Saginaw Parts Co. and the General Motors Corp. Credit Default Swap Custom Case Solution & Analysis

Case Evidence Brief: Saginaw Parts Co.

1. Financial Metrics

• Accounts Receivable Exposure: Saginaw maintains a constant balance of approximately 70 million dollars in outstanding receivables from General Motors -GM-.
• Payment Terms: GM operates on a net-60 basis, meaning Saginaw carries two months of revenue as credit risk at any given time.
• CDS Pricing: Credit Default Swap spreads for GM debt have expanded from 400 basis points to over 4,000 basis points within the last twelve months, reflecting a market-implied default probability exceeding 80 percent.
• Insurance Cost: Protecting the full 70 million dollar exposure would require an upfront premium payment of roughly 28 million dollars plus annual coupons, given the distressed levels of GM debt.
• Saginaw Liquidity: The firm holds 45 million dollars in cash and equivalents, making the full CDS hedge a significant drain on current working capital.

2. Operational Facts

• Customer Concentration: GM accounts for 65 percent of Saginaw total annual revenue.
• Supplier Tier: Saginaw is a Tier-1 supplier of critical powertrain components, making its survival linked to GM production schedules.
• Inventory Cycles: Saginaw carries 30 days of raw material inventory specifically tailored to GM specifications, which has zero liquidation value if GM plants idle.
• Geography: Operations are centered in the Midwest United States, with proximity to GM assembly plants being a primary competitive advantage.

3. Stakeholder Positions

• CFO -Saginaw-: Concerned with balance sheet insolvency. Advocates for some form of credit protection to satisfy bank covenants.
• Board of Directors: Divided between preserving cash for operations and the fear of a total wipeout of receivables.
• Lending Banks: Have signaled that Saginaw revolving credit line may be frozen if GM credit rating drops further without a mitigation plan.
• General Motors Procurement: Expects continued supply despite their own liquidity crisis; offers no guarantees on receivable seniority in a potential reorganization.

4. Information Gaps

• Recovery Rate: The case does not specify the expected recovery rate for unsecured trade creditors in a GM Chapter 11 scenario.
• Counterparty Risk: The identity and creditworthiness of the institutions selling the CDS to Saginaw are not detailed.
• Bailout Specifics: The exact terms of potential federal government intervention remain speculative at the time of the decision.

Strategic Analysis

1. Core Strategic Question

• Should Saginaw incur a certain, massive financial loss via CDS premiums to prevent a potential terminal loss from a GM default?
• How can Saginaw maintain bank covenant compliance while its primary revenue source faces insolvency?

2. Structural Analysis

Risk and Exposure Assessment: The situation represents a classic tail-risk event where the probability of default is high and the correlation between the customer and the supplier is near 1.0. Applying a Risk Mitigation Framework reveals that Saginaw cannot diversify away from GM in the short term. The bargaining power of the buyer -GM- is paradoxically weak due to their insolvency, yet Saginaw is held hostage by its own fixed cost structure and specialized inventory. The cost of the CDS is no longer an insurance premium; it is a distressed asset purchase. The structural problem is that the cost of protection now approaches the expected loss, making the decision a bet on the timing and nature of a government intervention.

3. Strategic Options

Option A: Full Hedge via CDS. Purchase protection for the entire 70 million dollar exposure.
Rationale: Guarantees firm survival regardless of GM fate.
Trade-offs: Consumes 60 percent of available cash; eliminates profit for the fiscal year.

Option B: Partial Proxy Hedge. Purchase CDS for 35 million dollars -50 percent of exposure-.
Rationale: Balances cash preservation with catastrophe protection.
Trade-offs: Leaves Saginaw vulnerable to a 35 million dollar write-down, which could still trigger technical default on bank loans.

Option C: Operational Retrenchment and Cash Hoarding. Forego the CDS. Halt all non-essential CapEx and aggressively negotiate for shorter payment terms from GM.
Rationale: Bets on a government bailout that protects trade creditors.
Trade-offs: High probability of total insolvency if a bailout excludes Tier-1 suppliers or if GM undergoes a hard liquidation.

4. Preliminary Recommendation

Saginaw must execute Option B -Partial Hedge-. The cost of a full hedge is prohibitive and creates its own liquidity crisis. However, doing nothing is a violation of fiduciary duty given the market signals. A 50 percent hedge provides enough recovery to negotiate a workout with Saginaw own lenders while preserving the cash needed to keep the lights on during a potential GM production halt.

Implementation Roadmap

1. Critical Path

• Day 1-5: Finalize ISDA documentation with a cleared derivative dealer. Avoid over-the-counter trades with weak counterparties.
• Day 6-10: Execute the CDS purchase in tranches to avoid moving the thin market and spiking the premium further.
• Day 11-20: Present the hedging strategy to the lead lending bank to secure a waiver on credit-linked covenants.
• Ongoing: Weekly monitoring of GM production pull-signals to adjust raw material purchasing and minimize inventory exposure.

2. Key Constraints

• CDS Liquidity: As GM nears a filing, the market for protection may gap or disappear entirely, making execution timing the most critical variable.
• Cash Burn: The upfront cost of the premium reduces the cushion for operational disruptions. Any strike or plant closure at GM during this period will stress Saginaw payroll capabilities.

3. Risk-Adjusted Implementation Strategy

The plan assumes a 45-day window before a definitive GM credit event. If the cost of CDS exceeds 50 percent of the face value of the receivables, the strategy must pivot from hedging to factoring. Saginaw should attempt to sell its GM receivables at a discount to a distressed debt fund. This converts the AR to cash immediately, albeit at a loss, removing the need for complex derivative contracts and eliminating counterparty risk. This contingency should be triggered if the CDS spread exceeds 5,000 basis points.

Executive Review and BLUF

1. BLUF

Saginaw must immediately hedge 50 percent of its GM exposure through Credit Default Swaps. The 70 million dollar receivable balance represents an existential threat that the company can no longer carry unmitigated. While the 14 to 18 million dollar cost is severe, it is the only path to maintaining bank access. A full hedge is financially impossible without crippling operations, and a zero-hedge strategy assumes a level of government benevolence that is not supported by historical precedent in corporate reorganizations. Speed is the strategy: the window to buy protection closes as the default probability nears certainty.

2. Dangerous Assumption

The analysis assumes the CDS will pay out immediately and in full upon a credit event. In a systemic crisis, the protection seller may lack the liquidity to settle, or the definition of the credit event -restructuring versus bankruptcy- may be litigated, delaying the cash infusion Saginaw needs to survive.

3. Unaddressed Risks

4. Unconsidered Alternative

The team failed to evaluate an industry-wide consortium approach. Saginaw should lead a coalition of Tier-1 suppliers to demand the US Treasury Department grant trade receivables administrative expense priority in any government-led restructuring. This political solution would provide better protection than a CDS at a fraction of the cost.

5. MECE Analysis of Strategic Paths

• Financial Mitigation: CDS purchase, AR factoring, or credit insurance.
• Operational Mitigation: Production stoppage, inventory reduction, or customer diversification.
• Political Mitigation: Lobbying for supplier carve-outs in federal aid packages.

VERDICT: APPROVED FOR LEADERSHIP REVIEW