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GM At An Inflexion Point, CDS isn’t so bad


Bloomberg: General Motors Says It May Run Out of Operating Cash This Year

General Motors Corp., seeking U.S. aid to avoid collapse, said it may not have enough cash to keep operating this year and will be “significantly short” by the end of June unless the auto market improves or it adds capital.

Available cash fell to $16.2 billion on Sept. 30 from $21 billion at the end of June, the largest U.S. automaker said yesterday as it reported a $4.2 billion third-quarter operating loss. Merger talks with Chrysler LLC were suspended.

“Things are clearly deteriorating more quickly than people expected,” said Jill Fields, who manages $2 billion in high- yield debt as managing director at Babson Capital Management LLC in Springfield, Massachusetts. “They’re either going to need aid or they’re at risk for filing” for bankruptcy.

GM’s bankruptcy may not be as bad as people think. A number of reports out there mentioned that Credit Default Swaps on GM’s debt far outweigh the actual underlying debt, and that may cause a payment crisis. Reuter’s says this is not so:

The amount of debt outstanding at General Motors Corp , Ford Motor Co , General Electric and others dwarfs the amount of credit default swap (CDS) risk on the companies, according to new data.

The data contrasts with fears that CDS volumes have surged to represent several times the amount of debt they insure, and that the high volumes raise the risk that protection sellers will be unable to make payments when borrowers default.

Credit default swaps are used to protect against the risk of a corporate, sovereign or other borrower defaulting on their debt, or to speculate on their credit quality.

Growth in the contracts has propelled gross volumes to $33.56 trillion globally, drawing ire and fear from regulators and observers concerned about the market’s runaway growth.

New data however, shows that for most of the actively-traded companies, the real amount of CDS exposure is far below their debt.

The confusion arises from the oft-quoted gross numbers, which vastly overstate the actual amount of risk.

For example, $64.72 billion in gross CDS exposure, known as its notional volume, is outstanding on GM, according to data the Depository Trust & Clearing Corporation (DTCC) released for the first time on Tuesday. DTCC clears the majority of CDS trades and has agreed to release the data on a weekly basis to improve the transparency of the market.

The gross number may stoke concerns that investors on the wrong side of the trade could face massive losses if the automaker defaults.

However, after reducing trades that offset each other, for example where a dealer has both bought and sold protection in equal measure, the net exposure to GM is a much more manageable $4.06 billion, the DTCC data shows.

GM’s net exposure is significantly lower than the $32.45 billion the company has in outstanding long-term debt.

But how does this work with counterparties? Let’s say one big guy had $1 billion on the buy side and $1.5 on the sell side, being net short $0.5 billion. This, let us just surmise, is too much – the guy is overleveraged, and GM defaults, with our guy needing to payout $0.5 billion. He defaults, and declares bankruptcy.

Effectively whoever bought from this guy is now short $0.5 billion, which can trigger another bankruptcy and so on. The risk of counterparty default will dramatically increase margins – and that will render the business unprofitable, but you can’t get out. This kind of risk isn’t usually encapsulated in the VaR models of protection sellers, and if you do account of it the returns are so small there will be no bonuses. Uhem.

This could either destroy profitability or take more players down. It’s interesting that with defaults at Lehman, the three Iceland banks and others, there has been no announcement of bankruptcy. But if GM joins the fray will it trigger a round? We’ll have to wait and see.


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