Aug. 15 (Bloomberg) -- General Motors Corp.bondholders may lose as much as 73 percent in the event of a default by the world's biggest automaker, based on the price of contracts used to fix a recovery value for the securities.

The recovery swap rate on GM dropped to 26.5 percent, from 39.5 percent at the end of June, meaning investors expect to get only 26.5 cents on the dollar in an insolvency, CMA Datavision pricing models show. Investors are pricing in a lower recovery rate than the average of 40 percent in bankruptcies as capital is eroded by $69.8 billion of losses since 2004.

``GM is on the highway to hell, there is no signal there is a way out for them,'' said Jochen Felsenheimer, the Munich-based head of credit strategy at UniCredit SpA, Italy's biggest bank. ``Recovery on GM might be significantly below 40 percent.''

GM's $29 billion of debt was downgraded by Moody's Investors Service this week to Caa1, a category for borrowers that may be in default or show ``elements of danger.'' The cost to protect the bonds using credit-default swaps indicates an 88 percent risk of the Detroit-based company reneging on its obligations within five years, compared with a 77 percent risk for competitor Ford Motor Co., according to Bloomberg data.

Falling U.S. sales and the declining value of truck leases caused GM to report the third biggest quarterly loss in its 100- year history on Aug. 1 at $15.5 billion. The company, which says it must have $11 billion to $14 billion each month to pay its bills, burned through $3.6 billion in the second quarter.

Chief Financial Officer Ray Young said this week he's trying to reap more of the $10 billion in projected savings from capital-spending reductions and cutbacks in the salaried payroll for this year instead of in 2009.

Spokeswoman Julie Gibson said GM has no comment on the market activity. Ford spokesman Bill Collins didn't provide an immediate comment.

Ford, Chrysler

Holders of recovery swaps agree in the event of a default to exchange a preset fixed rate for the actual amount recovered by bondholders. The investor receiving the fixed amount will benefit if the payment recovered by bondholders is lower than the rate agreed. Banks offer contracts on about 55 companies that are considered to the highest risk of default, including U.S. mortgage insurer Radian Group Inc., bond insurer MBIA Inc. and automaker Ford.

``Trading of recovery swaps on GM has picked up, especially over last couple of weeks,'' Felsenheimer said.

Ford, the second largest U.S. automaker, shows the same recovery rate at 26.5 percent, down from 37 percent at the end of June, CMA data show. Combined with Chrysler LLC, the probability that one of the three car companies will be unable to fund its business over the next five years is more than 95 percent, Felsenheimer wrote in a note to investors last week.

Hedging Risk

The cost of credit-default swaps on GM soared to $4.3 million upfront and $500,000 a year to protect $10 million of bonds, up from a total of $642,000 a year in May, CMA data show.

Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A rise indicates a deterioration in the perception of credit quality; a decline signals the opposite.

Credit-default swaps are priced on an assumed 40 percent recovery rate. Sellers of debt protection use recovery swaps as a hedge against recouping less than 40 percent.

Recovery rates are likely to fall as the economy weakens, said Matt King, head of quantitative credit strategy at Citigroup.

``Recoveries tend to be lower in recessions largely because there are more defaults,'' said King. ``With more defaults, there are more companies trying to sell assets to work their way out of difficulty. With so many assets up for sale, the price of those assets tends to be driven down.''

To contact the reporter on this story: Abigail Moses in London Amoses5@bloomberg.net

Last Updated: August 15, 2008 08:55 EDT