Another Credit Downshift for GM


Amid "increased skepticism" about General Motors' (GM) prospects in the North American market, Standard & Poor's Ratings Services on Dec. 12 lowered its corporate credit rating on the carmaker to B from BB- and its short-term rating to B-3 from B-2. S&P removed GM's ratings from CreditWatch, where it was placed on Oct. 3, 2005, with negative implications. The outlook is negative.

(The BB/B-1 ratings on General Motors Acceptance Corp. [GMAC] and the BBB-/A-3 ratings on Residential Capital Corp. [ResCap] remain on CreditWatch with developing implications, reflecting the potential that GM could sell a controlling interest in GMAC to a highly rated financial institution.) Consolidated debt outstanding totaled $285 billion on Sept. 30, 2005.

EFFORTS FALL SHORT. "The downgrade reflects our increased skepticism about GM's ability to turn around the performance of its North American automotive operations," says Standard & Poor's credit analyst Robert Schulz. If recent trends persist, GM could ultimately need to restructure its obligations (including its debt and contractual obligations), despite its currently substantial liquidity and management's statements that it has no intention of filing for bankruptcy.

GM has suffered meaningful market-share erosion in the U.S. this year, despite prior concerted efforts to improve the appeal of its product offerings. At the same time, it has experienced marked deterioration of its product mix, given precipitous weakening of sales of its midsize and large SUVs, products that previously had acted as highly disproportionate contributors to GM's earnings.

This product mix deterioration has partly reflected the aging of GM's SUV models, but with SUV demand having plummeted industrywide, particularly during the second half of 2005, it's now dubious whether GM's new models, set for debut over the next year, can be counted on to help restore North American operations to profitability.

UAW BRIGHT SPOT. In addition, GM is paring the product scope of its brands. It has also announced recently that it will undertake yet another significant round of production-capacity cuts and workforce rationalization. But the benefits of such measures could be undermined unless its market share stabilizes without GM resorting again to ruinous price discounting.

One recent positive development has been the negotiation of an agreement with the United Auto Workers providing for reduced health-care costs. Yet, this deal (which is pending court approval) will only partly address the competitive disadvantage posed by GM's health-care burden. Moreover, GM would realize cash savings not until the beginning in 2008, because it has agreed to make $2 billion of contributions to a newly formed VEBA trust during 2006 and 2007.

It remains to be seen whether GM will manage to garner further meaningful concessions in its 2007 labor negotiations.

GMAC FUNDING HAMSTRUNG. This year has witnessed a stunning collapse of GM's financial performance compared with 2004 and initial expectations for 2005 (see BW Online, 12/9/05, "Running on Empty in Detroit"). In light of results through the first nine months of 2005, S&P believes the full-year net loss of GM's North American operations could approach $5 billion -- before substantial impairment and restructuring charges.

S&P also thinks the consolidated net loss could total about $3 billion (again, before special items). With nine-month 2005 cash outflow from automotive operations a negative $6.6 billion (after capital expenditures, but excluding GMAC), S&P expects substantial full-year 2005 negative cash flow from automotive operations. GMAC's cash generation has only partly mitigated the effect of these losses on GM's liquidity.

Deterioration of GM's credit quality has limited GMAC's funding capabilities. On Oct. 17, 2005, GM announced it was considering selling a controlling interest in GMAC to restore the latter's investment-grade rating.

MORE DEFENSIVE? GM recently indicated that it's holding talks with potential investors. As S&P stated previously, it views an investment-grade rating for GMAC as feasible if GM sells a majority stake in GMAC to a highly rated financial institution that has a long-range strategic commitment to the automotive finance sector.

Even then, GMAC still would be exposed to risks stemming from its role as a provider of funding support to GM's dealers and retail customers. However, S&P believes a strategic majority owner would cause GMAC to adopt a defensive underwriting posture by curtailing its funding support of GM's business, if that business were perceived to pose heightened risks to GMAC.

One key factor in achieving an investment-grade rating would be S&P's conclusions about the extent to which financial support should be attributed to the strategic partner. S&P will continue to monitor GM's progress in this process and the potential for rating separation. However, if the time frame for a transaction gets pushed out, or if further deterioration occurs at GM, GMAC's rating could face a drop, perhaps to the same level as GM's.

RESCAP ADVANTAGE. Ultimately, in the absence of a transaction that will significantly limit GM's ownership control over GMAC, the latter's ratings would be equalized again with GM's.

The ratings on ResCap sit two notches above GMAC's, its direct parent, reflecting ResCap's ability to operate its mortgage businesses separately from GMAC's auto-finance business -- from which ResCap is partially insulated by financial covenants and governance provisions.

Nonetheless, S&P continues to link the ratings on ResCap with those on GMAC because of the latter's full ownership of ResCap. Consequently, should GMAC's ratings drop, the ratings on ResCap would likewise decrease by the same amount. Or, if the ratings on GMAC go up, as explained above, ResCap's ratings also could rise.

MORE DELPHI TROUBLE? Prospects for GM's automotive operations look cloudy. The ratings face further decline if S&P comes to expect that GM's substantial cash outflow would continue beyond the next few quarters due to further setbacks -- whether GM-specific or stemming from market conditions.

Even though the concern over the situation at GM's bankrupt lead supplier, Delphi, served as the primary factor behind the rating downgrade of Oct. 10, 2005, events at Delphi could precipitate a further review if GM were to experience severe Delphi-related operational disruptions or if GM agreed to fund a substantial portion of Delphi's restructuring costs.

GM's rating could also encounter trouble if the carmaker decided to distribute to shareholders a meaningful portion of proceeds generated from the sale of a controlling interest in GMAC. GM would need to reverse its current financial and operational trends, and sustain such a reversal, before S&P would revise its outlook to stable.

From Standard & Poor's Ratings Services


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