12/12/2008

Investors Lack Faith in Automaker Rescue

Structured-product investors remain skeptical about government efforts to bail out Chrysler, General Motors and possibly Ford.

Even after the U.S. House of Representatives passed a $14 billion rescue plan for Chrysler and GM Wednesday, bonds backed by their car loans - and Ford's - were trading at massive yields. The message: failures are still likely, even if the rescue measure ultimately clears the Senate and is signed into law.

The sentiment is evident in an increasing differential between the yields investors are demanding on bonds backed by loans from the Big Three automakers and offerings from their healthier competitors in Japan.

For example, triple-A-rated 1.8-year securities issued earlier this year by Ford and GM affiliate GMAC have been making the rounds on the secondary market at prices of just above 80 cents on the dollar, a trader said. That translates into spreads as wide as 1,400 bp over Eurodollar futures.

By contrast, Honda fetched spreads of 350 bp over Libor for the 1.7-year senior piece of a $297 million transaction it priced via bookrunner J.P. Morgan on Dec. 8 (see Initial Pricings on Page 10). Similar bonds have been trading just above 500 bp over Libor on the secondary market.

Even a few weeks ago, there was a far smaller gap between returns on bonds from the two categories of automakers - with the growing disparity driven by falling values among issues from U.S. players. Single-A and triple-B subordinate securities from the Big Three have lost 10-15 cents on the dollar over the past week, as worried bondholders overwhelmed the market with bid lists amid weakening demand. In some cases, those products are now trading around 40 cents.

Even senior securities, backed by prime-quality loans, are trading at levels closer to those for subprime auto paper. For instance, 4-month notes from AmeriCredit are going for 1,800 bp over benchmarks.

The clear implication is that asset-backed bond investors have little faith in the business models, and underlying assets, of the Detroit automakers at a time when car sales are plunging. That has actually been the case for a while, as the recent loss in value among the companies' bonds merely accelerated a pattern in which spreads on those issues have widened in "a straight line" for a year, one buysider said.

At this point, investors want to see firmer indications that the House bailout will be signed into law, as support in the Senate remains unclear and concerns mount that Chrysler and GM may run out of cash by yearend. "Until [the lending package] has some teeth," bond values aren't likely to improve, the buysider said.

Investors are also worried about whether the rescue effort will be enough to keep Chrysler and GM afloat. Traders say the main factor driving spreads wider is a belief in the "imminence of default" - a widespread conviction that at least one of the Big Three will fail or at least go bankrupt even after receiving government funds.

There is a layering of factors at work in how bankruptcy fears translate into dipping values for the companies' asset-backed bonds. Generally speaking, already credit-averse investors are skittish about payment disruptions stemming from both operational troubles at the automakers and weakening performance among borrowers. Vehicle resale values also come into play, as do individual deal structures and uncertainty about whether government assistance would do anything to help bondholders directly.

A bankruptcy would have the most impact on holders of bonds backed by dealer-floorplan credits. That's because most of those deals, backed by loans that finance dealer inventory, would enter early amortization under such a scenario, according to a Dec. 4 report from Deutsche Bank. Dealers would also find it harder to pay their bills as automakers cut off financial support to those shops and the few consumers who are buying lean toward manufacturers on more solid footing.

Auto-loan or lease bonds aren't as likely to pay off ahead of schedule. But an issuer bankruptcy would often trigger provisions in which noteholders could vote to install a new servicer. That could lead to a disruption or slowdown in payments as a new servicer is found and brought up to speed.

The dual effect of declining overall sales and a bankruptcy would also speed up an ongoing decline in used-car values, which would make it harder to compensate for defaults by liquidating repossessed vehicles. Barclays analysts wrote in a Nov. 21 report that Oldsmobile values fell 5-6% after GM discontinued the line in 2004. An automaker bankruptcy would likely result in a 25% reduction in the value of cars made by that company, they said.

Borrowers are also less likely to pay loans ahead of time when their vehicles are worth less, slowing the flow of cash into securitization trusts.

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