Next Up: GM's Bondholders

If the latest communiquÉ from the bondholders of General Motors (GM) is any indication, the struggling auto giant could follow its crosstown rival Chrysler into bankruptcy court in a month's time.

A committee representing the owners of about $12 billion of GM's $27 billion bond debt filed a counterproposal to GM's debt-for-equity offering on Apr. 30, and the gulf between the two deals is enormous. If those bondholders—and the owners of another $12 billion in debt—don't agree to the swap, GM would need bankruptcy court to restructure its balance sheet.

Part of it could be posturing by the bondholders' ad hoc committee to see if GM will sweeten the offer. On Apr. 27, GM offered them stock worth an estimated 2¢ to 5¢ on the dollar for their debt, according to Barclays (BCS) analyst Brian Johnson. The bondholders may hope that GM and the U.S. Treasury Dept. will offer them more, just as Chrysler and the government tried to sway holdouts with a better deal before Chrysler declared bankruptcy.

"They have been going back and forth. It's like a labor contract negotiation," says David E. Cole, chairman of the Center for Automotive Research in Ann Arbor, Mich.

The bondholders want to trade their $27 billion in debt for 58% ownership in the newly restructured GM. Under the proposal, the United Auto Workers' health-care trust, to which GM owes $20 billion, would get no cash and a 41% stake in GM. The government wouldn't get any equity.

Cutting Out the Feds and Workers

The proposal is a far cry from what GM offered on Apr. 27. Under that plan, which was crafted with input from the Treasury Dept.'s auto task force, the government would get a 59% stake in GM in exchange for $10 billion of an estimated $20 billion debt to the government that GM would have on June 1. The UAW would own 39% of the company and get $10 billion of the $20 billion the union health-care fund is owed in cash. The current bondholders would get just 10% of GM's equity.

It's easy to see why the bondholders came up with this new proposal. Not only do they end up with a bigger piece of the company, but the government would have no ownership, says Eric Siegert, senior managing director at Houlihan Lokey Howard & Zukin, which is advising the bondholders' ad hoc committee. That keeps government oversight and politics out of management decisions.

There's another benefit in the eyes of bondholders. Under GM's offering, the UAW's health-care trust, called a Voluntary Employee Benefits Assn., or VEBA, would get $10 billion in cash. Since Treasury is loaning GM money, Siegert says he believes government money is going into the VEBA trust. "Instead of Treasury putting money out for the VEBA, the taxpayers would keep their money," he said in an interview.

Under the bondholders' proposal, GM would also have just as much debt as it would under the company's proposal, about $48 billion after the restructuring is done.

The bondholders are also worried that the labor deal won't be competitive enough and that the 22,000 or more workers whose jobs will be eliminated will be bought out with cash that could pay back some of the bond debt. Says Siegert: "Offering taxpayer money to buy out people isn't a concession. It's rearranging chairs on the Titanic."

Obama Plays Hardball

But given President Barack Obama's speech on Chrysler on Apr. 30, it's unlikely the bondholders will get far with their offer. Obama, when speaking about the Chrysler creditors who refused to take a 67% haircut on their debt—at the same time workers, dealers, and management were making concessions—said: "I do not stand with those who hold out when others are making sacrifices."

When Obama let Chrysler go into bankruptcy, he sent a clear signal that he will play hardball with Wall Street creditors to try to save the industry and the well-being of workers.

GM declined comment on the counterproposal. But GM executives and Treasury officials say privately that they have made their offer to bondholders and will see who accepts rather than deal with the ad hoc committee's proposal.

Treasury wants GM to get 90% of the debt restructured under GM's offer, which has a May 26 deadline. That 90% take rate may be the best GM and Treasury can expect. Some bondholders own credit default swaps, which amount to an insurance policy that pays them in full if GM enters bankruptcy and defaults on the debt.

There are insurance contracts representing about $2.7 billion in GM bond debt—about 10% of the total—on the market, according to Credit Derivatives Research, which follows the derivatives markets. If a few more bondholders refuse GM's offer, the debt-for-equity swap will fail and GM will be in bankruptcy.

That doesn't give GM much margin for stubborn bondholders. "This is workable," Cole says. But he adds: "The whole thing is on the edge."