 3.2bn T-bills will be rolled - but not increased 4 3 2 1 0 May Jun Jul Aug Sep Oct Nov Dec IMF loan Eurosystem bonds GGB coupons T-bill Senior Analyst Pernille Bomholdt Nielsen +45 45 13 20 21 perni@danskebank.dk Analyst Anders Vestergård Fischer +45 45 13 66 41 afis@danskebank.dk Source: IMF, ECB, Bloomberg, Danske Bank Markets Senior Analyst Anders Møller Lumholtz +45 45 12 84 98 andjrg@danskebank.dk Important disclosures and certifications are contained from page 6 of this report. www.danskeresearch.com

What are the first steps in a Grexit? If Greece continues to refuse the austerity requirements on pension reforms, labour market, tax etc, Greece could simply run out of money. In this case, Greece would initially be in a liquidity crisis, which would transform into a full-blown banking and currency crisis: Greece would miss a debt obligation triggering a credit event where the ECB removes the Emergency Liquidity Assestance (ELA). The Greek banking sector would be insolvent and the removal of liquidity access implies that the initial bank run would be replaced by capital control, preventing capital from leaving the banking system and the country. The next step is then likely to be the introductions of the New Drachmar. When is the risk of a Grexit highest? The risk of a Grexit increases as we approach summer. Greece has two large repayments (SMP holdings) to the ECB totalling EUR6.7bn. Ahead of this, Greece must repay EUR3bn to the IMF with EUR772mn due 12 May. Following Greece s latest decree on mandatory transfer of cash balances of local government entities to the central bank (see Reuters), the needs should be covered through end May. Would a Grexit result in a euro break-up? No, a Grexit would NOT result in a euro break-up. The euro area is in a much better shape to deal with a Grexit compared to both 2010 and 2012. Greek public debt has been transferred from the private to the public sector, and the other peripheral countries current account and fiscal deficits have been reduced significantly while the growth outlook is improving. But such a scenario would clearly be unchartered territory and just the fact that it has been compared with the Lehman situation in 2008 (i.e. deemed OK to fail ) implies that risky assets are set to be under pressure. Much less contagion today than in 2012... but periphery market has reacted to recent Greek turmoil Source: Bloomberg, Macrobond and Danske Bank Source: Bloomberg, Macrobond and Danske Bank How would other euro leaders respond to a Grexit? The Eurogroup would clearly signal that the coalition is even stronger without Greece. The heads of states and governments are likely to gather and jointly present the unity. Note, that Irish and Portuguese finance ministers have been among the hardliners when it comes to Greece. Public opinion in these countries does not seem in favour of granting Greece additional help. The risk of who s next is no longer a real market scare. But what about Spain and the positive sentiment towards Podemos? Compared to Greece, the pressure on Spain is very limited as it has implemented economic reforms, the economy is recovering and the unemployment rate is declining. 2 22 April 2015 www.danskeresearch.com

The risk of anti-establishment parties like Podemos gaining power is creating attention, however. But Podemos s popularity has faded in 2015 and it does not look to be the largest party. However, it will be seated in the parliament and it will affect negotiations. What about the longer term when a new country is in trouble? Whether countries in the future could opt for leaving the euro will depend on Greece s performance after the exit. However, another chicken game might be less likely, as the threat of being kicked out of the euro is more real. In the longer term, we do not expect the option of leaving the euro will lead to a higher default premium on sovereign debt, as it should already be priced in that member states have the possibility to default on their debt as Greece did with the PSI in 2012. How would the ECB react to a Grexit? The ECB will do whatever it takes to limit contagion in the sovereign bond market. At this weekend s IMF spring meeting, Draghi underlined that the ECB can do more, saying we have enough instruments at this point in time with OMT, QE which, though they have been designed for other purposes, they would certainly be used at a crisis time if needed. But the OMT programme has conditionalities? The OMT programme can be activated if a country requests support, and it would then be attached with conditionalities. However, Draghi s comments clearly show these conditions can be changed if needed. Added to this, the scope of the QE programme could be increased to limit any contagion in the sovereign bond market. What about the ELA from the ECB if Greece defaults? The ECB will suspend the ELA to Greek banks, as a default would result in a collapse in the banking sector, implying the ECB can no longer judge banks to be solvent. Will a Grexit affect other banks in the euro area? There would be spill-over effects to other banks in the euro area, but the exposure that they previously had to Greece has been reduced significantly (see below). Official sector exposure is higher that private sector Greek Debt Composition, ult. 2014, EUR bn Bonds and Notes 81.1 Bonds issued domestically 63.8 Bonds issued abroad 2.6 Securitization issued abroad 0.1 Short-term notes 14.5 Loan 243 Bank of Greece 4.3 Other domestic loans 0.1 Special purpose and bilateral loans 7.1 Financial Support Mechanism loans (EFSF, IMF and bilateral) 217.9 Other external loans 5 Repos 8.6 Total 324.1 Source: PDMA Consolidated foreign claims of reporting banks - ultimate risk basis, Danske Bank Markets European banks exposure to Greece is very limited 350 300 250 200 150 100 50 USD bn European banks 0 05 06 07 08 09 10 11 12 13 14 Source: BIS Foreign claims by nationality of reporting banks, immediate borrower basis, Danske Bank Markets Could Greece default on payments without leaving the euro? Very little is legally written about exiting the euro, but the ECB s Constancio has said Greece might not have to leave the euro if it defaults. Added to this, Greece defaulted on its debt with the PSI in February 2012 and is to this day still a member of the euro. While this was an orderly default, a disorderly default with Greece not paying the redemption is set to cause a termination of the ELA and possible capital controls. 3 22 April 2015 www.danskeresearch.com

