Author: Gordon Platt
United States

chevrolet01 Ford Motor and General Motors are worried about their rollover and crash-test ratings. Not the ratings on their cars so much as the ratings on their debt. The bonds of both big US automakers are rated at one notch above junk status by Standard & Poor’s. One more downgrade, and the red flag could come out for some institutional investors such as mutual funds and pension funds that are allowed to hold only investment-grade securities.

A downgrade of either company would send shock waves through the corporate bond market. Ford and GM are the second- and third-largest issuers of US corporate debt in the Lehman Brothers US Credit Index, following General Electric.

Analysts warn that rising interest rates could have a debilitating effect on US auto manufacturers, which will see their cost of borrowing rise while they are still required to offer low-cost financing and other incentives to attract buyers for their cars. With both Ford and GM rated triple-B-minus, a downgrade would affect other issuers as well. Major auto-parts manufacturers, for example, also could be downgraded to below investment grade.

Ford was forced to reduce the size of its euro-denominated benchmark bond issue ford01 in November from a planned €1 billion to €750 million and to sweeten the terms to satisfy hesitant investors. Auto-industry bonds have fared poorly in recent months, as earnings have disappointed and worries have mounted about pension and healthcare liabilities. Meanwhile, Asian competitors are taking a bigger share of the US auto and truck markets. Toyota Motor says it may pass GM as the world’s number-one automaker sometime in 2006. It has already driven past Ford to the number-two position.

With their higher cost of producing vehicles compared to the Asian producers, Ford and GM likely will be forced to announce more layoffs and plant closings before too long, according to industry analysts. Both carmakers said they would reduce production for the first quarter of 2005 after disappointing sales for November. GM announced in October that it would cut as many as 12,000 jobs in Europe over the next two years in an attempt to staunch losses in the region. Ford’s luxury brand Jaguar is cutting 1,150 jobs in Britain in an effort to return to profitability.

Knowing the disruptive effect a downgrade could have on the markets, the rating agencies are expected to move cautiously. They likely would put the automakers on a negative outlook well in advance of making any change. Analysts say the risks are high that the market could start pricing in such a development later this year.

Gordon Platt