End Game For GM Bondholders

As Originally Posted to the Wall Street Journal

The steps taken this weekend by the Obama Administration to reach a resolution for the troubles in the automotive industry increase the chances of a bankruptcy filing by General Motors or its rival, Chrysler.

For the moment, GM’s benchmark debt issue is valued at about 15 cents on the dollar, down a few cents from Friday, according to KDP Investment Advisors. The bondholders, according to published reports, have been asking for as much as 33 cents on the dollar as part of some kind of pre-packaged bankruptcy filing.

But such a recovery rate may be optimistic, analysts say. Earlier today, President Obama said that “it will require creditors to recognize that they cannot hold out for the prospect of endless government bailouts.” The administration’s actions this weekend were termed by Dan Alpert, managing director at Westwood Capital, as the removal of the “put to politics,” that is, the implied guarantee that the auto companies will continue to function, thus strengthening the bondholders’ position, much in the way Federal Reserve guarantees embolden risk-takers in a way they would not otherwise behave.

With that ballast removed, the expectations for recovery by the bondholders runs from about 15 to 20 cents, although it could be less. “The likely outcome is going to be more pain for all those involved, all direct and indirect stakeholders of General Motors,” says Sean Egan, co-head of ratings desk at Egan-Jones Ratings Co. “The equity they’ll receive will be nowhere near the face value of their debt.”

(Update: In a statement, the advisors to GM’s bondholder committee issue lukewarm support of the administration’s plans. They say that “all parties seem to agree that an out-of-court restructuring would be the preferred path to viability,” and that “bondholders are more than willing to work towards a comprehensive, sustainable solution in which GM emerges a leaner, more competitive entity.” However, they note that “we have been very disappointed that the government and company have had virtually no real dialogue with bondholders while designing the proposed restructuring plan.”)

Shares of GM were down 21% on the New York Stock Exchange. The company’s outstanding senior debentures due in 2033 were traded above 90 cents on the dollar as late as October 2007 until falling sharply as the business floundered (see chart, below). Debtholders clearly understand the gravity of the situation — the company’s credit-default swaps, a measure of insurance against default bearing some resemblance to surety bonds, cost about $7.9 million upfront to insure $10 million in bonds for five years. The notional value — that is, the price of the underlying asset (the debt) insured by the CDS — of the outstanding credit default swaps is nearly $37 billion, according to Barclays Capital. GM has $45 billion in secured fixed debt.

Kip Penniman, automotive analyst at high-yield research firm KDP Investment Advisors, says that the likely outcome is a pre-packaged bankruptcy that is worked out in legal proceedings. “There has to be some enticement to get the bondholders to agree,” he says. “They do have leverage. They still have the legal obligation that GM owes them, and if they fail to honor that they will take them into bankruptcy.”

GM bond prices have declined sharply in the last few years. (Source: KDP Investment Advisors)