Financial Strategy, Second Edition

CASE STUDY 9

Journey to Junk

Jenny Wiggins

Owning General Motors' bonds in recent years must have seemed to some like being a passenger in a car speeding down a mountain road. From a position close to the peak of creditworthiness, the largest US carmaker has seen its credit rating career towards the precipice that separates the best-rated, investment grade companies from their junk-rated counterparts.

Now, the edge of the cliff appears to some to be drawing closer. Over the past few weeks, bonds issued by GM and General Motors Acceptance Corp – its finance subsidiary, which issues the vast bulk of the car company's overall debt – have fallen sharply in value. Investors have become increasingly convinced that Standard & Poor's, one of the three leading credit ratings agencies, is moving closer to lowering GM's ratings to junk.

Such a downgrade would be a striking confirmation of the problems at a company whose fortunes have traditionally been regarded by investors as closely intertwined with those of the wider US economy. But just as important would be the potential reaction in US debt markets. If GM loses its investment-grade rating some holders of its bonds will be forced to sell them – and it is the extent of any market upheaval this could cause that has been unnerving many.

In 2002, the downgrade to junk of more than $30bn of debt issued by WorldCom, the telecommunications company that went bankrupt, was one of the factors contributing to a sharp widening in yield spreads. ...