Wednesday, May 13, 2009

By the end of last year, the reported cost of swaps protection ballooned to $8 million up front and $500,000 a year


Recalcitrant creditors were made scapegoats for the collapse of Chrysler, Breakingviews says. And, it says, they may play the same unhappy role if General Motors runs off the road.

G.M. bondholders who have hedged their exposures are said to want the carmaker to file for bankruptcy. But that doesn’t make them opportunistic speculators, Breakingviews argues.

If G.M. files, these investors could indeed collect on their credit-default swap contracts. But in many cases, Breakingviews says, they’ve already suffered big losses on their bonds. Making up for those is what hedging is all about.

Meanwhile, G.M.’s government-inspired overhaul plan looks like a raw deal, the publication argues. Lenders would get only 10 percent of G.M.’s new equity, rather than the lion’s share, which, as the largest block of creditors, is arguably their due, it says.

It’s also unlikely that most of the bondholders concerned are short-term speculators, according to Breakingviews. The economics of hedging G.M.’s bonds haven’t looked great in a while, it notes.

The last time it was attractive was probably in early 2007, when G.M.’s bonds fetched around 97 cents on the dollar, the publication suggests. An investor seeking to hedge $10 million of those bonds for five years would have paid about $390,000 a year in the credit-default swap market, a cost covered by the interest received on the bonds, Breakingviews calculates. By last summer, that bondholder had lost $1 million on the bonds, but that was roughly offset by the increased value of the swaps contract, it says.

But then the carmaker’s wheels had started coming off. By the end of last year, the reported cost of swaps protection ballooned to $8 million up front and $500,000 a year, and the bonds plunged in value to about 25 cents on the dollar, Breakingviews says. Buying the bonds then and insuring their $10 million face value would have cost $11 million in the first year, a losing proposition even if G.M. filed for bankruptcy, it says.

So the hedged bondholders have probably been in the game for a while, Breakingviews argues. They have the advantage of some bankruptcy insurance. But there’s little reason to excoriate them for risking a G.M. failure when the alternative deal on offer is so meager, the publication says."

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