GM and Ford downgradings catch dealers off guard

A wave of frenzied trading on Thursday afternoon was triggered by Standard and Poor’s downgrading of General Motors and Ford Motor, and their financing units, to junk status, driving credit spreads to record highs.

The credit rating agency’s move came sooner than expected and caught traders off guard, despite the widespread market anticipation of the downgrades. The two US auto manufacturers have combined debt of almost $500 billion.GM and its financing arm, General Motors Acceptance Corp (GMAC), were cut to BB with negative outlooks, two notches below S&P's lowest investment grade rating; while Ford and Ford Motor Credit Co were assigned BB+ with negative outlooks, one notch below the lowest investment-grade rating.

“It is possibly the worst day ever for credit,” said one dealer. He described a brief scene of relative calm immediately following the downgrade, followed by havoc.

At close of trade on Thursday, five-year credit protection on GMAC and Ford Motor Credit cost 700/725 basis points and 610/625bp, wider by around 150bp and 170bp from pre-downgrade levels, respectively. GM and Ford closed at 900/960bp and 710/770bp respectively.

Dealers said Lehman Brothers will remove GM and Ford debt from its investment-grade index at the monthly reset on June 1. This would likely trigger additional forced selling by investment-grade portfolio managers, which widely use the index.

But Lehman Brothers will start including Fitch’s ratings for its indexes on July 1, in addition to S&P and Moody’s. Whether Ford and GM debt will be re-admitted to Lehman’s index will depend on how Fitch and Moody’s react, as one out of three junk ratings will not be enough to confer junk status for the index.

There is some market speculation that Fitch may keep GMAC as investment grade while downgrading GM to junk.