S&P Cuts GM Debt to BBB-
On Oct. 14, Standard & Poor's Ratings Services lowered its long-term corporate credit rating on General Motors (GM ), General Motors Acceptance Corp. (GMAC), and all related entities to 'BBB-' from 'BBB', and its short-term rating to 'A-3' from 'A-2'. The rating outlook is now stable. Consolidated debt outstanding totaled $284 billion at September 30, 2004.
The downgrade reflects heightened concerns about the profit potential of the company's automotive operations. In its North American operations, GM continues to suffer from shortcomings in its competitive position. Thus, its market share has been off slightly to date this year, despite aggressive discounting, increased sales to daily rental companies, and past efforts to enhance its product offerings. Soaring oil prices heighten the risk that there could be a market mix shift away from sport utility vehicles and pickups, segments that contribute a highly disproportionate share of GM's automotive profitability.
Even with robust industry sales in North America and strides the company has made to improve its cost position, GM has been unable to achieve satisfactory profitability in North America in recent years: its automotive net margin in this region will likely be only about 1% for the full year 2004. Increases in health care and commodities costs add to the challenges GM faces in improving its financial performance, notwithstanding the benefits expected from additional new-product launches.
GM's losses in Europe are accelerating, and management has just confirmed publicly that further costly restructuring must be undertaken, involving a reduction of its workforce by up to 12,000 over the next two years. And although GM had until recently been highly profitable in China, it is now suffering from a rapid, industrywide weakening of demand that could prove temporary, but underscores the volatility of that market, where virtually all the world's automakers are investing heavily to expand their presence.
Although GM's aggregate industrial earnings have been poor in recent years, the effect on overall results has been mitigated by record-level earnings at GMAC. The subsidiary's auto finance business has benefited from lower credit losses, record-low funding costs, and improved performance on lease residuals. Also, GMAC's mortgage unit has been a disproportionate earnings contributor, due in part to heavy refinancing volume sparked by low general interest rates.
We now believe GMAC's net earnings for the full year could equal or exceed the $2.8 billion realized in 2003. Although it is unlikely that GMAC will be able to sustain earnings at recent levels, it should remain a strong earnings contributor, and a stable source of cash flow, for the parent.
GM continues to generate substantial operating cash flow, including dividends from GMAC and excluding the calls on cash that its large, unfunded pension and retiree medical liabilities represent. GM's worldwide pension plans, in aggregate, were underfunded by $8.6 billion at year-end 2003, following extensive special funding actions undertaken that year, which included the contribution to its pension plans of $13.5 billion of debt issue proceeds, and $4.2 billion from the sale of its approximate 20% stake in Hughes Electronics Corp.
GM's unfunded retiree medical liability remains massive, at approximately $57 billion at Dec. 31, 2003, net of long-term VEBA (employee medical-expense plan) funds and the estimated cost savings from the new Medicare prescription drug program. Even considering the potential for GM to further contribute to its VEBA in 2004 ($5 billion was contributed in early 2004), this could be insufficient to materially reduce the retiree medical liability if soaring health care inflation persists. For financial reporting purposes, GM has assumed an initial health care cost trend rate of 8.5%, subsiding to 5.0% in six years. A 1-percentage-point increase in this trend rate would add $7.6 billion to the liability. Short-term credit factors: GM's short-term rating is now 'A-3', as is GMAC's. GM's fundamental challenges are short- and long-term in nature. However, the company's liquidity and financial flexibility minimize any potential for near-term financial stress. We believe GM will generate free cash flow (before pension and VEBA contributions, and dividends from GMAC, but taking account of working capital changes and capital expenditures) of at least several billion dollars during the next year. Notwithstanding the high operating leverage--and the resulting volatility–-experienced by automakers, we believe GM is highly unlikely to generate negative cash flow during the next year, even if industry conditions become significantly more difficult than anticipated. Moreover, GMAC should be able to continue paying substantial dividends to the parent, without its financial leverage suffering appreciably.
