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Get Four
|  | MAY 6, 2005
By David Welch A Deeper Rut for GM and FordJunk status for the two auto giants' debt will mean higher interest costs, further cutting into the beleaguered outfits' profitsGeneral Motors (GM ) and its shareholders had been bracing for the bad news. But Ford Motor (F ) and its stockholders thought a cut to the outfit's credit rating was a little farther down the road. On May 5, Standard & Poor's downgraded the debt of both carmakers to junk status (see BW Online, 5/5/05, "GM and Ford: To the Junk Yard"). GM took the bigger hit, with its debt downgraded two notches, to BB, and Ford one notch, to BB+. Says Jack Malvey, chief global fixed income strategist at Lehman Bros: "It's a sad day for Corporate America to see two blue-chip companies sink beneath the waters of investment grade." CAUGHT UNPREPARED. The news could put GM shareholders on a wild roller-coaster ride. The stock shot up 18% on May 4 after billionaire Kirk Kerkorian announced that he would boost his stake in GM to almost 9%. Investors took the news as a sign that either Kerkorian sees something in GM's long-depressed shares that they don't, or that he'll try to make something happen (see BW Online, 5/5/05, "Just What GM Needs"). However, GM shares fell 6% after the downgrade, to close at $30.86 on May 5. Ford is now in a tight spot as well. It didn't expect a downgrade so soon and issued a statement disagreeing with S&P's action. Its stock fell 4.5%, to $9.70, on the news. Unlike Kerkorian's surprise announcement, neither credit downgrade came as welcome news for investors. For GM, the rating will boost borrowing costs, thus hurting profits from the auto giant's GMAC finance arm. And S&P analyst Scott Sprinzen questions whether GM's redesigned full-size SUVs -- the Chevrolet Tahoe and Suburban and GMC Yukon -- can really make the big impact that management is hoping for. RELYING ON GMAC. "Sales of its midsize and large SUVs have plummeted, and industrywide demand has evidently stalled, partly because of high gas prices," Sprinzen says. "Competition has intensified due to a proliferation of new SUVs." The vehicles are expected to be rolled out early next year. With the auto business likely to lose money in 2005, GM is relying on its GMAC unit to come up with about $2.5 billion in annual profits and pay a $2 billion dividend to the parent company. That may not be enough to keep the auto company in the black, but it will mitigate the losses and cash burn. Ford's finance earnings will also take a hit. The company has given earnings guidance for this year of $2.3 billion to $2.7 billion. But most of that will come from Ford Credit. The auto business will at best break even. With rising borrowing costs, its guidance has sunk to an iffier proposition. "BEST LIQUIDITY EVER." Unlike GMAC, Ford Credit doesn't have a mortgage business. While GMAC can rely on home loans -- possibly made with more cheaply borrowed capital -- Ford Credit makes its money writing car loans. Says Rochdale Securities research director Nick Colas: "Ford Credit does not have the diversity GMAC has." Anyway you look at it, the downgrade will make life for GMAC and Ford Credit difficult going forward. At GMAC borrowing costs have already risen, jumping to an average of 4.3% in the first quarter, compared with 3.62% in the first quarter of 2004, due in part to a pair of downgrades over the past few years. GMAC already was using less bank and bond debt to raise loan capital, perhaps anticipating the rating downgrade. Instead, GM has been packaging up loans and selling them in the asset-backed securities market. GM also has become an originator of loans, selling them directly to banks that need a source for auto loans. "Our outlook remains strong," said GMAC's CFO Sanjiv Khattri in March. "We enter the second quarter with our best liquidity ever." PROTECTIVE MOVES. Its GMAC Bank has already raised $1 billion by taking deposits from consumers. And GM now raises at least two-thirds of its roughly $40 billion in funding from sources not affected by the credit downgrade. Plus, the finance unit has $18.5 billion in cash. GM also made the right moves to protect GMAC's mortgage business, which accounted for $385 million of GMAC's $728 million in first-quarter profits. On May 4, GMAC walled off the mortgage business by placing it under a separate holding company called Residential Capital Corp. It may get a separate credit rating. Ford, too, had already been moving to protect Ford Credit from a downgrade. The company expects to raise between $16 billion and $25 billion by selling securitized loans, rather than using interest-sensitive borrowing. That should be about two-thirds of its funding needs. But Ford will still get between $6 billion and $10 billion in more traditional debt, which will likely be more expensive. No joy in Motor City today.  Welch is BusinessWeek's Detroit bureau chief Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | |
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