GM Fails to Make Investment Grade

Automaker's $26 bln pension termination is not enough to improve its credit rating.

General Motors Co.’s record $26 billion pension termination falls short of improving the largest U.S. automaker’s finances enough to let it join Ford Motor Co. as an investment-grade marque.

While transferring some retirement obligations to a Prudential Finance Inc. unit will remove liabilities from Detroit-based GM’s books, the use of as much as $4.5 billion of its own cash “will balance out” the benefits, Moody’s Investors Service said in a report yesterday.

“The transaction is too small,” Colin Langan, an analyst at UBS Inc.’s investment-banking unit in New York, wrote in a note to investors yesterday. Even after the pension shift, GM’s “obligation would still be larger than any company within the S&P 500.”

A ratings upgrade would let GM, which had $134 billion of pension obligations at the end of last year, borrow at lower cost relative to benchmarks. Ford’s bond yields increased 22 basis points from a year earlier to 279 basis points more than comparable-maturity Treasuries on April 24, the day it was raised to investment grade by Fitch Ratings, while all high-yield automakers’ costs rose 86 basis points to 409 over that span, according to Bank of America Merrill Lynch index data.

GM isn’t surprised that the pension changes didn’t result in an immediate upgrade to its credit rating, Jim Cain, a spokesman, said in a telephone interview yesterday.

“The rating agencies have certainly recognized our progress and there’s clearly a lot more work to do, both to drive our margins higher and address other risks to the business,” including the company’s European division, he said.

The automaker is shifting liabilities for salaried U.S. employees, whose plans are better-funded than hourly and foreign retirees. Removing salaried-pension payments from its books while leaving $24 billion unfunded for the rest of its future retirees didn’t do enough to improve GM’s credit profile to warrant an upgrade, Moody’s said.

Moody’s rates GM debt Ba1 and Standard & Poor’s gives it an equivalent BB+, both of which are one level below investment grade. Fitch has the automaker at BB, two steps into speculative status. None of the ratings companies changed their evaluations of the automaker after last week’s pension shift.

GM said in a June 1 statement it will offer lump-sum payments to about 42,000 salaried retirees and shift plans to Prudential. Moody’s said it was the largest pension termination of its kind. The changes apply to some retired U.S. salaried employees, not former union workers or retirees in other countries.


GM Swaps

Five-year credit-default swaps on GM have added 32 basis points to 385 basis points since May 31, the day before it announced the pension change, according to prices compiled by Bloomberg. That means investors pay $385,000 annually to protect $10 million of GM’s debt from losses. Rising credit swap prices imply increasing investor concern that the company may default on its debt.

The GM swaps imply the company’s debt rating should be Ba3, according to Moody’s Corp.’s capital markets group, one level below the current Fitch grade and two below Moody’s and S&P.

Swaps linked to Ford’s debt are 265 basis points and those of its finance arm are 238 basis points, Bloomberg data show. Bob Shanks, Ford’s chief financial officer, said his company would not emulate GM in shifting pension obligations. “We don’t think we have excess cash,” he said in an interview with Bloomberg in his Dearborn, Michigan office yesterday. The automaker, which has a $74 billion global pension liability, is offering lump-sum pension payments to about 98,000 U.S. salaried employees and retirees.

GM is joining companies including Alcoa Inc. and Textron Inc. that are digging out of pension deficits created by near-zero interest rates, which drive down the corporate bond yields used to determine future pension obligations. Lower rates mean companies must set aside more cash for future payouts to retirees or undertake novel arrangements like transferring the liabilities to insurance companies.

“The bulk of the remaining $24 billion underfunded position relates to GM’s U.S. hourly workers and non-U.S. pension plans, which are not affected by the transaction,” Moody’s analyst Bruce Clark wrote in the report yesterday. “We don’t believe that the salaried pension plan actions will meaningfully improve GM’s overall credit profile, rating, or prospects for returning to investment grade.”


Insurers Rally

GM posted a profit of $9.19 billion and regained its status as the world’s top selling automaker last year, following a U.S.-government bankruptcy reorganization in 2009.

Prudential led a rally of life insurers today as investors bet the company’s agreement to handle GM’s pension obligations may signal more opportunities for the industry. Prudential, the second-largest U.S. life insurer, advanced 2.8 percent to $46 at 12:31 p.m. in New York. MetLife Inc., the largest U.S. insurer, climbed 2.3 percent.

“A reluctance to commit to long-term investments may put large, old-line Fortune 500 firms in a fiscal position and a corporate mindset to engage in pension closeout-type transactions similar to the GM deal,” Wells Fargo & Co. analysts led by John Hall said in a note yesterday. “We would not be surprised to see more such deals from Prudential or other competitors in the pension risk-transfer space including MetLife.”

While Chief Executive Officer Dan Akerson said he hopes GM returns to investment-grade status within the next year, he has said there are other ways to judge the performance of the company. Akerson, 63, is pushing to improve operating margins and build Chevrolet and Cadillac into more global brands.

GM’s pension move reduces future volatility and allows the company to focus on building cars, Joseph Spak, an industry analyst with RBC Capital Markets, said as the lead author in a note to investors on June 1.

“We view the announcement favorably as it reduces GM’s risk and improves their flexibility,” Spak wrote. “Moreover, we believe this sets a template to deal with the larger U.S. hourly worker pension obligation.”

Such a deal with the United Auto Workers union might cost about $9 billion, Brian Johnson, an industry analyst at Barclays Plc said in a telephone interview yesterday. He first raised the possibility of a pension buyout in September 2011.


‘Major Overhang’

“Those of us with a longer, historical view recognize that it’s been a major overhang on the company,” Johnson said of the pension liabilities.

The pension termination will allow GM to eliminate about $26 billion from its obligations. The offers are a first for GM, which projects a second-half expense of $2.5 billion to $3.5 billion and a $200 million decrease in annual pension income.

GM, along with Ford, fell to junk status in 2005 as part of a slide that eventually included the company’s government-backed bankruptcy reorganization in 2009. Ford avoided bankruptcy, recorded a $20.2 billion profit last year and was returned to investment grade by Fitch and Moody’s.

The gap between the assets of the 100 biggest company pensions and projected liabilities increased by $39 billion to $267 billion in April, the first time this year the gap has widened, according to Milliman Inc., a Seattle-based actuarial and consulting firm.

S&P said in a June 1 report that the pension changes don’t affect GM’s credit ratings. Fitch characterized them as a positive because they will reduce future volatility in the company’s cash pension obligations and said it has enough free cash flow to make the payments under the agreement.

While GM posted its ninth straight profitable quarter in the first three months of 2012, earnings were reduced by continued losses in Europe. GM has lost $16.4 billion in the region, which includes its Opel operations, since 1999.

The automaker last year appeared on track to break even until November as Europe’s economy worsened. Akerson was part of the GM board that decided against selling the company’s German-based Opel unit in 2009.

European uncertainty regarding its debt crisis and weakening Chinese economic performance aren’t helping convince investors that it’s time to purchase GM securities even with the pension changes, Johnson said.

“It’s taking away a reason not to buy GM, but in this kind of macro market we’re going to have to wait for a reason to buy it,” he said.


Bloomberg News


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