Key aspects of GM's financial flexibility and liquidity are as follows:
• A large liquidity position--Cash, marketable securities, and short-term VEBA funds totaled $24.5 billion at Sept. 30, 2004 (excluding GMAC);
• Moderate near-term, parent-level debt maturities--Long-term debt has an exceptionally high average maturity;
• In the wake of recent funding actions, GM faces neither ERISA-mandated pension fund contributions through this decade nor the need to make contributions to avoid Pension Benefit Guaranty Corp. variable-rate premiums; and
• As of June 30, 2004, GM had unrestricted access to a $5.6 billion committed bank credit facility expiring in 2008, $800 million in committed credit facilities with various maturities, and uncommitted lines of credit of $1.7 billion.
GMAC has substantial ongoing funding needs. As of June 30, 2004, short-term debt (including current maturities of long-term debt) was $79.6 billion, not including maturing off-balance-sheet securitizations. Reflecting the close linkage between GMAC and GM, GMAC's funding flexibility has suffered in recent years from the problems affecting GM's automotive operations. Thus, commercial paper outstanding totaled only $12.7 billion at June 30, 2004, down from more than $40 billion before 2001. Also, GMAC's unsecured bond spreads have been volatile, reaching a peak of 437 basis points over 10-year Treasuries in late 2002. This calls into question the extent to which GMAC can rely on consistent future access to the public unsecured debt market.
However, GMAC has responded by taking the following actions:
• Accumulating a large cash position ($24.4 billion at Sept. 30, 2004);
• Expanding its relatively less-credit-sensitive retail debt issuance programs, such as its SmartNotes program;
• Diversifying its securitized funding channels, including expanding its bank conduit asset-backed securitizations (ABS) and, recently completing a securitization of lease assets;
• Entering the nascent whole-loan market, completing transactions totaling $4 billion in 2003 and establishing committed, whole-loan sale flow agreements; and
• Recently commencing operations of Utah-chartered GMAC Automotive Bank.
At June 30, 2004, GMAC had a $4.6 billion syndicated line of credit committed through June 2005, $4.3 billion committed through June 2008, $4.3 billion of bilateral committed lines with various maturities, and $20.4 billion in uncommitted lines of credit. In addition, New Center Asset Trust (NCAT) had $19.5 billion of liquidity facilities committed through June 2005. Mortgage Interest Networking Trust (MINT) had $3.4 billion of liquidity facilities committed through April 2005. NCAT and MINT are qualified special-purpose entities administered by GMAC for purchasing assets as part of GMAC's securitization and mortgage warehouse funding programs. These entities fund the purchase of assets through the issuance of asset-backed commercial paper.
GMAC also had $53 billion in funding commitments (of which $26 billion was unused) with third parties, including third-party asset-backed commercial paper conduits, that may be used as additional secured funding sources. A leverage covenant in the bank credit facilities restricts the ratio of consolidated debt to total stockholders' equity to no more than 11 to 1 (excluding on-balance-sheet secured debt from the definition of consolidated debt). By this definition, the debt-to-equity ratio was 8 to 1 at June 30, 2004.
This covenant would be problematic only if, contrary to our expectations, GMAC's access to the ABS market were disrupted. (GM and GMAC have no financial covenants or other credit triggers in financing arrangements that we view as potentially problematic.) GMAC's automotive asset composition is highly liquid, given that about half of its total gross receivables is due within one year and that a substantial portion of receivables is typically repaid before contractual maturity dates. However, GMAC is constrained in its ability to reduce the size of its automotive portfolio, given its need to support GM's marketing efforts.
Given the liquidation of loans originated in recent years, GMAC's automotive asset levels are unlikely to increase substantially in the next one to two years, even if price competition in the auto sector remains intense as expected. As part of its funding diversification strategy, GMAC is pursuing opportunities to fund part of its commercial mortgage operations externally. In addition, we believe that if GM were to experience liquidity pressures, it could monetize GMAC's mortgage operations.
Outlook: The ratings outlook is now stable. We have long-range concerns about whether GM's strategy will be effective in boosting profitability to more satisfactory levels in light of the competitive challenges it faces. However, over the two-year timeframe covered by the outlook, GM's cash generating ability (including dividends from GMAC) and its liquidity position provide considerable support to its near-term financial flexibility. We assume that management is committed to using the bulk of surplus cash generated in the foreseeable future to add to cash balances, fund postretirement benefit obligations, and/or reduce debt.
From Standard & Poor's Ratings Services
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