"Shake-up of GM complicated by prospect of credit insurance deals
By Henny Sender in New York
Published: May 12 2009 03:00 | Last updated: May 12 2009 03:00
Hedge funds and other investors stand to make billions of dollars on credit insurance contracts if GM declares bankruptcy - a prospect that is complicating efforts to persuade creditors to agree to a restructuring plan for the carmaker, analysts say.
Holders of $27bn in GM bonds have until June 1 to decide whether to swap their debt for a 10 per cent equity stake in the company as part of an offer that would give the US government 50 per cent of the shares; a United Auto Workers union-run health care fund 39 per cent; and existing shareholders 1 per cent.
However, analysts say the chances that the proposal will be accepted have been diminished by the large number of credit default swap (CDS) contracts written on GM's debt.
Holders of such swaps would be paid in the event of a default - but would lose money if they agreed to restructure GM's debt. For investors who own bonds and CDS, this could create an incentive to favour a bankruptcy filing.
According to the Depository Trust & Clearing Corporation, investors hold $34bn in CDS on GM. Once off-setting positions are considered, the DTCC estimates that CDS holders would make a net profit of $2.4bn if GM were to default.
The opposition of 10 per cent of bondholders is enough to derail the restructuring proposal, which has already triggered protests from investors who argue that it unfairly rewards the UAW at the expense of bondholders.
"You have every incentive not to agree," said one bondholder, a large credit hedge fund.
Prices for GM's debt and CDS indicate investors believe that a bankruptcy filing is highly likely. GM's bonds are trading at between six and 12 cents on the dollar. To insure $100m in GM debt for five years, an investor would have to pay $89m plus another $5m a year over the life of the CDS contract.
The CDS positions mark a key difference between GM and Chrysler, which filed for bankruptcy protection as part of what it hopes will be a swift restructuring. Chrysler had $6.9bn in bank loans, on which there were few credit insurance contracts.
"Chrysler looks like a simple two-car funeral compared to the traffic jam of assets and liabilities and contracts at GM," said credit research boutique CreditSights.
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