Drive My Car

Tonight the Wall Street Journal is reporting that GM is "more open" to a bankruptcy filing. After taking billions of taxpayer dollars with no meaningful restructuring, it is nice of GM to finally acknowledge reality. This is what happens to a company which has enough capacity (and workforce) to supply approximately 50% of the U.S. auto market, but barely holds a 20% market share. GM is finally acknowledging reality after its auditors expressed serious doubts that the former American icon could avoid a restructuring.

What kind of restructuring might it be? My guess is it will eventually be a pre-packaged deal in which terms are agreed upon by GM, creditors, suppliers and the unions before the plan is filed with the bankruptcy court. This would result in a speedy turnaround. However, look for the old guard within the UAW to make a stand (with help from members of Congress). This time however, members of the UAW and Congress will discover that the laws of mathematics apply to them as well as everyone else. What may bondholders expect to receive in a bankruptcy? The very unofficial estimate I have heard around the street has been about 50 cents on the dollar for GM senior debt (paid in a combination of cash and new shares). This is the only color I have.

Note: This does not necessarily affect GMAC bonds. There are not now, nor have there ever been, cross default protections between GM and GMAC (or between Ford and Ford Motor Credit). As long as GM is building vehicles, GMAC will have something to finance (both consumers and dealers) and may survive this debacle. GMAC is a bank holding company and can issue FDIC-backed TLGP bonds. If GM survives, albeit through bankruptcy, GMAC may get the go ahead to issued TLGP bonds thereby remaining well-capitalized.



Thanks to Detroit outsider CEO Alan Mulally, Ford has been the most forward-looking and proactive of the Detroit Three throughout the recession and credit crisis. Mr. Mulally mortgages facilities while doing so was possible and drew down bank lines of credit while they were still available to keep Ford afloat. In spite of his valiant efforts Ford announced that it needs to attempt to retire some of its debt below par. Ford Motor Company is attempting to retire approximately 40% of its outstanding debt at 27 cents on the dollar (30 cents if one tenders early). Details can be found on the Ford website.

Here is the link: http://media.ford.com/images/10031/table_of_Ford_notes.pdf

Note: Ford Motor Credit Bonds are unaffected.

There is much misunderstanding regarding what is going on in the markets. I still receive call sand e-mails suggesting that of mark-to-market was eliminated that all the banks' problems would be solved. Unfortunately the cat is out of the bag. The market knows that much of this collateral is never going to be worth par (possibly nothing close to par). What is doesn't know is precisely how bad bank balance sheets may be. The "Bank Vigilantes" want to know the extent of the damage and how and when these assets will leave bank balance sheets.

There is also a misconception that the banks have already marked all of their assets to market and are being beaten up because of the resulting damage. This belief also states that these prices are lower than what the assets maybe worth of held to maturity. Although it may be true that assets marked to the current market may be worth more when all is said and done, this ignores the fact that hundreds of billions (or more) of so-called Level III assets (assets too complex or illiquid to properly value) have never been marked down a dime. Since these assets may be the worst of the bunch, losses to some banks may be much more severe than what has already been acknowledged.

If it was as simple as the government buying assets from banks at prices reflecting their held to maturity value, The Treasury probably would have done so during the first round of TARP. Instead, then Treasury Secretary Hank Paulson decided to inject Tier-1 capital into the banks to permit them to take losses (hopefully pairing them off versus operating profits in the future) over time. The markets are having none of it. Many of the hedge funds know the deal because they hold some of the same (or similar) toxic assets, albeit on a smaller scale.

Has anyone noticed that the market hates the Presidents response to the deep recession? This is because mortgage relief programs which forgive principal could result in the failure of mortgage-backed and asset-backed securities. If the underlying mortgages are not being paid back in full, then the security containing these mortgages will be paid in full. This can create an event of default for CDS insuring MBS and ABS. With unemployment rising (wait until the effects of GM, Ford, and Chrysler are felt in throughout the economy), the bank losses will probably rise. This is why strong banks such as JPM and PNC have voluntarily slashed equity dividends in preparation for tough sledding ahead. We appear to be still on the downward slope of this recessions.


Lastly, before panic-selling preferreds please be sure you understand the structures. I have observed investors selling GE Cap preferreds because they do not appear to be cumulative. This is because all of the GE Cap preferreds are senior notes. They interest payments cannot be halted short of a bankruptcy filing. Although credit downgrades are probable, bankruptcy is note. Why do I say this? Because GE Cap is a bank holding company, has access to TARP, can issue TLGP bonds and participates in the Fed's Commercial Paper program. Since GE Cap has a deep-pocketed parent (albeit with no legal obligation to back GE Cap debt), it is likely that, if necessary, the government would pressure GE to support GE Cap rather than risk a default. A default would put the government on the hook to repay (principal and interest) on outstanding GE Cap TLGP bonds. Mr. Geithner and Mr. Paulson would probably give GE CEO Jeff Immelt the Ken Lewis treatment rather than have GE Cap go under.

Have a good night and brace yourselves for tomorrows employment data.