GM creditor cracks show as bankruptcy looms

The risk of a General Motors Corp bankruptcy is rising, causing bondholders to pursue independent strategies to protect their interests if GM's survival battle moves to bankruptcy court, two sources close to the government talks with GM said on Tuesday.

The Obama administration's auto task force led by Steven Rattner is in its second week of talks in Detroit in an effort to revamp GM's restructuring plan and wrest concessions from bondholders and labor, and is preparing a reduced term sheet for GM bondholders for about $28 billion of unsecured debt.

Until now, a 10-member bondholder committee has shown a united front, but cracks may be starting to show, leading to independent bankruptcy strategies, according to two sources familiar with the group.

With about 45 days for GM to present new restructuring plans before the government's June 1 deadline, creditors are beginning to shift tactics to prepare for a possible Chapter 11 filing.

GM creditors specifically have expressed frustration over the lack of direct communication from the U.S. government or from GM in their talks.

Bankruptcy court is a big unknown, and saying that we'll be in and out within two months doesn't sit right, said one person close to the bondholder committee, referring to the surgical bankruptcy scenario U.S. officials have described as an option for the automaker.

At least one large bondholder is preparing for potential bankruptcy by reviewing which courts may be most favorable to bondholders, and has ruled out the Eastern District of Michigan as being more favorable to the United Auto Workers union, according to a second source familiar with the talks.

The perception is that GM and the union would have a home court advantage in Michigan, and that the issue may draw protests in Detroit and enflame emotional confrontations, as opposed to a potential filing in New York or Delaware, that person said.

The government seems on track to direct this to a controlled bankruptcy, said Shelly Lombard, senior high-yield analyst with research firm Gimme Credit headquartered in New York. The key question is how can bondholders extract value. They don't have a lot of leverage or options other than lawsuits.

GM bonds were the second most actively traded in the high-yield bond market, with GM's 8.375 percent notes due in 2033 dropping almost 1 cent on the dollar on Tuesday to 9 cents, yielding more than 91 percent, according to MarketAxess data. They traded as high as 20 cents last month.

In negotiations with bondholders, GM last month offered 8 cents cash on the dollar, 16 cents on the dollar in new unsecured debt, and a 90 percent stake in the automaker, according to one person who saw the term sheet.

A new offer may include no cash, no new debt and perhaps as little as 10 percent equity in the company, which may amount to almost zero recovery value for bondholders, Lombard said.

These investors are starting to consult advisers on their own, but ultimately in a capital structure bondholders can probably cut a better deal as a group, she said.

GM already faces a lawsuit in Canada from unsecured bondholders over dividends GM paid from a Nova Scotia unit last May to its U.S. operations, according to court documents.

Those bondholders claim the company wrongfully pulled around $600 million from the Canadian subsidiary because company officials should have known the U.S. business was near insolvency, the documents said.

More legal battles are likely, according to Lombard and bondholders.

The goal is to have an honest negotiation and that's what we're holding out for, one source said, who declined to be named due to the confidential nature of the negotiations. An out-of-court scenario is becoming less and less likely with each passing day.

GM's shares, which traded above $24 a year ago, rose 4 percent on Tuesday to $1.78.