Debt for equity swaps: General Motors

The whole Chrysler Chapter 11 debacle, which appears to involve disentanglement from Daimler and proposed entanglement with Fiat; government pressure on partially state-owned banks to forgive debts and/or swap it for equity; government pressure to ensure that the United Auto Workers union (who in turn made large donations to Obama's election campaign, of course) end up owning a large part of it etc. is just too gruesome to 'blog about, but worth a read if you're interested, see e.g. here or here.

What's much more fun, as it illustrates the horse-trading involved in a debt-for-equity swap, is the General Motors story. A lot of articles portray this as a battle between the bondholders and 'the company' (which would be the case were the company to refuse to pay a normal trade supplier). It's actually a battle over who should end up owning GM and in what proportions.

GM has a certain 'enterprise value' as a going concern, but unfortunately it does not generate enough money to repay $27 billion in unsecured loans (I have no idea how much there is in secured loans on top of that). So the battle is between these bondholders, existing shareholders and the unions, who have unsecured claims against the business in terms of healthcare and pension promises. An article in Friday's FT shows that they are some way from reaching agreement (to put it mildly):

The [administration's] auto taskforce and the carmaker have come up with a plan that would see bondholders exchange $27bn (€20bn, £18bn) in unsecured loans for a 10 per cent equity stake, much less than the creditors want and less than the government and the United Auto Workers union...

GM's ad hoc bondholders' committee said yesterday they would be willing to swap their $27bn of notes for 58 per cent of the carmaker's shares. The plan would see a healthcare fund managed by the United Auto Workers union own 41 per cent of "the new GM" and current shareholders retain 1 per cent of Detroit's largest carmaker. The government would have no ownership stake.

The bondholders appear to have the whip hand, if they don't get the deal they want, they will push for bankruptcy, which, bluntly speaking, is supposed to get the best deal for unsecured creditors with legal claims (as against the union's claims, which are 'moral' rather than 'legal' claims).

Anyway, the key to all this is "The government would have no ownership stake". We know that UK banks have some 'enterprise value' - however bad things get, they are still collecting well over £100 billion a year in loan repayments and interest, that cash flow must be worth something. Minus off the liabilities due to depositors covered by the £50,000 deposit guarantee scheme and whatever's left has to be divvied up between shareholders (who'd end up with pretty much nothing, but hey, they've lost 95% of their money over the past couple of years) and the bondholders (whose bonds are trading considerably below par value, so they've already lost a third of what they invested), SPVs and depositors with more than £50,000. You end up with well-capitalised banks, by definition, and lessons will have been learned.

Sure, it's tough being forced to accept that you've made a loss, but it must be better to get it over with via a debt-for-equity swap and for everybody to get on with their lives than to a) bury your heads in the sand and hope for b) taxpayer-funded bailouts.