GMAC Leaves Individuals Holding Car Lender’s Junk

A GMAC Real Estate sign, attached to a sign advertising 0% down financing, is posted in the front yard of a home in Norcross, Georgia, on Sept. 12, 2007. Photographer: Chris Rank/ Bloomberg News

Nov. 7 (Bloomberg) — GMAC LLC may leave thousands of individuals on the hook for about $15 billion of junk-rated debt unless the auto and home lender finds a way to pay its bills.

GMAC, the largest lender to car dealers of General Motors Corp., issued more than $25 billion of debt called SmartNotes over the past decade to retail investors. While GMAC has paid off the debts as they matured, five straight unprofitable quarters raised doubt about GMAC’s survival, and SmartNotes due in July 2020 have lost about three-quarters of their value.

“An investment like this is totally unsuitable for the retail investor,” said Sean Egan, president of Egan-Jones Ratings Co. in Haverford, Pennsylvania, who rates GMAC bonds junk, or below investment grade. “You’re selling it to the widows and orphans who think of GMAC as being this strong, long- standing corporation when the reality is far from that.”

GMAC’s losses since mid-2007 total $7.9 billion, driven by record home foreclosures and auto sales that GM has called the worst since 1945. Stomaching some of Detroit-based GMAC’s deficit are individuals who purchased SmartNotes through brokers at firms including Merrill Lynch & Co., Fidelity Investments and Citigroup Inc.’s Smith Barney unit.

Chuck Woodall, 66, who lives with his wife in Columbus, Ohio, amassed $200,000 of SmartNotes starting eight years ago, and they now equal about 25 percent of his investments. At the time, the securities were rated investment-grade and they paid more interest than government bonds or certificates of deposit. They also were backed by Detroit-based GM, the biggest U.S. automaker.

Safe Ride

Woodall, a former owner of apparel stores and a pet-supply business, holds SmartNotes due in 2018 that he says have lost about 80 percent of their value. He said his Merrill broker told him that in more than 20 years, no client had lost money on bonds.

“He assured me they were safe,” Woodall said. “I just wasn’t aware enough and didn’t have my hand on the pulse.”

GMAC said Nov. 5 its mortgage unit may fail and analysts have questioned the viability of the entire company, which is now 51 percent-owned by New York-based Cerberus Capital Management LP. GM controls the rest.

Of GMAC’s $64 billion in debt outstanding at the end of June, about $15 billion was in SmartNotes. They rank equal to senior unsecured debt, which recovers an average of about 40 cents on the dollar in bankruptcy cases, according to Mariarosa Verde, an analyst at Fitch Ratings in New York.

GMAC spokeswoman Gina Proia said the company “has honored its commitments and intends to continue honoring its commitments to investors.” She declined to elaborate.

Bonds Drop

SmartNotes maturing in July 2020 fell 6.5 cents on the dollar, or 20 percent, to 26.7 cents at 4 p.m. New York time, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The debt yields 35.8 percent, or 32 percentage points more than similar-maturity Treasuries, Trace data show.

Brokers traditionally handle the task of determining whether an investment is suitable for a particular investor, depending on factors such as assets, sophistication and tolerance for losses. Merrill spokesman Mark Herr, Steve Austin from Fidelity and Citigroup’s Alex Samuelson declined to comment.

SmartNotes were introduced in 1996 by ABN Amro Holding NV’s Chicago-based LaSalle Bank, which is now part of Bank of America Corp. in Charlotte, North Carolina. The notes include features designed to appeal to investors seeking interest income — a concern for older people and retirees.

Prosperous Times

The notes were sold in denominations of $1,000 and offered a “survivor’s option,” allowing spouses to sell the bonds back to the issuer if the owner dies. The SmartNotes program opened to European investors in 2004.

GMAC and LaSalle said in statements from 1998 through 2003 that the notes were intended for individual investors. Patrick Kelly, a LaSalle managing director, described the buyers in a 2003 interview as “mom-and-pop investors.”

“If Wal-Mart sold bonds, these would be the bonds they would sell,” Kelly said.

Back then, SmartNotes may have been safer bets. GMAC debt was rated BBB by Standard & Poor’s, GM and GMAC were profitable, and the lender was still a wholly owned unit of the automaker. Sales of GMAC SmartNotes reached $1 billion in 1998, doubled the following year and exceeded $25 billion in 2003, when GMAC was on its way to earning $2.8 billion for the year.


“GM was considered a can’t-miss company,” said Thomas Smicklas, a retired high school principal and now a homebuilder in Wadsworth, Ohio, who started buying SmartNotes in 2003. Smicklas said he owns about $75,000 of short-term SmartNotes and hasn’t lost any money. “When the GM name is on something, many investors assumed it’s gold-plated.”

By 2005, GMAC’s debt was reduced to junk — Moody’s Investors Service now rates the firm seven levels below investment grade — and GMAC continued offering SmartNotes as late as 2007. Today, S&P downgraded GMAC to CCC from B-, citing the lender’s “dire situation.” Analysts have also raised concerns about the survival of GM, which today reported a $4.2 billion third-quarter operating loss and said it may not have enough cash to make it through the year.

Tom Ricketts helped create SmartNotes at ABN Amro before leaving in 1999 to start Chicago-based Incapital LLC, which earlier this year bought LaSalle’s retail bond unit. Ricketts said his firm doesn’t issue GMAC notes and sticks with investment-grade bonds. He recommends that individuals who buy them own a wide variety of assets.

Circumstances Change

“When you don’t diversify in any portfolio, you expose yourself to risk that you’re not getting paid for,” Ricketts, 43, said in an interview. “Typically, investment-grade corporate bonds are very good investments.”

GMAC and underwriters of its debt were sued in a 2005 class action that claimed the lender misrepresented SmartNotes in financial statements. A federal judge in eastern Michigan dismissed the case in February 2007, and the plaintiffs are appealing.

“In corporate bonds, time has shown that volatility, credit ratings and potential deterioration in credit means you may own something very different than what you thought you owned,” said Michael W. Boone, founder of MWBoone & Associates, an investment advisory and money management firm in Bellevue, Washington. Boone said individuals should hold corporate debt only in mutual funds, “where they have instant diversification and management.”

To contact the reporters on this story: Ari Levy in San Francisco at; David Mildenberg in Charlotte at

Last Updated: November 7, 2008 17:06 EST
By Ari Levy and David Mildenberg

Source: Bloomberg

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