- The Washington Times - Thursday, May 5, 2005

American icons GM and Ford were downgraded to junk-credit status yesterday in a development that shocked financial markets and could shake the economy if the automakers’ rapid decline continues. Standard & Poor’s Corp., in announcing the cut to the lowest corporate-bond rating, said both companies will have trouble staying afloat, with its “greatest immediate concern” that they depend on sales of large sport utility vehicles for profitability at a time when high gasoline prices have brought back into favor smaller models made by Japanese and Korean competitors. “GM’s financial performance has been heavily dependent on the profit contribution of SUVs,” said agency analyst Scott Sprinzen. “Recently, though, sales of its mid-size and large SUVs have plummeted … partly because of high gas prices. Also, competition has intensified due to a proliferation of new SUVs.” The automakers’ aggressive efforts to retain market share through discount programs, including deep rebates and no-interest loans, have not succeeded, said the credit agency, which also dismissed as inadequate the companies’ recently announced plans to regain profitability. “We believe the companies’ reliance on discounts has itself been detrimental” and cheapened the famous brands, it said. Soaring health care and pension costs also were cited as reasons for the steady decline of Detroit’s “big two,” despite layoffs and other cost-cutting efforts. Toyota Motor Corp. last month reported its best-ever sales performance in the U.S., even as GM and Ford reported further slumps in demand. GM had an “alarming” $1.1 billion loss in the first quarter, S&P; noted, while Ford is studying plans to sell off its Hertz rental division to raise cash. The ratings cut sent stocks tumbling yesterday only a day after GM’s fortunes seemed to rise and lifted the market with a major stock purchase offer by billionaire Kirk Kerkorian. The bond market was hit even harder, as investors braced for a wholesale sell-off of GM and Ford debt. The downgrade to junk status, which means a company is more likely to default on its debt, affects $375 billion of the companies’ $453 billion of outstanding debt. Most mutual funds, pension funds and insurance companies are not allowed to invest in junk bonds and will have to divest their GM and Ford portfolios. The news caused an earthquake in the corporate bond market, where GM and Ford — at one-tenth of the market — are dominant players. Investors scurried into the safe haven of Treasury bonds, sending their prices soaring. “It’s definitely a kick in the shin,” said Art Hogan of Jefferies and Co. “It shouldn’t catch us by surprise” but the markets were comforted Wednesday by Mr. Kerkorian’s vote of confidence in GM, he said. A GM spokesman said the company was disappointed with the downgrades but that it has enough cash to fund its business for the foreseeable future. Ford Chief Financial Officer Don Leclair said the company disagrees with S&P.; “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.” Moody’s and Fitch ratings services have not cut the companies’ ratings from investment grade, though analysts say that may happen soon. Standard & Poor’s suggested that one way the companies could start to turn their financial fortunes around is by substantially “rolling back” overly generous health care benefits for workers and retirees. But it said it doubted the United Auto Workers union would allow that. It also suggested that the companies’ profitable finance divisions, which have subsidized the auto divisions for years, may need to be split off so they can retain high-enough ratings to keep issuing the debt they need to continue operations. Peter Morici, University of Maryland business professor, said the companies are making “cars people don’t want to drive” anymore, and unless they eliminate “legacy” pension and health care costs, “it is unlikely that either company can survive long term.” Roger M. Kubarych, an economist with HVB Group, said the automakers “have had serious problems for some time” and that their woes are likely to be a drag on the U.S. economy in the months ahead.

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