Greek bondholders are preparing to lose as much as 60 percent oftheir investments as European leaders try to impose a solution thatreduces the nation's debt burden by enough to end the debtcrisis.

“Everyone is coming to the conclusion that a much deeperrestructuring is needed to make Greece in any way sustainable,”said Emiel van den Heiligenberg, chief investment officer of globalbalanced solutions at BNP Investment Partners in London, whichoversees about $742 billion. “If the stock of debt doesn'tdiminish, then the problems are going to be bigger and bigger andGreece will require rescue package after rescue package.”

Greek 10-year bonds yielded 23.98 percent at 8:31 a.m. Londontime, with the price on the securities at 37.40 percent of faceamount. The rate was 2,186 basis points, or 21.86 percentagepoints, more than benchmark German bunds and compares with a yieldof 11.59 percent for similar-maturity Portuguese debt and 5.87percent for Italian bonds.

Europe's leaders are intensifying efforts to contain the crisisthat broke out in Greece almost two years ago, drove up stateborrowing costs from Ireland to Italy and triggered the collapse ofDexia SA, Belgium's biggest lender by assets. European CommissionPresident Jose Barroso said two days ago the region needs acoordinated approach to backstop the region's banks and “get aheadof the curve.”

Standard & Poor's downgraded Spain yesterday, citingheightened risks to growth prospects. Fitch Ratings cut thelong-term issuer default grades of UBS AG, Lloyds Banking Group Plcand Royal Bank of Scotland Group Plc, and put more than a dozenother lenders on watch negative.

Fresh Plan

German banks are preparing for losses of as much as 60 percenton their Greek holdings, three people with knowledge of the matter,who declined to be identified because the talks are private, saidyesterday. The risk is that creditors balk at forgoing more thanthe 21 percent initially suggested in a plan crafted in July,forcing Greece to miss debt payments and sparking a chain-reactionacross the euro area's markets involving rating downgrades andpayouts on credit-default swaps.

Hatching a fresh plan for Greece would mean rewriting thepackage agreed to in July, which included a 21 percent voluntaryreduction in repayments on some bonds. With a deepening recessionin Greece pushing the nation further away from the July accord'sdebt-reduction targets, the price of two-year notes slid to aslittle as 36.79 percent of face value on Sept. 13, indicatingdwindling faith in the nation's ability to repay investors evenafter the so-called haircut.

Brussels Talks

“A reopening of the deal is very likely,” said PatrickArmstrong, managing partner at Armstrong Investment, which hasabout $345 million in assets under management. “In the past, theywere trying to avoid Greece defaulting and avoid recapitalizing thebanks and what's going to happen now will probably be moresensible. It will allow the euro zone to move forward.”

The London-based fund manager owns a “small amount” of Greek 4.3percent bonds due March 20, 2012, which it bought in July,Armstrong said.

Deutsche Bank AG Chief Executive Officer Josef Ackermann, wholed talks on private sector involvement in Greece's rescue packagein July, said yesterday that he will go to Brussels next week todiscuss the potential for investors to accept deeper losses.Luxembourg's Jean-Claude Juncker, who leads the group of euro-areafinance ministers, said separately yesterday that talks are underway with the Washington-based Institute of International Finance onthe cost to investors of a second bailout package for Greece.

'Larger Haircut'

“You need a significantly larger haircut because what's beingdiscussed now isn't enough to put this country back on the path offiscal sustainability,” Pacific Investment Management Co. ChiefExecutive Officer Mohamed A. El-Erian said in a radio interview on“Bloomberg Surveillance” with Tom Keene and Ken Prewitt. “We'regoing to see it soon because I think the politicians and policymakers understand that debt reduction is part of the solution.”

Since German Chancellor Angela Merkel and French PresidentNicolas Sarkozy put bank recapitalization at the top of thepriority list in an Oct. 9 declaration, the Stoxx Europe 600 Indexof shares has risen 1.7 percent. Yields on benchmark German bunds,perceived to be Europe's safest government bonds, rose to asix-week high yesterday, the euro rallied 2.8 percent to $1.3751and a measure of how much European banks pay to fund in dollarsslid to a five-week low today.

Bank Capabilities

Ensuring banks in Greece and the euro area are capable ofwithstanding greater losses on Greek debt is “imperative,” saidSpyros Politis, CEO of TT-ELTA AEDAK, a Greek manager of mutualfunds with 262 million euros ($360 million) of assets.

“You need this society to function in order to, at the minimum,guarantee that whatever is left after the haircuts is repaid,”Politis said. “This in turn needs a functioning domestic bankingsystem.” TT-ELTA AEDAK values the Greek bonds in its portfolio at50 percent of face amount, he said. An eventual haircut of around35 percent “appears to be a solution that keeps everyone lessunhappy,” he said.

The drop in Greek bond prices already means investors are goingto save Greece more money through the July debt-exchange plan thanpreviously thought, because they save it from selling securities attoday's higher yields, Charles Dallara, managing director of theIIF, said on Oct. 4.

Greek CDS

Credit-default swaps on Greece signal a more than 90 percentchance the government will renege on its obligations within fiveyears, assuming investors would recover 32 percent of theirholdings in the event, according to CMA, which is owned by CMEGroup Inc. and compiles prices from dealers in the privatelynegotiated market. The swaps market is factoring in a 62 percentprobability Portugal will default in that time, a 47 percent chancefor Ireland and about 8 percent for Germany, all assuming a 40percent recovery.

“A managed default in Greece may increase speculation ofrestructurings elsewhere, which would certainly put Portugal underpressure, also Ireland and we would see Italy and Spain undergreater speculative pressure,” said Richard McGuire, a seniorfixed-income strategist at Rabobank International in London. “It'sa very difficult balancing act.”

S&P cut Spain's long-term sovereign credit rating to AA-from AA, the ratings company said in a statement late yesterday.The country faces high unemployment and public sector debt, tighterfinancial conditions and may be affected by the slowdown of tradingpartners, S&P said.

ECB Involvement

The European Central Bank will also need to be persuaded toallow a greater writedown on Greek bonds, potentially alsoincluding its own holdings, amassed under a previous plan tosupport the nation. The involvement of the private sector ineuro-area bailouts through enforced investor losses is a risk tofinancial stability and would have “direct negative effects” on thebanking sector, the central bank said yesterday in its monthlybulletin.

ECB President Jean-Claude Trichet said on June 30 that thecentral bank didn't expect to participate in the voluntary rolloverof Greece's debt agreed to in July.

“Very likely the ECB will defend its position of taking nohaircut up until the last moment but I think at the end of the daythe ECB will stop being the blocking point,” said van denHeiligenberg. “If you recapitalize the banks first then you havemore potential to do bigger haircuts on Greek bonds. If they mix upthe order then the market would probably get very nervous.”

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