GM Bankruptcy Looms Large for Bondholders

As General Motors (GM) sputters toward a likely bankruptcy, the company’s bondholders might be feeling a bit carsick. The government gave the ailing car maker until June 1 to lay the groundwork for a possible bankruptcy filing. In a press call on Friday, new CEO Fritz Henderson said that while bankruptcy is not the company’s first choice, a Chapter 11 filing is “probable” since “the clock is ticking.”

The fate of GM’s $27.3 billion in bonds — held by mom-and-pop investors, mutual funds and other big institutions — remains unclear. GM bonds (more specifically, its “senior unsecured debt”) are not backed by any collateral, like the company’s assembly plants or real estate assets. And it’s what most individual investors own, says Andrew Rahl, bankruptcy partner at Reed Smith. Part of the negotiations with bondholders will involve a business plan that GM plans to present to them sometime this month, Henderson said on Friday.

The past offers some guidelines about what bondholders can expect in the bankruptcy process. When a company files for bankruptcy, the court appoints an official committee to represent bondholders in negotiations that will take place among the company, the government, the unions and other stakeholders, says Evan Flaschen, head of the financial restructuring practice at Bracewell & Giuliani. Bondholders can register with the federal bankruptcy court where GM files for Chapter 11 to receive regular email updates on the negotiations that will hash out, among other topics, how much bondholders can expect to recover. When the negotiators reach a reorganization plan, all bondholders will receive a paper ballot in the mail so they can vote on the plan, Flaschen says.

As companies cut their debt loads in a bankruptcy restructuring, bondholders often receive stock shares to replace their bonds. Companies stop paying interest on their bonds in bankruptcy, and interest doesn’t accrue for unsecured debt. Individual bondholders can then decide whether to hang onto their shares or sell them.

Investors whose mutual funds hold GM debt have already suffered losses. Bellwether GM bonds maturing in 2033 have dropped 39% since March 30, the day after President Obama asked former CEO Rick Wagoner to resign and gave the company until June 1 to prepare for a possible bankruptcy. In a diversified bond fund, one particular credit shouldn’t have an outsize effect on the fund’s net asset value. Nonetheless, investors should check to see how much GM debt their fund owns, or how many shares it owns if they’ve been substituted. And investors should assess whether their fund continues to meet their needs, something they should do regularly in any case, says Matt Hastings, portfolio manager of the Schwab Premier Income fund (SWIPX).

A big question looming over GM’s potential bankruptcy is how the government’s deep involvement in the company will affect the process. GM has already taken $13.4 billion in bailout funds from the federal government. Any decision to enter bankruptcy would be made among company management, the board of directors and the U.S. Treasury, Henderson said on Friday. But the government can be a wild card, says Sandeep Dahiya, associate professor in Georgetown University’s McDonough’s School of Business: “Whenever politics is involved, decisions are not made for economic reasons.”