Page last updated at 12:43 GMT, Sunday, 31 May 2009 13:43 UK

Ugly choice for GM creditors

By Greg Wood
BBC News, New York

Paint peels from the GM logo painted on a chimney at a shuttered GM assembly plant, Wisconsin
Dissident bondholders may mount legal challenges in the bankruptcy court

When investors lend money to a company, they expect to get it back.

But those who lent $27bn to General Motors when they bought its corporate bonds - the IOUs issued by big companies - risk losing the lot.

Their only alternative is to accept a shareholding in a new company with a very uncertain future. It is an ugly choice.

The bondholders turned down an earlier deal to swap their $27bn for a 10% stake in General Motors. They thought that was too little for the amount of money they were owed.

But the deal was a vital part of GM's plan to reduce its debts and avoid bankruptcy. Without an agreement, bankruptcy became inevitable.

New offer

Shortly after that deal collapsed, the US government's motor industry task force, which has been handling all the talks, approached the bondholders with a new offer.

It's enough for me to have moved from rejecting the deal and trying our luck in bankruptcy court to the side of recommending the deal
GM bondholder

It wanted to make sure that they would support its bankruptcy plan.

That plan will split General Motors in two - "Old GM", with all the "bad" assets like defunct car plants - and "New GM", which will own the "good" assets, such as viable factories and brands like Chevrolet and Cadillac.

The bondholders were offered up to 25% of "New GM" if they would come on board.

After a few hours deliberation, a committee representing a fifth of the bondholders accepted last week.

And by this weekend a majority of bondholders had decided to support the new offer

"It's enough for me to have moved from rejecting the deal and trying our luck in bankruptcy court to the side of recommending the deal," one leading investor said.

A bond is simply an IOU issued by a company or a government
The bond states when a loan must be repaid and what interest the borrower (issuer) must pay to the holder
Banks and investors buy and trade bonds

So, what are the bondholders really getting out of this?

Well, they will only receive their full 25% stake in "New GM" if it achieves a market value of $30bn. In other words, "New GM" has to survive and thrive in a cut throat car market, or at least do well enough to support a strong share price.

This is sensible.

Bondholders do not want to end up owning extra shares which have little or no value.

But it is a tough challenge for General Motors, and one which goes to the heart of the company's problems - its failure to compete.

The $27bn of bondholder debt will stay with "Old GM".

As senior creditors they may get some money back when unwanted assets, such as shuttered car plants, are eventually sold off to property developers or the like. But it will only be a tiny fraction of what they are owed.

Disparate bunch

Will bondholders support the bankruptcy process?

Most of them have pledged to do so. But they are a disparate bunch, ranging from large hedge funds to "mom-and-pop" investors. Their interests do not necessarily coincide.

It is possible that dissident bondholders will mount legal challenges in the bankruptcy court.

Many of them have bought "credit default swaps" - insurance policies which will pay out if General Motors defaults on its debts.

They may view the certainty of that payout as preferable to the uncertainty of a punt on the future of "New GM".

It is a cautionary tale. Investors have been inclined to view corporate bonds as a relatively safe investment.

But companies do go bust - even those with a history as glorious as General Motors.

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