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S&P Says GM Debt Stable, With Caveats

The rating agency says it will soon review its outlook on the automaker's credit.
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Standard & Poor's affirmed

General Motor's


stable credit outlook Friday after the company gave a lower earnings outlook for 2005. But the credit rating agency signaled that the "appropriateness" of the stable outlook will be reviewed in the coming months.

The rating agency stuck with its triple-B-minus rating on GM, leaving the largest U.S. automaker with its credit rating one step above junk. But after having downgraded GM's debt on Oct. 14, S&P conceded the firm faces continued challenges to maintaining a stable rating, the removal of which would likely be the first step in S&P lowering GM's debt to speculative-grade status. Considering the enormous effect such an event would have on the corporate debt markets, and (potentially) the economy as a whole, S&P will likely be measured in its approach to any change in its rating on the automaker.

"Our concerns regarding GM's ability to improve its competitiveness over a longer time period have grown incrementally in recent months, given the company's relatively poor sales performance in the U.S. and the aggressive growth plans articulated by competitors," said Standard & Poor's in a prepared statement. "In the coming months, we will further assess our views regarding GM's long-range prospects, focusing on the appropriateness of the stable rating outlook."

A stable outlook means the company's rating is less likely to be lowered or raised over the next two years. If Standard & Poor's lowered its outlook, that could clear the way for a downgrade for one of the largest corporate bond issuers in the U.S.

With short-term debt of $56 billion on its balance sheet and long-term borrowings of $235 billion as of September, a credit rating downgrade would multiply GM's already high borrowing costs. Add that to the company's astronomical health care and pension obligations, competitive weakness, declining profits, rising steel costs and litigation vulnerability, and the automaker's financial solvency could be in danger.

While the three major credit rating agencies -- Standard & Poor's, Fitch Ratings and Moody's Investor Services -- have maintained the lowest investment-grade ratings on GM to date, their willingness to lower ratings any further could be hampered by the conflict of interest inherent to their position; these firms are compensated by the companies they rate. Meanwhile, some independent firms, like Egan-Jones Ratings, have already lowered their own ratings on the automaker to junk levels.

"We don't see anything on the horizon that is going to dramatically change their prospects," said Sean Egan, managing director with Egan-Jones. A potential downgrade from one of the major rating agencies would be "very significant," he said: Given GM's high degree of leverage, the increase in funding costs that would result would "offset all of GM's net income over the last two years," he said.

On Thursday, when GM forecast a decline in earnings for 2005, a statement from the company raised concerns in the credit markets that it was preparing for a debt downgrade. It said in a filing that its GMAC finance unit might set up an independent mortgage unit in a separate holding company that would have its own credit rating. That would shield its mortgage assets from the pain of a downgrade at GM. Spreads on the company's publicly traded debt widened in response to the filing, and its stock dropped 2.8% Thursday.

While the markets reacted negatively to signs that the company was taking steps to prepare for a downgrade, Egan said shielding its mortgage unit would be a smart move for GMAC.

"They don't have very many attractive cards to play, but this would be an intelligent move given their situation," Egan said. "It could isolate their mortgage unit from at least the threat of a credit downgrade. It also might be preparation for selling assets. GM is going to have to come up with some cash over the next 12 months for funding its pressing obligations to retirees in healthcare costs and pensions. Also, a settlement related to asbestos litigation is probably likely soon, so that's yet another cost, along with rising steel costs and declining market share."

Recently down 15 cents, or 0.4%, to $37.17, GM's stock is off about 10% since the beginning of the year, having made a new 52-week low of $36.90 intraday Friday. This week's slide began Monday, when CEO Rick Wagoner declined to comment on the $10-a-share earnings goal in a meeting with reporters. Thursday's release appeared to revive the target.

"We will achieve our 2004-earnings objectives despite a tough competitive environment," the company said, highlighting a strong performance in financial services and market-share gains in three out of four automotive regions. GM expects "record" profitability in the Asia Pacific region and a return to profitability in its American/Africa/Mid-East region.

The company said its 2004 earnings will be in line with previous guidance of $6 to $6.50 a share, excluding items. Analysts surveyed by Thomson First Call are currently forecasting 2004 earnings of $6.31 a share. For 2005, GM reiterated an earnings target of $4 to $5 a share, excluding items. The consensus analyst estimate is for earnings of $4.78 a share.

On Friday, Wall Street analysts labeled GM's earnings targets for the New Year as optimistic.