Financial Times: GM Bondholders to Obama: We Are Main Street

Private GM bondholders face large losses
By Nicole Bullock

Published: May 18 2009 19:34 | Last updated: May 18 2009 19:34

“Creditors have better memories than debtors,” says Chris Crowe, an electrician and home inspector from Denver, who stands to lose his son’s college fund on what has turned out to be a poor investment in the bonds of General Motors.

Quoting Benjamin Franklin, Mr Crowe made an impassioned plea for a better deal for GM’s bondholders during a rally of individual investors in Philadelphia last week. The group, which calls itself the “Main Street” bondholders, has also gathered in Tampa, Florida and Warren, Michigan. This week they head to Washington, DC, to lobby their congressional representatives. A press conference is planned for Thursday.

Small bondholders and large money managers alike oppose a government-backed plan that calls for them to swap their $27bn in bonds for a 10 per cent equity stake in GM. Without their support, GM is likely to follow its smaller rival Chrysler to bankruptcy court by the end of the month.

Individual investors hold about 20 per cent of the $27bn in unsecured debt in question. Beyond GM, individuals form a significant part of the overall US corporate bond universe – although their presence in this market is not as big as it is in the municipal bond market, where individuals are the bedrock buyers, or the stock market.

Data from the Federal Reserve show US households hold $1,600bn in corporate bonds, 25 per cent of the $6,300bn market. Typically, they are holders of blue-chip companies, rather than obscure small caps.

One of the main reasons for this is that retail investors and particularly retirees in need of income have been attracted by the higher yields that corporate bonds pay, against the background of a long decline in US interest rates.

Robert Williams, director of income planning at the retail brokerage Charles Schwab, said: “People look at their bond portfolio and they want to chase yield.

“There is no way around the fact that higher yields come with higher risk.”

Bondholders at the GM meeting in Philadelphia did not understand that risk as they scooped up GM bonds yielding 7 to 8 per cent. Several said they thought their money was relatively safe because they owned bonds instead of GM stock, even as the company’s business prospects deteriorated. Equity holders have a weaker position than bondholders in the event of a corporate default. GM also sold $4.7bn “retail notes” that were designed for individuals.

The GM bond dispute is playing out against a rally in corporate bonds, in spite of expectations of the worst spate of defaults in US history and larger losses than ever on the debt of companies in distress.

Since early March, US investment-grade corporate bonds have returned 6.7 per cent and high-yield bonds 23 per cent after losing 6.8 per cent and 26 per cent, respectively, in 2008, according to a Merrill Lynch index. MGM Mirage, the casino operator that warned of default just a few months ago, sold $1.5bn junk bonds last week.

Retail investors have recently poured cash into high-yield mutual funds at a record rate. They are drawn by high interest rates compared with the alternatives and a confidence that the losses will not be as severe as they might have thought a few months ago. If they are right, the rewards for this extra risk will be high.

The average yield on investment-grade bonds is 6.81 per cent and for junk bonds it is almost 15 per cent. The 10-year US Treasury yields 3.15 per cent.

However, the GM experience shows losses can be large when a corporate bond investment sours, a fact that will have been noted by many other individual holders of GM bonds.

With time running out on a June 1 deadline imposed by the government for GM to sort out sacrifices among its creditors, a bankruptcy filing looks likely. GM bonds fell to fresh lows last week with long-term debt quoted at less than 5 cents on the dollar.

GM’s bondholders argue that they are being asked for disproportionate concessions compared mainly with the United Automakers Union. Bond analysts largely agree. Unions will receive 39 per cent of GM and $10bn in cash over time for a $20bn claim that is related to a healthcare benefit fund and, like GM bonds, is unsecured.

The GM situation follows a bankruptcy at Chrysler where a group of its secured lenders, which did not inc­lude individuals, dismissed a debt-cutting deal as unfair.

The GM bondholders are calling on Barack Obama, US president, to intervene on their behalf for better terms in GM’s restructuring and for a voice in the negotiations. Only about 35 supporters attended the Philadelphia meeting and about 30 showed up for the rally the same day in Tampa. But the Main Street bondholders have one advantage over the large money managers who dominate the market and GM’s investors base.

“These retail bondholders might have a political lever to pull,” said a securities litigator at a big New York firm.

At last week’s rally, Mark Modica took the podium and said: “I have more than one reason to hope that GM stays out of bankruptcy.” Mr Modica not only holds GM bonds; he is also a manager at a GM dealership.

The group and the events are being sponsored by the 60 Plus Association, a non-profit conservative advocacy group for senior citizens.

Meanwhile, William Nast, a semi-retired lawyer from Harrisburg, Pennsylvania, is looking at a loss of almost $9,000 that he will not soon forget. “Maybe the next time I look for a car, I will look at a Ford,” he says. But he makes it clear he will probably steer well clear of Ford bonds.

Copyright The Financial Times Limited 2009