What if Greece does not repay the loans to the IMF? A missed payment to an official creditor like the IMF is not characterised as a default in e.g. S&Ps framework. A missed payment has happened multiple times (Sudan, Zimbabwe and Somalia are currently in arrears), and the IMF credit facility's grade period covers several months, see IMF. Note thought that the IMF s Managing Director Christine Lagarde said last week that 'no advanced country has ever asked for it before'. Would the IMF help Greece if it defaults on other loans? The IMF is not likely to grant additional help to Greece following a missed payment. Hence, the Greek case is in this sense unique, as the traditional IMF approach involves a debt writedown and a devaluation followed by IMF aid. Without additional aid, the likelihood that Greece recovers strongly after a default should be lower. Does Greece have alternative funding sources? The Greek authorities have recently had meetings with both Russia and China. Both could be alternative funding sources following a default event and a Grexit and China seems like a very likely source as it has helped Greece before. What happens after the current bailout programme runs out? If Greece comes up with sufficient reforms and the last EUR7.2bn tranche is released, it is a knife-edge whether Greece has enough money to pay the ECB and the IMF over the summer. Currently, visibility on Greek cash flows remains poor, but it still has to pay state pensions and wages. Hence, a third bail-out package is most likely needed as Greece s access to markets is non-existent in the current environment. Will the uncertainty about a Grexit continue? In a scenario where Greece cooperates with its creditors and gets approval for the last tranche in the current bailout, the conditions for a third bailout programme are also likely to be agreed upon. The release of upcoming tranches will still require economic progress. Can Greece avoid an OSI? The Greek public debt still remains unsustainably high. However, the redemption profile is manageable once the summer repayments have been conducted. Greece was promised a carrot once a primary surplus was achieved. At some point, some form of OSI is likely and it could take many forms, such as lowering interest costs further, extending loans, etc. Greek debt to GDP Greek public deficit Source:IMF, Macrobond and Danske Bank Source:IMF, Macrobond and Danske Bank In short, we do not expect a Grexit but do expect negotiations to continue until the end-june deadline. If a Greek incident happened, the policy response from both the political leaders and monetary policy would imply that contagion should be short lived. 4 22 April 2015 www.danskeresearch.com

Greek timeline Date Event 22 April Weekly meeting of ECB governing Council to review ELA 24 April Informal Eurogroup meeting w. focus on Greece Ultimo April Conclusion of Greece's current bailout programme review 8 May EUR1.4bn T-bill matures 11-12 May Regular Eurogroup/ECOFIN meeting 12 May EUR0.8bn debt repayment to the IMF 15 May EUR1.4bn T-bill matures 15 May Fitch may publish Greek sovereign debt rating 15 May Q1 GDP flash estimate to be released 3 June ECB policy meeting and press conference 5 June EUR0.3bn debt repayment to the IMF 12 June EUR3.6bn T-bill matures 12 June EUR0.3bn debt repayment to the IMF 16 June EUR0.6bn debt repayment to the IMF 18-19 June Regular Eurogroup/ECOFIN meeting 19 June EUR1.6bn T-bill matures 19 June EUR0.3bn debt repayment to the IMF 25-26 June EU Summit Ultimo June End of Greek bailout extension 10 July EUR2.0bn T-bill matures 13 July EUR0.5bn debt repayment to the IMF 16 July ECB policy meeting and press conference 17 July EUR1.0bn T-bill matures 20 July EUR3.5bn debt repayment to the ECB 31 July Moody's may publish Greek sovereign debt rating 7 August EUR1.0bn T-bill matures 13 August Q2 GDP flash estimate to be released 20 August EUR3.2bn debt repayment to the ECB 3 September ECB policy meeting and press conference 4 September EUR0.3bn debt repayment to the IMF 4 September EUR1.4bn T-bill matures 11 September S&P may publish Greek sovereign debt rating 11 September Informal Eurogroup meeting 14 September EUR0.3bn debt repayment to the IMF 16 September EUR0.6bn debt repayment to the IMF 21 September EUR0.3bn debt repayment to the IMF 9 October EUR1.4bn T-bill matures 13 October EUR0.5bn debt repayment to the IMF 15-16 October EU Summit 22 October ECB policy meeting and press conference 13 November Fitch may publish Greek sovereign debt rating 13 November Q3 GDP flash estimate to be released 20 November Moody's may publish Greek sovereign debt rating 3 December ECB policy meeting and press conference 7 December EUR0.3bn debt repayment to the IMF 16 December EUR0.6bn debt repayment to the IMF 17-18 December EU Summit 21 December EUR0.3bn debt repayment to the IMF IMF repayments T-bill matures EU meeting ECB meeting ECB repayment Ratings Data releases Source: IMF, ECB, Bloomberg, Danske Bank Markets 5 22 April 2015 www.danskeresearch.com

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