Mark Gilbert is a columnist for Bloomberg News. The opinions expressed are his own.
General Motors' Pause on Way to Junk Is Troubling: Mark Gilbert
March 30 (Bloomberg) -- When General Motors Corp. tore up this year's financial projections on March 16, credit rating companies should have responded by instantly slashing the automaker's debt to junk. Their failure to pull the trigger is both puzzling and troubling.
It's puzzling because lesser financial crimes have prompted cuts in the past. And it's troubling because it's hard to shake the feeling that the reluctance to kick General Motors out of the investment-grade category has more to do with the size of its debts than any lingering faith in its creditworthiness.
It's now cheaper to buy insurance in the credit derivatives market against Fiat SpA failing to pay its debts than it is to buy coverage against a default by General Motors, even though the Italian automaker is rated three levels lower than its U.S. counterpart with a junk grade of BB- at Standard & Poor's.
A default swap on Fiat costs 370,000 euros ($481,000) per year to insure 10 million euros of debt for five years, compared with 435,000 euros a year to guard against not getting repaid on General Motors euro-denominated debt.
General Motors doesn't keep its ratings for as long as other companies, says Gary Jenkins, head of European credit strategy at Deutsche Bank AG in London. The carmaker lasted 728 days at BBB, compared with the average for other companies of 1,776 days. It stayed at BBB+ for just 366 days, less than the average of 1,759. Borrowers stick at BBB- for an average of 1,511 days; General Motors has been there since Oct. 14, for 167 days.
October Cut?
``Extrapolating out on an extraordinarily simplistic basis, the next downgrade will be on April 23, 2006,'' Jenkins says. ``We would be surprised if it took that long.''
Many corporate-bond investors measure their performance against indexes, with those compiled by Lehman Brothers Holdings Inc. among the most used. A downgrade to junk by either S&P or Moody's Investors Service would currently prompt Lehman to kick General Motors out of its investment-grade dollar-bond benchmark, where it accounts for almost 3 percent of the $1.7 trillion index. Bondholders who track that index would probably dump their General Motors bonds.
Starting July 1, Lehman will change the way it sorts between investment-grade and junk borrowers, adding ratings from Fitch Ratings to its calculations. For borrowers covered by all three companies, the index will use the middle assessment.
Averting Turmoil
So, provided General Motors clings on to the investment-grade scale until mid-year, the market turmoil resulting from a cut to junk for the $113 billion it owes bondholders may be limited. After July, it will take junk ratings from two of the three assessors before the automaker's bonds drop out of the index. The Lehman announcement in July that it planned to make the change sparked a rally in General Motors bonds.
Companies that drop out of investment grade are twice as likely to default as borrowers whose ratings start at junk, with the greatest risk of nonpayment coming in the first three to four years following a drop, according to a study of 24 years of data published by S&P earlier this month. They also tend to default more quickly than their high-yield peers, though about a fifth of them climb back up the ratings scale within three years of tumbling to junk.
`Heightened Concern'
When S&P cut its credit rating for General Motors to the lowest investment-grade level in October, it cited ``heightened concern about the profit potential of the company's automotive operations.'' Moody's rates the company one level higher at Baa2, though that's being reviewed for a reduction.
S&P should have cut the rating after General Motors announced earlier this month that it expected a first-quarter loss of $1.50 a share, abandoning its previous pledge to at least break even. Instead, it added a ``negative'' outlook to the grade, described the BBB- assessment as ``tenuous,'' and said it ``could be lowered at any point'' without being put on review for a reduction.
``We'll be commenting further regarding General Motors in due course,'' S&P auto analyst Scott Sprinzen wrote on March 24 in an e-mailed response to a request for an interview. ``For now, I have nothing to add to what I've said previously.''
Reluctant to Cut?
In an October note, S&P listed some frequently asked questions about its ratings of General Motors and Ford Motor Co., including this poser: ``Would you ever be reluctant to lower GM's and/or Ford's ratings below investment grade, given the turmoil in the debt markets that would result?''
Unsurprisingly, the rating company's answer to itself was: ``No. If we ever came to believe that deterioration in either company's credit quality warranted such rating action, we would not hesitate to act.''
Instead of having positive cash flow of $2 billion this year, General Motors now sees negative cash flow of $2 billion. Instead of earnings per share this year of $1 to $2, the automaker might make only 50 cents, UBS analyst Robert Hinchcliffe wrote in a report last week. Its cash reserves might drop below $16 billion by the end of the year, from about $24 billion, Hinchcliffe wrote.
That looks very much like a deterioration in credit quality. Equity investors have wiped almost 30 percent off the market value of General Motors this year; debt investors already treat the company's bonds like junk. Hesitating on cutting the credit rating of General Motors is just delaying the inevitable. |
