Cars and bonds have nothing in common.
You probably are thinking that any fool knows that.
But on an emotional level, investors missed that point the last few years. They bought bonds of General Motors Corp. and its General Motors Acceptance Corp. financial-services subsidiary, figuring they were as rock solid as the cars they’ve seen on the street all their lives.
Familiarity with the GM name and its vehicles bred complacency. But with GM’s financial problems a mainstay of business headlines lately, retirees have sought assurances from me that they will be able to count on income from their bonds and preferred stock.
Unfortunately, those assurances are not available.
“The risks are significant, and investors must incorporate these risks into their investment decisions,” Merrill Lynch analyst Matthew Burnell said in a recent report.
Burnell thinks there’s more than a 30 percent probability that GM will file for Chapter 11 bankruptcy protection over the next two years.
And if that happens, he said, investors probably would not get back their full principal–the money they originally invested in the bonds. If the company were to be liquidated, he estimates, GM bonds would be worth less than half of their value. And if GMAC filed separately for bankruptcy, those bonds would be worth about 90 cents on the dollar, he said.
Rather than liquidating the company, analysts think it’s more likely that GM would file for Chapter 11 as a strategic move. That would give the company a chance to get out from under contracts with the United Auto Workers–contracts that saddle GM with pension and retiree health-care costs the company cannot afford on a long-term basis, analysts say.
In Chapter 11, GM would continue to build cars, but it would attempt to renegotiate union contracts. The bankruptcy court could force the matter.
Bond analyst Richard Lehmann of Income Securities Advisors estimates that if GM goes through Chapter 11 bankruptcy, investors would end up with bonds worth about 65 cents on the dollar, or a little less than where they are trading. But he doesn’t think the company will file for Chapter 11. He assumes GM will be able to renegotiate union contracts with the UAW.
But predicting the outcome of union negotiations is not easy.
Analysts are focused on union negotiations at Delphi Corp., a major supplier of GM’s auto parts that has filed for bankruptcy protection. If talks fail and workers strike, that could present dire consequences for GM, said Shelly Lombard, a high-yield-bond analyst for Gimme Credit.
GM has about $19 billion in cash. But lately GM has been burning through cash at a disturbing rate, about $2 billion a quarter, because customers are reluctant to buy sport-utility vehicles, and GM has to cut prices to compete with overseas automakers.
If Delphi workers strike, and GM has to cut production sharply, UBS analyst Rob Hinchliffe estimates GM would burn through its cash in 10 weeks.
The concern is, said Lombard, “They won’t have enough cash to pay the bills.”
If the Delphi matter is resolved without a strike, GM would have time to try to secure stronger footing. The automaker is attempting to sell a 51 percent stake in GMAC, which makes auto, commercial and residential loans.
While Wall Street’s immediate attention is focused on the threat of a Delphi strike, or the relief that a GMAC sale could provide, analysts say General Motors also has long-term challenges that must be resolved.
Previously, GM struggled through recessions, but now the economy and employment are strong, said Margaret Patel, who manages the Pioneer High Yield bond fund.
“If GM is not prospering in these times, that ought to tell you this is different,” Patel said.
Consequently, she sees the bonds as too speculative for her fund.
Meanwhile, Burnell looked back at how bonds have acted over the last 35 years, when rated B by Moody’s, the current GM rating. It’s a sobering view. About 59 percent default within 20 years, 30.5 percent within five years, and 5.8 percent within one year.
That leaves investors with tough decisions if they are holding GM bonds.
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Contact Gail MarksJarvis at gmarksjarvis@tribune.com or leave a message at 312-222-4264.
