Insolvency experts say a possible Chapter 11 filing for General Motors would likely be protracted – lasting at least a year – and could provide a blow to markets.
Although Washington has taken steps to soften the impact of a possible GM bankruptcy on automotive parts makers and US consumers, industry experts still warn of a ripple effect that could see many suppliers fail and lead to knock-on effects in other parts of industry, including overseas.
“While the bankruptcy filing of Lehman Brothers was a defining moment for the financial sector and the credit crisis, the filing of Chapter 11 by GM would be a defining moment for the manufacturing sector,” said Malcolm McKenzie, managing director at Alvarez & Marsal, the restructuring firm.
The US Treasury and Fritz Henderson, installed as GM chief executive in late March, are increasingly speaking of bankruptcy as an option – government officials believe a filing could be quick and “surgical”.
On Friday, Mr Henderson said he still hoped GM would restructure outside court but that “the clock is ticking” on talks with unions and bondholders aimed at winning sweeping cuts to its costs and debt load ahead of a government-set June 1 deadline.
Mr Henderson said GM was making contingency plans on “several tracks” and studying options including a pre-packaged bankruptcy agreed beforehand with the US government, bondholders and unions, or the split of the company into more- and less-viable assets under Section 363 of the Bankruptcy Code.
Analysts said the statements are in part calculated to cajole GM’s stakeholders into a deal.
President Barack Obama and officials from his administration’s auto industry task force have spoken of their commitment to sustaining a US domestic car industry.
However, some restructuring experts believe a Chapter 11 filing by GM is unavoidable and warn that its fall-out could be hard to predict.
“A Chapter 11 filing by GM is inevitable and, while the administration is likely to try and minimise any shock from a filing, it is likely to be protracted and messy,” said Steven Smith, global head of restructuring at UBS in New York.
“It could also be challenging to restructure its overseas operations [and] the bankruptcy filing of a US premier blue-chip company could have a further negative impact on the consumer,” he added.
It would mark potentially the largest failure of an industrial business by far.
With the complexity of the company and the likelihood of creditors holding out, John Fenn, US credit strategist at Citi, said credit investors believed a filing could last one to two years.
In 2005, the downgrading to junk status of GM and Ford dealt a severe blow to markets. Investment grade bondholders were forced to sell and many investors suffered losses as they moved to unwind positions in complex vehicles that had been structured on the assumption that a big company – such as GM whose debt is widely held – would not fail.
Credit investors are prepared for an insolvency this time around but “the equity markets will likely take a GM bankruptcy harder than credit markets”, Mr Fenn said. “There will be a certain amount of shock on the event of a GM filing for the man in the street.”
The psychological impact of a US industrial icon filing for bankruptcy protection in an economy in recession has some observers worried.
“Remember, many policymakers believed the financial system could handle the Lehman Brothers bankruptcy,” said Joseph LaVorgna, chief US economist at Deutsche Bank, in a report. “Similar to then, we worry policymakers may underestimate the impact a bankruptcy could have on the real economy.”
He added that financial markets are right to be worried about the prospect of a GM and Chrysler insolvency.
“A bankruptcy (even a controlled one) would put downward pressure on production, further upward pressure on the unemployment rate and likely negatively impact consumer confidence with obvious adverse consequences for spending,” he said.
Estimated job losses as a result of an insolvency could add another percentage point to forecasts of the peak unemployment rate – currently 10.5 per cent.
The US Treasury, while raising the spectre of bankruptcy for GM and Chrysler, last month agreed to backstop warranties for both carmakers’ vehicles in a bid to allay customers’ worries that they could not obtain parts or service for an insolvent company’s product – a fear that could both hurt consumer confidence and accelerate Detroit’s downward spiral.
Washington also agreed to provide up to $5bn for imperilled suppliers. Yet while GM will likely seek court permission to continue paying some “critical” vendors after filing for bankruptcy, other supply contracts would be automatically up for renegotiation.
Some suppliers would inevitably fail, analysts say, endangering both their own customers and other carmakers that buy from them.
“There continues to be a very serious risk in the sector because the majority of suppliers have razor-thin liquidity and won’t be covered by the GM programme,” said Craig Fitzgerald, a partner with Plante & Moran, an accounting and consulting firm that has many parts makers as clients.
GM’s suppliers overseas, where it has operations on five other continents, would also be at risk.
“A bankruptcy could clearly cause knock-on effects on the already weak players on the market,” said Markus Leitner, a Frankfurt-based director with Fitch Ratings.