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GM and GMAC: Till Death Do Us Part?

GM and GMAC are still addicted to each other. If GM fails, what would GMAC fund? If GMAC fails, who will fund the dealer network?

General Motors (GM) - Get General Motors Company Report and major investor Cerberus Capital Management appear to be on the verge of getting a divorce, but there is no agreement possible on the terms. The seemingly irreconcilable difference? GM needs GMAC, and GMAC needs GM. The failure of either the automaker or its financial-services firm would have catastrophic consequences for the GM brand and the dealer network.

When GMAC Financial Services shocked the dealer network in the U.S. by announcing significant consumer and wholesale funding changes, the charge was that GMAC was no longer "there for the dealers" through good and bad times. This was GMAC's stock argument when competing banks and finance companies perennially offered better financing packages for non-subvented business.

GM traditionally subsidized GMAC for up to 89% of consumer financing offered. For regular business, GMAC was frequently uncompetitive. In return, GMAC funded dealerships that, under normal credit guidelines, would not have received the facilities granted. For several years, GMAC struggled to maintain a competitive position as the cost of funds rose due to GM's declining credit rating. Being unable to pass on the additional costs, GMAC was forced to cut expenses and become more and more efficient.

GM realized that it was causing GMAC to incur a significant financial penalty for being part of the corporation. Knowing how successful GMAC had been over the years at generating profits when everything else was red at GM, it decided to enter into what has turned out to be a disastrous relationship with Cerberus, or a mark of genius depending on your perspective. Closing the deal in 2006, GM raised billions that were urgently needed to fill the deficit in its pension fund and gave GMAC the opportunity to improve its credit rating.

It was entirely possible that if GMAC had remained profitable GM could have realized almost as much cash from the 49% retained in the company as it had with 100% because of the cost of borrowing. Not a bad thing you might say, but the next quarter GMAC started to rack up losses. GMAC had bet heavily on the housing market and as the market crashed, the chickens started to come home to roost. The red ink at GMAC flowed quarter to quarter and borrowing costs rose exponentially with the credit downgrades that followed.

Now

GMAC is struggling

to borrow from the market and finding it impossible to raise cash at a rate that would allow it to lend at reasonable rates. It has decided that funding under the

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Troubled Asset Relief Program

, would at least help keep the business alive. But to get the aid from the $700 billion TARP, which was set up in October to bailout troubled banks, GMAC must become a bank holding company. The request was considered, and GMAC was commanded to improve its capital base.

As a result, the bondholders were requested to swap their bonds for cash or preferred stock. GMAC is trying to raise more than $30 billion. After an embarrassing lack of take up, GMAC extended the offer period three times. If it fails to get the 75% acceptance of the offer by 5 p.m. EST today, GMAC has stated that it will withdraw the application for bank status and consequently access to the TARP funding.

The consequences of that action are potentially far-reaching. Cerberus has indicated that GMAC could be forced into bankruptcy. This would have a terminal effect on many of GMAC operations, including overseas, where inevitably the credit lines extended would be withdrawn and the dealer lines of credit would have to be closed. Dealers in many cases would be unable to refinance the operations and several thousand could be forced to close their doors permanently.

GM has stated that it is over-represented at the dealership level and needs to cut back around 2,000 dealers; however, a disorganized series of closures could be a disaster for GM. GMAC filing Chapter 11 could put GM under, whether or not bailout funds are made available to GM, because banks are still unwilling to lend and will almost certainly not offer inventory funding to the extent that GMAC has always provided, around 80% of all new GM vehicles. This would make funding the newly manufactured vehicles impossible, and GM cannot possibly fund them on its balance sheet.

GM announced today a significant reduction of planned production for the first quarter of 2009 due to the ongoing and severe drop in industry sales. This will result in the temporary idling of roughly 30% of GM's North American assembly plant volume during the first quarter of 2009 and will remove about 250,000 units from production.

GM's announcement today said: "The speed and severity of the U.S. auto market's decline has been unprecedented in recent weeks as consumers reel from the collapse of the financial markets and the resulting lack of credit for vehicle financing."

So, while everyone holds their breath over the President's decision to offer the automakers a bailout, market forces in the form of bondholders of GMAC could hold the key to the survival of both GMAC and GM in their hands. What is interesting is that Cerberus appears to be disinterested in additional investment. This is not a positive sign and raises the question: "If they won't support their own investment, why should the taxpayer?"

Gavin Magor joined TheStreet.com Ratings in 2008, and is the senior analyst responsible for assigning financial strength ratings to health insurers and supporting other health care-related consumer products, including Medicare supplement insurance, long-term care insurance and elder care information. He conducts industry analysis in these areas. He has more than 20 years' international experience in credit risk management, commercial lending and analysis, working in the U.K., Sweden, Mexico, Brazil and the U.S. He holds a master's degree in business administration from The Open University in the U.K.