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Cash for Clunkers

GM's road to insolvency has been littered with unhappy shareholders.

As General Motors Corp. drove into a financial ditch, its trip to bankruptcy court was greased by $33 billion in loans from the U.S. Treasury and from Export Development Canada, a state-owned enterprise. Such loans to bankrupt companies, known as debtor-in-possession financing, can be notoriously expensive. Rates, including fees, reached as high as 20 percent in February and generally remain in the low to mid-teens.

GM won’t be paying nearly market rate on its credit, though. The U.S. and Canadian governments, which will own a combined 70 percent of the new auto company expected to emerge from bankruptcy, perhaps as early as July, have provided it with some of the cheapest DIP financing in history. Neither the company nor the Treasury would comment on the details. The Treasury referred all inquiries from Institutional Investor about the cost of the loan to GM, which in turn addressed questions by referring II to its 166-page DIP filing. The document includes a formula for calculating the floating-rate loan. According to that formula, the nondefault rate for the bulk of the deal has a floor of about 5 percent. The rate is calculated by adding LIBOR or 2 percent — whichever is higher — to a base of 3 percent.

"The interesting question is whether the rate on the DIP loan was lower than appropriate," says S. David Cohen, professor of law at Pace Law School in White Plains, New York, who is writing a book on the GM bankruptcy.

GM filed for protection on June 1, reporting assets of $82.3 billion and liabilities of $172.8 billion. Based on assets it’s the fourth-largest bankruptcy filing in U.S. history, after those of Lehman Brothers Holdings, Washington Mutual and WorldCom. The reorganization will be financed with $19.5 billion that the Treasury issued earlier this year and $30 billion that it will issue later. That $49.5 billion, along with $9.5 billion from the Canadian EDC, which provides credit to exporters, will be rolled into $59 billion in equity in the reborn company. Most of the funds have been distributed, in the form of about $15 billion in bridge loans and the $33 billion DIP financing.

Only one other company has been able to negotiate DIP funding at such a low rate. That’s bankrupt automaker Chrysler Group, which secured $3.3 billion in DIP funding from the U.S. government. Other recent bankruptcies financed by private lenders have been much more expensive. Lyondell Chemical Co., which filed for bankruptcy protection in February, is paying 13 percent in interest and 7 percent in fees to lenders. Shopping mall operator General Growth Properties, which filed for Chapter 11 protection this spring, secured $400 million in DIP financing from half a dozen investment companies in early May with a rate of LIBOR plus 12 percentage points. At the end of June, most DIPs still had rates of LIBOR plus 10 to 14 percentage points.

General Motors’ DIP loan was arranged with the help of William Repko, head of the restructuring practice at Evercore, the New York–based investment bank founded by former Clinton administration deputy Treasury secretary Roger Altman. According to an affidavit, Evercore was paid $25 million for its work on the deal. Repko declined comment. Weil, Gotshal & Manges provided legal counsel for GM.

GM will derive a competitive advantage from its cheap government financing, asserts Dan Ikenson, associate director of trade policy at the Cato Institute, a libertarian think tank in Washington. "No one else has access to capital at that rate," he says. Allows Pace Law School’s Cohen: "It is a significant advantage for GM. But at the same time, GM is giving up control."

DIP lending is a lucrative business for private investors. But it’s not clear how much return taxpayers will see on their DIP financing, which will be converted into equity in the new GM. If the new owners, including the U.S. and Canada, can’t operate GM in the black or sell it for a profit, the return on the DIP loan could be zero.

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