Capital Markets

GM, Ford Downgraded to Junk

What seemed to have surprised the bond markets was not the downgrades themselves, but the timing.
Stephen TaubMay 6, 2005

Standard & Poor’s downgraded the debt ratings of struggling U.S. automakers General Motors Corp. and Ford Motor Co. below investment grade, sending shockwaves through the capital markets, especially the bond markets.

Outstanding GM bonds total about $292 billion, and Ford bonds, about $161 billion, according to The New York Times.

Standard & Poor’s cut GM and General Motors Acceptance Corp., its finance arm, to BB, two notches below investment grade; S&P cut Ford and its finance arm to BB-plus. The agency added that both companies’ rating outlook is negative.

What seemed to have surprised the bond markets was not the downgrades themselves — S&P had suggested that they might be in the offing — but the timing, two days after the Federal Reserve raised short-term interest rates once again. GM’s earnings warning about six weeks ago also hit bonds hard.

The downgrades not only knocked down Ford’s share price by nearly 5 percent and GM’s by nearly 6 percent, but they also sent the automakers’ bonds tumbling. According to The Wall Street Journal, a Ford bond maturing in October 2028 fell 5.547 to 71.449, to yield 9.742 percent; a GM bond maturing in July 2033 fell 4.454 to 74.000, to yield 11.494 percent.

It is unclear these events will affect financier Kirk Kerkorian’s offer to buy up to 28 million shares of GM for $31 apiece through his investment firm, Tracinda Corp.

Certainly, however, the downgrades will strain the high-yield market and could make it more difficult for other companies to raise money, given the enormous sums of GM and Ford paper that will compete for institutional investors’ assets.

“What we have is a decline in the product segment that represents one of the most substantial sources of earnings for these companies,” S&P auto analyst Scott Sprinzen said in a conference call, according to the Journal. “They won’t be able to look at [midsize] and large SUVs the way they have over the last decade for much of their earnings and cash flow.”

In a press release, Sprinzen noted that “GM’s financial performance has been heavily dependent on the profit contribution of its SUVs,” but added that sales have plummeted, due in part to high gas prices and increased competition.

GM spokeswoman Toni Simonetti told the Journal that the company is “disappointed” by the downgrade. “We know we have challenges in North America. We’ve been moving aggressively to address these challenges,” she added.

According to the Detroit Free Press, Ford chairman and chief executive officer Bill Ford tried to use the downgrade as a tool to rally his troops. In an e-mail to employees, he said: “Today’s action was unwelcome, but we should consider it an undeniable call for us to accelerate our business plans. That means being even more aggressive in driving down our costs so that we can successfully develop and build high-quality cars and trucks that people want.” (We profiled Ford’s ambitious revenue-management strategy in our 2003 article “The Right Price.”)