Video: Junk status

updated 5/6/2005 8:13:51 AM ET 2005-05-06T12:13:51

Standard & Poor's Thursday declared billions of dollars of debt owed by General Motors and Ford to be “junk” on Thursday, a significant blow that will increase borrowing costs and limit fund-raising options for the nation’s two biggest automakers.

Shares of GM fell almost 6 percent and Ford shares declined 4.5 percent after the New York rating agency downgraded the debt to below investment grade, which is commonly known as junk or high-yield status.

Both companies responded by saying they face no cash crunch and disagree with the decision by S&P analysts.

The announcement came only a day after billionaire Kirk Kerkorian jolted GM shares to their biggest one-day gain in more than 40 years by offering to invest nearly $870 million in the automaker to boost his stake to about 9 percent.

The S&P decision amounts to one more hit for two automakers that are losing market share at home to Asian competitors, seeing sales soften for their most profitable models and facing enormous health care and post-retirement liabilities. GM’s U.S. sales fell nearly 5 percent in the first four months of the year and Ford’s declined 4.2 percent.

S&P based its decision in part on its conclusion that No. 1 GM and No. 2 Ford can no longer count on enormous profits from their lineups of sport utility vehicles. Besides higher gas prices, SUVs are losing market share to smaller, car-based "crossover" vehicles.

“GM’s financial performance has been heavily dependent on the profit contribution of its SUVs,” said S&P credit analyst Scott Sprinzen. “Recently, though, sales of its midsize and large SUVs have plummeted, and industrywide demand has evidently stalled.”

GM and Ford bonds fell in value on the news, and while the companies say they have no immediate need for large new debt sales, analysts said they can expect to pay substantially higher interest rates on funds they borrow in the future.

The numbers involved are enormous: GM paid about $12 billion in interest on debt last year and Ford’s tab totaled about $7.1 billion. GM’s consolidated debt as of March 31 was $291.8 billion and Ford’s totaled $161.3 billion, S&P said.

The two other major debt rating agencies, Moody’s Investors Service and Fitch Ratings, still rate the debt of both GM and Ford as investment grade.

Even though it acted alone, the move by S&P will force many institutional investors to reshuffle their portfolios, causing massive selling of GM and Ford bonds at a lesser value. That’s because some institutions are banned from dealing in high-yield bonds, an asset class known to trade with more volatility and greater risk of default than investment-grade securities.

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S&P said its downgrade of GM’s long-term debt reflects its conclusion that the current strategies of GM chief executive Rick Wagoner and his management team may not be effective in dealing with the automaker’s competitive disadvantages. S&P also cited concern about GM’s European operations, which have been unprofitable since 1999, and weaker demand in what had been a sizzling Chinese market.

However, S&P noted GM should have no difficulty accommodating “near-term cash requirements.” It also said GM’s highly profitable GMAC finance arm still likely has “sufficient funding flexibility” to support GM even without an investment-grade rating.

In a statement, GM said it was disappointed with S&P’s decision but that it and its finance arm have adequate cash and liquidity to fund their operations “for the foreseeable future.”

GM said it had $19.8 billion in cash at the end of the first quarter, and GMAC had $18.5 billion in cash and securities. “Clearly, GM has many challenges in North America, but the company is moving aggressively to address these challenges,” the company said.

S&P said Ford could be hurt financially by increasing competition from GM and Toyota Motor Corp. in the pickup category. Ford’s best-selling vehicles are its F-Series lineup, most notable the full-size F-150 pickup.

Another hindrance for Ford is its relationship with its struggling former parts subsidiary, Visteon Corp. “We assume Ford will have to subsidize in some fashion a radical restructuring of Visteon’s operations, at a cost that could well be greater than all the direct support it has already extended,” S&P said.

Last month, Ford posted earnings of $1.2 billion, down from $1.95 billion the year before. The company also predicted a tough second quarter, with earnings break-even at best.

Don Leclair, Ford’s executive vice president and chief financial officer, said in a statement the company disagreed with S&P’s action. “We’re disappointed that it discounts our considerable liquidity and our access to diverse funding sources, as well as the recent successes of our new products,” Leclair said.

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