GM Swaps Traders Prepare for Biggest Settlement Since Lehman
By Shannon D. Harrington and Abigail Moses
May 29 (Bloomberg) -- Traders of credit-default swaps on
General Motors Corp. are preparing for the biggest settlement of the derivatives since last year’s collapse of Lehman Brothers Holdings Inc.
A bankruptcy by the biggest U.S. automaker, which the company is preparing to file June 1, according to people familiar with the plan,
would trigger credit-default swaps protecting about $3.1 billion of GM debt. Unlike Lehman’s September bankruptcy filing, the market for months has been pricing in a high probability of default by Detroit-based General Motors as it tries to meet demands from President
Barack Obama to restructure.
“I would doubt there are a lot of investors out there who still have exposure that is not marked to or close to where it should be,” said
Philip Gisdakis, a Munich-based credit strategist at UniCredit SpA.
“If there is someone who has not adapted yet, they deserve the loss.”
GM, which this week failed to persuade enough bondholders to exchange their bonds for equity in a streamlined company, faces a June 1 deadline to restructure its debt or lose the government loans that have kept it afloat. The company plans to file for bankruptcy protection June 1 and seek a sale of most of its assets to a newly formed company, people familiar with the plan said yesterday.
Credit swaps traders have been pricing in all but certain odds of a GM default since the Obama administration said March 30 that it was giving the company 60 days to “fundamentally restructure.”
Cost of Protection
Dealers are demanding a mid-price of 88.3 percent upfront for credit-default swaps protecting GM bonds for five years, an increase of 11 percentage points since March 23, according to London-based CMA DataVision. The price is in addition to 5 percent a year, meaning it would cost about $8.8 million initially and $500,000 annually to protect $10 million of debt.
GM’s 8.375 percent bonds due in July 2033 traded at 9.75 percent of face value at 9:26 a.m. in New York, according to Trace, the bond-price service of the Financial Industry Regulatory Authority.
Insurance companies, hedge funds and other investors that sell credit-default swap guarantees pay the buyer of the contracts face value of the amount protected, less the value of the bonds, which is typically set at an auction within a month after a default.
Based on the value of the 2033 bonds, for example, if a seller of credit swaps guaranteed $10 million of debt, they would pay about $9 million to the buyer.
Lehman Experience
The price shows
GM debt investors have been far more prepared for a bankruptcy than Lehman investors were before a crisis of confidence in the fourth-largest U.S. securities firm and the inability of regulators to strike a deal for the sale of the broker pushed it into bankruptcy on Sept. 15.
Before then, credit swaps on New York-based
Lehman were trading at about 7 percentage points annually with no upfront payment, according to CMA. A month later, sellers of default protection on the firm paid 91.38 cents on the dollar to settle contracts guaranteeing against a Lehman default.
Dealers in the market also say mechanisms for settling the derivatives have been well tested.
During the past eight months, dealers have held auctions settling swaps on the debt of 34 companies, from newspaper publisher
Tribune Co., which filed for bankruptcy protection, to Fannie Mae and Freddie Mac, the two largest U.S. mortgage finance companies, which were seized by the government last year.
‘Not Worried’
“While there are some fundamental fears associated with the fact that a major company might default, the auction process is pretty well understood now,”
Athanassios Diplas, global head of the counterparty portfolio management group at Deutsche Bank AG in New York, said in an interview this month. “We are not worried in the same way we would have been worried four years ago. The industry has significant experience doing these auctions, so from a technical standpoint, we can deal with it.”
Banks, hedge funds, insurance companies and other investors had bought or sold a net $2.31 billion of default protection on the automaker’s debt as of May 22, according to the Depository Trust & Clearing Corp., which runs a central registry that captures most trades. Another $776 million was bought through contracts on indexes that include GM among groups of companies, the New York-based Depository Trust’s data show.
Offer for Bondholders
GM yesterday said it reached an agreement with some of its largest bondholders that would smooth its way through bankruptcy. The company would give 10 percent of its equity to the old GM to pay bondholders and issue warrants for as much as 15 percent more. The U.S. Treasury would get 72.5 percent and 17.5 percent would go to a union health trust, according to a regulatory filing yesterday.
GM’s bankruptcy will be the third-biggest in U.S. history after Lehman’s and WorldCom Inc.’s, based on GM’s reported global assets of $91 billion and total liabilities of $176.4 billion as of Dec. 31. The automaker has been surviving with the aid of $19.4 billion in U.S. loans.
At the urging of regulators after the Lehman default, Depository Trust in November started disclosing the amount of protection sold on companies and on indexes of companies. Before that, no data was made public, leading to speculation from analysts that as much as $400 billion in credit swaps would need to be settled after the Lehman failure
Concerns that sellers of protection may struggle to come up with payments not already collected through collateral calls contributed to a decline in stocks before the settlement.
The actual amount of protection sold on Lehman turned out to be $72 billion, Depository Trust said after the Oct. 10 auction to settle the contracts. When offsetting trades were subtracted, only $5.2 billion had to actually change hands, DTCC said.
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