Detroit's Next Headache: Dangerous Debt

All three U.S. automakers are carrying a huge debt load, but GM's position is the most precarious

When Detroit's Big Three CEOs return to Washington on Dec. 2 with a plan tailored to sell Congress on a $25 billion bridge loan, they will try to convince lawmakers that they are in the throes of big restructuring moves that will bring profits back as soon as the economy picks up.

Sources at the companies and in Congress say that General Motors (GM), Ford Motor (F), and Chrysler are mulling symbolic moves like executive pay cuts and scaling back use of corporate planes.

But given the huge debt load they may be taking on, they might have to show more substantial ways to save money. Congress will be allocating billions in taxpayer dollars to invest in the Big Three carmakers, so the lawmakers should know what the prospects are for these companies to compete should the bridge loan see them through the downturn.

Close to the Brink

It's not pretty. All three companies are already carrying massive debt and interest payments that will sap their ability to develop and market new models once the economy turns around. GM has $43 billion in debt and Ford has $24.9 billion in borrowings. "Their debt burden has been escalating for some time," says Mark Oline, managing director for debt-rating agency Fitch & Co. "These companies will be smaller so their earnings capacity will be smaller. The interest will be a big burden."

Let's look first at GM, which is closer to the brink of collapse than Ford. GM already pays more than $3 billion a year in interest. JPMorgan (JPM) analyst Himanshu Patel estimates that GM needs $17 billion in government loans to make it through 2009. That would add another $900 million in interest. That means GM would have close to $60 billion in debt and more than $4 billion a year in interest payments.

Plus, GM has to pay back $2.3 billion next year, $200 million in 2010, and $1.7 billion in 2011, according to company financial statements. All of that will require cash that could go into new cars, marketing, or disposing of brands.

Health-Care Trust Could Help

Ford pays $2.4 billion a year in interest. While the company is in a better cash position, since it borrowed $23 billion while credit markets were liquid, its interest costs also would rise.

The carmakers racked up huge debt over the past few years largely to fund pension plans, buy out workers, close plants, and set up a union-led health-care trust that will hand management of medical benefits to the UAW.

GM President and COO Frederick A. Henderson said in a Nov. 18 interview that the debt is only a big burden if GM can't improve profits. A union health-care trust, called a voluntary employee benefits association, or VEBA, would save $4.8 billion a year in cash outlays. That deal and other union concessions will make the company more profitable once the market turns around (, 9/26/08).

Big Savings in 2010

With a better market, GM could handle the debt, Henderson said, but he conceded that right now, "our earnings power and cash flow is out of proportion" with the company's debt.

But getting that health-care deal done is no snap, either. Those debt numbers don't count what they owe the UAW to seed the health-care trust that will kick off the massive savings that the companies hope to get starting in 2010. On that score, GM owes $7 billion in January 2010, and Ford will pay $52 million a year for 15 years. Henderson says the $7 billion payment, "in the current environment, is a very tough number to deal with."

All of these obligations will cut into product spending. The Big Three already spend less than Japanese rivals on new product development. According to a report from Merrill Lynch (MER), GM, Ford, and Chrysler replace between 14% and 16% of their total sales volume with new models every year over the past decade. The Japanese replace 21% of their sales volume and the Koreans 28%.

Counting on the Volt

With more cash for R&D, the Asian carmakers can keep pumping out new models. For its part, GM has already cut product spending this year from a planned $8 billion to under $5 billion. And that number would be even smaller if it weren't for the company's push to bring the electric Chevy Volt to market by 2010 (, 9/16/08).

That's why plenty of analysts think Detroit's carmakers—especially GM—need to renegotiate their debt. JPMorgan's Patel thinks GM needs to get concessions from both the UAW and its creditors to trim a total of $4.2 billion in costs.

GM's long-term bonds are already trading at about 20¢ on the dollar. So GM may be able to offer a swap for notes with a smaller principal or exchange them for zero-interest bonds. GM could also swap debt for equity, Patel wrote in the report. With the right cuts, GM could slash interest by $2.1 billion a year, he said.

A Tough Sell in Washington

The UAW would have to give some, as well. Patel says GM would need to get the UAW to agree to cut its total per-worker cost of $125,000, including benefits, by almost $33,000. That means GM would have to retire out more of the veteran workers to get new hires in under the two-tiered wage agreement settled in last year's labor pact. Or, the company needs to get workers to take a pay cut and accept weaker health-care benefits.

But here comes the Catch-22. Oline says GM would be positioned to negotiate with its bondholders on favorable terms if bankruptcy were a threat. But if the government gives the companies a bridge loan, creditors may not see a sense of urgency. "To be effective, it has to be coercive," Oline says. "But with government assistance, that would make a debt exchange a tougher sell."

It's a tough sell in Washington, too. Representative Thaddeus McCotter (R-Mich.) says the companies "will project out how much restructuring will continue into the future. The Big Three have never said they were done." They might be about to start another round.

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