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GM's bond swap fails; bankruptcy is next step

The Associated Press

Detroit — A General Motors Corp. bankruptcy filing seemed inevitable after a rebellion by its bondholders forced it to withdraw on Wednesday a plan to swap bond debt for company stock.

GM has until Monday to complete a U.S. government-ordered restructuring that includes debt reduction, labour cost cuts and plant closures. But a Chapter 11 reorganization is likely after the company said its offer to exchange $27-billion (U.S.) in unsecured debt for 10 per cent of the company's stock had failed.

GM has received $19.4-billion in federal loans. The Monday deadline was set by the government and includes debt reduction, labour cost cuts and plant closures.

The auto maker said its board will meet to decide its next step.

“The principal amount of notes tendered was substantially less than the amount required by GM to satisfy the debt reduction requirement under its loan agreements with the U.S. Department of the Treasury,” GM said in a statement issued Wednesday.

The Obama administration has said it would only provide more funds if 90 per cent of the bondholders, as well as unionized workers, agreed to concessions that substantially reduced GM's costs.

GM also said it cancelled meetings set for Wednesday with holders of notes that were not sold in U.S. dollars. The statement said the meetings were to discuss amendments to the debt-for-equity offers, but it did not specify what the amendments were.

There was a small hope Tuesday that GM could avoid a bankruptcy filing when the United Auto Workers union disclosed that it would take a 20 per cent stake in GM — down from the original plan of 39 per cent. That seemingly freed 19 per cent of the Detroit-based company's shares to sweeten the pot for its recalcitrant bondholders.

But because the bondholder deal did not go through, the equity freed by the UAW deal now apparently will go to the U.S. government, which may have to commit billions more for GM's restructuring in court.

The U.S. government's stake in the company originally was to be 50 per cent, according to GM's regulatory filings. But it now could be as high as 69 per cent. The Canadian government also could get equity for up to $8-billion in aid for the auto maker.

Such an arrangement would leave bondholders back where they started — and a Chapter 11 filing all but certain. The deadline for GM's bondholders to tender their debt was midnight Tuesday.

Meanwhile, crosstown rival Chrysler LLC heads to court Wednesday to ask a bankruptcy judge for permission to sell the bulk of its assets to a group headed by Italy's Fiat Group SpA in hopes of saving itself from liquidation. Attorneys for Chrysler maintain that the Fiat deal is the company's only hope to avoid being sold piece by piece, but car dealers, bondholders, former employees and others are protesting what they see as the government speeding Chrysler through the bankruptcy process without regard for certain creditors.

Chrysler filed for bankruptcy protection April 30, after the government ended talks with a group of holdout bondholders.

Auto makers worldwide are struggling as the global recession has reduced demand for new vehicles. But GM and Chrysler have been particularly hobbled by promises to cover the health and pension costs of tens of thousands of unionized retirees — along with recent record-high gasoline prices that reduced demand for their low-mileage trucks and SUVs.

The UAW disclosed Tuesday it agreed to take a much smaller 17.5 per cent stake in GM, plus a warrant for an added 2.5 per cent stake to partially fund the $20-billion that GM must put into a trust that will start paying retiree health care costs next year.

In exchange for agreeing to a lower equity ownership stake, GM promised the union $6.5-billion of preferred shares that pay 9 per cent interest, plus a $2.5-billion note. The union, facing the possibility that it may not be able to quickly sell GM shares to fund its trust, preferred the certainty of the $585-million annual dividend that accompanies the preferred shares.

The remaining $10-billion will come from health care trust funds that GM already has set up. The trust will get a seat on GM's board as well, although it will have to vote at the direction of GM's other independent directors. The concession deal, on which roughly 61,000 workers will vote by Thursday, also froze wages and cut retiree health care benefits, performance bonuses and cost-of-living raises.

When GM announced its debt exchange last month, the company offered bondholders 225 shares of common stock for every $1,000 in debt — or a 10 per cent stake in the restructured company. In addition to the UAW's share, the federal government was to take 50 per cent for exchanging a combined $20-billion of their debt to equity. Current stockholders would end up owning just 1 per cent of the company.

A committee representing GM's biggest bondholders — mostly big banks and other institutional investors — has opposed the debt-for-equity swap from the start.

Smaller, “retail” bondholders — individual investors like retirees and families — have also railed against the terms of the exchange. Both groups say the offer gives them too small a stake for the amount they are owed.

GM had said previously that the government was preventing it from offering bondholders more than 10 per cent of the restructured company.

Some analysts said GM's bondholders may be holding out for better terms in bankruptcy. Stephen Lubben, a law professor at Seton Hall University, said unsecured creditors like bondholders often recover 40 per cent of their investment in bankruptcy.

“They may not do much better, but they can't do any worse,” he said.

Another factor complicating the decision of GM's bondholders: Many large investors hold insurance policies on their bonds known as credit default swaps. Such policies would reimburse bondholders in the event of a “credit event” like a bankruptcy filing.

Investors who hold credit default swaps on GM debt stand to make about $2.33-billion if the insurance contracts are triggered, according to the Depository Trust & Clearing Corp.

Some believe the debt holder offer was doomed from the start. It's unclear how many of the thousands of individual and institutional bondholders have participated in the exchange, but analysts speculated that number was low.

If GM heads into bankruptcy, the chain of events would prove similar to what Chrysler faced one month ago. In that case, four banks holding 70 per cent of Chrysler's $6.9-billion secured debt agreed to take $2-billion in cash, but a collection of hedge funds refused to budge, sending the auto maker into bankruptcy protection.

However, the two cases are different in important ways. GM's bondholders are unsecured, meaning their debt isn't backed by hard assets like factories and property and are therefore likely to see a smaller recovery in bankruptcy. They are also more diverse and tougher to organize, ranging from big banks to hedge funds to mom-and-pop investors.

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