Greece is Likely to Get a Second Rescue Package Soon

• Leaks from euro area government officials suggest that a tentative agreement on a second aid package for Greece has been reached. It is likely to involve both additional contributions from the EU and private investor participation.
• A statement from the IMF following the finalisation of the fourth IMF review indicates that Greece will receive the fifth IMF tranche in early July, when the new package has been endorsed by euro area leaders and the Troika.
• A number of questions remain open. The magnitude of the additional support is not known, but Greece needs an extra EUR60bn for 2012-13. Private investor participation based on the Vienna initiative may cover half of that amount, but details remain unknown.
• It is also unclear whether such a "voluntary" rollover of debt will be a credit event triggering CDS contracts. European politicians would apparently like the ECB only to accept new bonds as collateral, which would make the decision to participate even less voluntarily. We doubt that the ECB will go ahead with this.
• Sovereign spreads decreased Friday following the release of the first rumours that a new package is in the pipeline. Two-year Greek sovereign debt dropped around 180bp to 21.25%, the lowest level in more than four weeks.
• Euro area politicians have a busy month ahead, trying to halt the escalation of the debt crisis. They will need to reach an agreement not only on the second aid facility for Greece, but also on the details of the enlargement of the EFSF lending capacity.

Funding for Greece via EFSF and rollover of old to new debt

According to leaks from euro area officials at the end of last week, an agreement on additional aid has "in principle" been reached, see for instance WSJ or Bloomberg. The package will most likely ensure Greece's financing for the next two years and it will be financed through a combination of more EU aid and private investor participation following the idea of the Vienna initiative.

The additional EU funds will be funded through the European Financial Stability Facility (EFSF). The magnitude of the additional support has not been decided yet. The original plan was for Greece to return to financial markets in 2012, but that is clearly not feasible. Greece was supposed to get EUR27bn in new funding in 2012 and another EUR38bn from the market in 2013. The new package will help to fill this funding gap. An aggregate package of about EUR60bn would thus buy Greece an extra two years before it would have to return the market. Half of the funding could come from private investor participation based on the Vienna initiative, see below. There have also been rumours of a package of up to EUR100bn, but we find that rather unlikely given the resistance to new rescue packages in e.g. Germany and Finland.

The details of the package will most likely be endorsed and presented either at the Eurogroup meeting on 20 June or the European Council meeting on 24 June (for more background on implications of different aid facilities see Greek debt restructuring difficult to avoid). The rumours do not indicate that the IMF will participate in the new package.

The second package for Greece will however ensure that the country will receive its fifth IMF tranche of EUR12bn in early July. This was stated in a press release from the IMF last Friday. In the light of these statements we now see very little risk that Greece will default on its debt in the short term.

As a precondition for the additional aid Greece will have to implement more reforms. This includes more budget cuts as well as realising the already planned privatisation of publicly owned harbours, real estate and corporations yielding EUR50bn by 2015. The privatisation and asset sales will be handled in cooperation with a number of major international banks including Deutsche Bank, Credit Suisse and Barclays.

Vienna initiative is gaining momentum

According to unnamed sources the private investor participation will happen via a voluntary rollover of maturing debt or an exchange of soon to mature debt with new debt. This is the so-called Vienna initiative. Euro area and in particular Greek banks, pension funds, and other private investors are according to the plan expected to accept a rollover of maturing debt to new debt with a maturity probably in the range of three and a half to seven years. The coupon on the new debt remains to be decided but officials have been cited that it will probably be close to the rate charged on EU support. This is expected to yield around EUR30bn in new funding. This process could start as early as July this year. The Vienna model would be a viable solution for the euro area banking system as it is likely to inflict minimal instant losses on their banking books.

The euro area policy makers favour this approach as they argue that this would not qualify as a "credit event" so CDS-contracts would not be triggered. In a report by S&P released Friday it was argued that even a voluntary debt exchange would qualify as a credit event if the terms are less attractive than those found in the secondary market, which is indeed the case. Hence, it is likely that an "almost" voluntary debt exchange will trigger CDS. Nevertheless, the CDS market for Greece is relatively small (net exposure is around USD5bn), so maybe policy makers should put less emphasis on whether it is a credit event and more on whether it is a viable solution for investors/ the market. One can question whether private investor participation really will be voluntary.

According to WSJ a senior euro area official is cited saying that the euro area governments are hoping that the ECB will encourage the exchange of old to new debt by only accepting the new debt as collateral. The ECB has so far accepted all euro area government bonds as collateral and we do not think that they will alter this practice. That said, it could be that the ECB decides that bigger haircuts will be applied for old Greek government bonds than for the new ones when used as collateral.

Market reaction

Sovereign spreads decreased Friday following the release of the first rumours that a new package was in the pipeline. Two-year Greek sovereign debt dropped around 180bp to 21.25%, which is the lowest level in more than four weeks. EUR/USD increased a large figure on increased risk appetite in the market.

Busy month ahead for euro area policy makers

The escalation of the debt crisis means that the euro area policy makers have a busy month ahead of them. At the Eurogroup meeting on 20 June and the European Council meeting four days later they will have to endorse and present the details of both the second aid facility for Greece and the enlargement of the EFSF to an actual lending size of EUR440bn. Also further negotiations on a potential interest rate reduction for Ireland remain undisclosed. Furthermore, stress tests of euro area banks are expected to be finalized during the month, and hopefully no unpleasant surprises will be revealed.