What we reported several weeks ago has come to pass. Back then, we told you that GM and Fords credit ratings were in danger of collapse. Last week, Reuters reported the bonding houses, led by Standard & Poors, slashed the ratings for the two big automakers to junk bond status.
The move reflects their struggles with rising competition and escalating health care costs for employees. GM has about $300 billion in outstanding long-term debt including secured notes.
The rating reduction will make it more difficult for the two companies to borrow funds while investors pursue higher rates on the bonds they buy in return for accepting a greater risk of default by GM or Ford.
Standard & Poors cut GMs long-term credit rating by two notches to BB, which is the second highest junk rating. The outlook for that classification is not promising.
Hugh Johnson, chief investment officer at Johnson Illington Advisors, told Reuters: Everybody knows they are facing substantial challenges. It is troubling that theyre reduced to non-investment grade, but I cant say its entirely unexpected.
Johnson said he believes the reduced ratings will apply only to GM and Ford and will not affect other industries. Its not a macro-economic issue, he said.
S&P said GM should have no problem in meeting its near term cash requirements, but added that the automakers management strategies may not be effective in rectifying GMs competitive disadvantages.
Investors have been dreading any reduction to junk status for GM in particular, fearing it may cause turmoil in the market for investment-grade bonds as well. Investment funds are barred from holding junk bonds and that means they may have to sell off billions of dollars in Ford and GM debt. That could have a pronounced effect on the market.
What appears to be in the works now is an effort to get a federal bailout for the two big corporations. That will mean taxpayers will end up footing the bill.
GM spokesman Jerry Dubrowski expressed confidence in the firms financial strength. Were disappointed with S&Ps decision to lower the credit rating for GM and GMAC, he said. GM and GMAC have adequate cash and liquidity to fund their business for the foreseeable future.
Fords long-term credit rating was cut to BB-plus, the highest junk rating, up from BBB-minus. The outlook on the new rating indicates another cut is possible within the next two years. Fords Chief Financial Officer Don Leclair issued a statement last week that said: Were disappointed that it (S&P) discounts our considerable liquidity and our access to diverse funding sources, as well as the recent successes of our new products.
Shares of GM and Ford plunged on the market with the announcement and pulled the wider market down. GM bonds dropped as well, according to one market trader, as prices of treasury bonds climbed, indicating investors wanted the perceived protection of government debt.
John Canavan, an analyst at Stone and McCarthy Associates, said: I dont think the downgrade itself was tremendously surprising. Despite that, there is an announcement effect here, and a majority of that effect has been a flight bid into Treasuries from the debt market. The yield on a 10-year T-bill fell to 4.16 percent from 4.19 percent last Wednesday. Prices and yields on bonds move in opposite directions (money.cnn.com).
From the May 11-17, 2005, issue