Hedge funds and other investors stand to make huge profits on credit default swaps (CDS) if GM deÂclares bankruptcy, a prospect that is complicating efforts to persuade creditors to agree to a restructuring plan for the automaker.Holders of $27bn in GM bonds have until June 1 to decide whether to swap their debt for a 10 per cent equity stake in the company as part of an offer that would give the US government 50 per cent of the shares, a United Auto Workers union healthcare fund 39 per cent and existing shareholders 1 per cent.
However, analysts say the chances the proposal will be accepted have been diminished by the large number of CDS contracts written on GMâ??s debt.
Holders of such swaps would be paid in the event of a default â?? but would lose money if they agreed to restructure GMâ??s debt. For investors who own bonds and CDS, this could create an incentive to favour a bankruptcy filing.
According to the Depository Trust & Clearing Corporation, investors hold $34bn in CDS on GM. Considering hedged positions, the DTCC estimates CDS holders would make a net profit of $2.4bn if GM were to default.
The opposition of 10 per cent of bondholders is enough to derail the proposal, which has already triggered protests from investors who argue it unfairly rewards the UAW at the expense of bondholders.
Prices for GMâ??s debt and CDS indicate investors believe a bankruptcy filing is highly likely. GMâ??s bonds are trading at between 6 and 12 cents on the dollar. To insure $100m in GM debt for five years, an investor would have to pay $89m plus another $5m a year over the life of the CDS contract.
