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S&P Cuts Ford Debt Deeper into Junk: Which of the Big Two Will Win the Race to Bankruptcy?
By James B. Bleeker
On June 28, 2006, Standard & Poor's cut its creditworthiness rating of Ford Motor Company's unsecured long-term debt one notch deeper into junk, from "BB-" to "B+," or in investor parlance, from double-B-minus to single-B-plus. The following table puts Ford's creditworthiness and the General Motors-Ford race to bankruptcy into perspective.
Table I S&P, Fitch, and Moody's Long-Term Debt Ratings as of June 28, 2006 Ratings Automobile Manufacturers S&P, Fitch Denominations Moody's Denominations Investment Grade Ratings AAA Toyota Motor Corporation AA+ AA AA- A+ Honda Motor Company A A- BBB+ Baa1 BBB Baa2 DaimlerChrysler AG BBB- Baa3 Junk Grade Ratings BB+ Ba1 BB Ba2 BB- Ba3 Ford Motor Company, Ford Motor Company B+ B1 Ford Motor Company B B2 General Motors Corporation B- B3 General Motors Corporation CCC+ Caa1 General Motors Corporation CCC Caa2 CCC- Caa3 Delphi Corporation (GM's jettisoned aggregation of parts plants is in Chapter 11 bankruptcy.) D S&P retained its negative outlook on Ford's long-term debt, meaning that it may cut Ford's debt rating further without advance notice.
For more than a decade, U.S. consumers have been abandoning Ford's and GM's products for the quality products of Toyota Motor Corporation and Honda Motor Company, and in the past two years the pace of this abandonment has quickened, as the following chart helps depict.
As it would likely take decades of determination and effort to significantly narrow the quality gap between the Big Two (GM and Ford) and the Reliable Two (Toyota and Honda) (see The Bottom Line on Auto Reliability), the Big Two are left with but one choice: Cut productive capacity to match dropping demand. Although this is normally a clear-cut business solution that puts things back into balance, it's not for these two. GM's and Ford's current contract with the United Auto Workers obligates them to pay furloughed employees most of their wages (after unemployment benefits are exhausted, per the Wall Street Journal), whether working or not. As a result, General Motors and Ford may exhaust their cash before their contract with the UAW expires in 2007. Without cash to pay their bills, GM and Ford would be forced into bankruptcy reorganization. Once there, their bonds may be converted to shares (preferred, common, or some combination of both), the market value of each of which may be but a small fraction of the face value of the preceding bond.
To help cope with the prospective cash crunch, Ford has sold its Hertz Corporation rental division and General Motors has sold, or is in the process of selling, a majority or all of its stakes in Fuji Heavy Industries Ltd., Suzuki Motor Corporation, Isuzu Motors Ltd. and GM's GMAC finance subsidiary.
GM has also offered more than 113,000 of its employees a buyout - cash to quit - ranging from $35,000 to $140,000. About 35,000 have accepted the offer; the acceptance likely reflects a concern that GM is too close to bankruptcy to stick around.
Another problem facing Ford and GM, and to a lesser extent other auto manufacturers, is a possible strike at Delphi Corporation, GM's jettisoned aggregation of parts plants that presently supplies both GM and Ford. The strike may result from Delphi's quest to cut wages and close most of its U.S. manufacturing facilities in order to staunch its huge losses and make it a viable business enterprise. As a first step to effect the wage cut and plant closures, it has requested its presiding bankruptcy judge to release it from its contractual obligations to the UAW and its members. In mid-May, the UAW membership authorized a strike in the event that the judge grants the relief that Delphi has requested. If a prolonged strike occurs, GM and Ford would likely exhaust their cash reserves well before their present labor contracts expire and force both into bankruptcy reorganization.
The gap between GM's credit ratings and those of Ford reflects a common assessment by the credit rating services that GM holds a solid lead in its sprint to insolvency. Respondents to Auto on Info's Poll on the race concur by putting GM into bankruptcy in December 2006 and Ford, in post-April 2007. However, insurers against default by Ford or GM are charging bondholders of both the same premium, so they apparently think that the race is neck and neck.
Sources for S&P's rating cut and outlook: "S&P Cuts Ford, Ford Credit Deeper into Junk Status," Reuters, June 28, 2006, available at Yahoo! News and "S&P Puts Ford a Bit Deeper into Junk," Serena NG, The Wall Street Journal, p. C5, June 29, 2006
Source for default insurance premiums: "S&P Puts Ford a Bit Deeper into Junk," Serena NG, The Wall Street Journal, p. C5, June 29, 2006
Source for GM's buyout offer: "Automaker's Downsizing Aims to Ensure Survival," Bill Vlasic and Brett Clanton, Detroit News, March 23, 2006, at http://www.detnews.com/apps/pbcs.dll/article?AID=/20060323/AUTO01/603230402/1148
Source for buyout acceptance: "GM Says 35,000 Workers Accept Buyouts," Poornima Gupta and Kevin Krolicki, Reuters, June 26, 2006, available at Yahoo! News
Source for Delphi losses: "Delphi's Troubles Multiply," Jason Roberson, Detroit Free Press, June 1, 2006, at http://www.freep.com/apps/pbcs.dll/article?AID=/20060601/BUSINESS01/606010374/1014
Sources for Strike Authorization: "UAW OKs Strike at Delphi," Brent Clanton and Bill Vlasic, Detroit News, May 17, 2006, at http://www.detnews.com/apps/pbcs.dll/article?AID=/20060517/AUTO01/605170337/1148, "Delphi Workers Approve Strike," Jason Roberson, Detroit Free Press, May 17, 2006, at http://www.freep.com/apps/pbcs.dll/article?AID=/20060517/BUSINESS01/605170346/1014, and "UAW Authorizes Strike Against Delphi," Dee-Ann Durbin, the Associated Press, May 16, 2006, available at Yahoo! News
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