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Setting up the Bondholders

posted by Stephen Lubben

GM’s CEO said today that the company would not alter the terms of its exchange offer, and that the company’s fate rested with the bondholders.

But GM can’t be that naïve – exchange offers rarely work, especially with a high threshold like 90%, and there is almost no chance it would work in this instance. The GM bonds are widely held by both retail and sophisticated investors, and GM is offering them almost nothing in exchange for their bonds. Many holders will rationally think they have nothing to loose by examining their bankruptcy option.  At the very least they might pick up the 1% currently being offered to GM shareholders.

But what if this is another attempt to set up the “bad guy” that forced an "unncessary" bankruptcy?

Hedge funds that bought both Chrysler and GM debt are going to fee a bit picked on, I suspect.  Of course, this time the "professor that cried CDS" might be right, so the story is going to be a bit muddy in both directions.

Comments

Keep in mind that most single name CDS trades with "restructuring" as a credit event. If so, a CDS holder is relatively indifferent between BK and restructuring. Both would trigger a credit event and payout. One might argue that a BK credit event would result in a lower recovery and hence greater payout, but that doesnt seem like a strong argument to me. The difference is not that great from the pittance of a restructuring offer to begin the negotiation.

And bondholders have submitted a counteroffer. So why is one inflexible but the other not? Seems to me like CDS is a distraction here.

Mark -- thanks for the comment. My understanding is that while "restructuring" persists as a credit event in Europe, it has largely been eliminated in North American CDS markets.

There are a multitude of state laws that would require GM to pay compensation to dealers they drop. In bankruptcy, they can shed the dealers they don't want without paying compensation.

Watch what happens with Chrysler LLC's unwanted dealers.

I think the interesting question about CDS and chapter 11 is this: the assumption in ch 11 is that creditors act in terms of their "long" position. We premise voting behavior on that assumption. When a creditor holds a CDS with a solvent counterparty, then the creditor is "short," and that affects that creditor's voting decision. Query: does this raise new analytical questions about designation of votes under 1126(e)?

Most GM CDS are traded without restructuring.

Imclark - Except you dont know what the proportions are. Assume that I own $1m bonds (long 1m credit risk), I also bought $100m of CDS protection (short $100m credit risk). I am not net short the risk and looking forward to BK. Also, collarary assume I am a competitor who happens to own bonds. Is my responsibility to my company/shareholders or to the defaulting company? Is there a law/precedent etc that prohibits that. If so, seems like a logical extension.

I am not a lawyer, so I am just proposing these to add to your questions.

Its likely be split between R and no-R. SNAC protocol isnt that old (a month or so), and most contracts initiated before that date will trade with a restructuring trigger. Many CDS holders have 'rolled' their contracts into the new format, but for names like GM where a restructuring is a real possibility, holders likely retained their R option.

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