GM: A Whirlpool Of SEC Investigations, Credit Downgrades
WASHINGTON (Nov. 14, 2005) - General Motors (GM) submitted a telltale filing with the Security Exchange Commission (SEC) on Nov. 9, 2005 that underscores a number of problems the automaker faces. -Namely, these problems include mistakes made in stating earnings, concerns about financial transactions between GM and Delphi Corp., accounting practices and insurance transactions of subsidiary GMAC. These matters are the subjects of SEC investigations.
GM acknowledges troubling waters Within the filing, GM informed the SEC that it would restate income from 2001 lower by 25 percent to 35 percent resulting from a mistake in the way it accounted for supplier credits. A GM spokesperson indicated that the error resulted from booking income at the time of the agreement, rather than when the business was completed. The income restatement would be between $300 million and $400 million, and would be added to earnings of later quarters.In GM's filing with the SEC, the automaker stated, "GM has been cooperating with the SEC in connection with investigations reported by the media concerning pension and OPEB and certain transactions between GM and Delphi. The SEC has issued subpoenas to GM in connection with various matters involving GM that it has under investigation. These matters include GM's financial reporting concerning pension and OPEB, certain transactions between GM and Delphi, GM's recovery of recall costs from suppliers and supplier price reductions or credits, and any obligation GM may have to fund pension and OPEB costs in connection with Delphi's proceedings under Chapter 11 of the U.S. Bankruptcy Code."
Pertaining to the SEC's investigation in GMAC, GM stated in its filing that, "Separately, SEC and federal grand jury subpoenas have been served on GMAC entities in connection with industry wide investigations into practices in the insurance industry relating to loss mitigation insurance products such as finite risk insurance."
GM securities sink in the market Where the liability will fall is anyone's guess, but late last week the Pension Benefit Guaranty Corp. (PBGC), the federal agency responsible for insuring corporate retirement plans, issued a report that Delphi's pension plans were under-funded by more than $10 billion. Under its mandate, the PBGC said it would only cover slightly more than $4 billion of that deficit, should Delphi elect to terminate its retirement obligation while under Chapter 11 protection.In the wake of the filing with the SEC, the markets and public reacted. GM shares sank to a 23-year low of $22.75 per share at close of market on the next day. Ironically, the last time the share price was this low, GM also flirted with bankruptcy. The decline in share value is over 40 percent just this year alone.
Some auto analysts, including Ronald A.Tadross at Banc of America Securities LLC, are suggesting the world's largest automaker is further down the road to declaring bankruptcy. Tadross cited a bankruptcy probability of 40 percent.
GM spokesperson Gina Proia refuted this, saying such speculation is inflammatory. With regards to the restating of income, it is not a matter of losing it, but properly stating it in the proper quarter the income was earned.
GM in its third quarter report indicated it had $19.2 billion in cash at the end of the third quarter, despite a loss to date in 2005 of $3.8 billion. In earlier press releases by GM the company has said its obligations to Delphi retirees could range from nothing to as much as $12 billion. Should the liability be closer to the $12 billion, it could be the genesis of a GM liquidity crunch.
Safety has a price In addition to the drop in share price, the risk of GM's debt instruments sold in the market is subject to constant review several credit-rating firms, including Standard and Poors (S&P), Fitch Ratings and Moody's Investment Services. A rating cut indicates increased concern by a credit-rating firm that bond and credit note holders of GM and its business units' debt are less likely to be paid in full and on time.This year, increased concern about GM's ability to implement its restructuring program, eroding market share and GM's ability to rebuild profitability has been a focus of the rating firms. Concern as to whether GM's autoworkers and the courts would accept a revised healthcare proposal, and the recent threat of a strike at Delphi Corp. - GM's primary supplier - has intensified the concern of rating agencies.
All three agencies had already rated GM below investment grade, in an area more commonly referred to as "junk bonds." S&P has not made any further downgrades in the last month, but has GM under watch with a negative outlook. Moody's and Fitch have both cut GM's debt-rating one notch lower than S&P, deeper into non-investment grade. A Fitch spokesperson stated that, "A labor disruption at Delphi for any extended period would have an immediate impact on GM's ability to operate and would quickly reduce liquidity."
In the derivatives market, sellers of protection against GM defaulting on its debt payments, known as credit-default swaps, have begun to treat GM debt the same way Delphi and Delta Airlines debt was treated as their situations worsened, leading to each declaring bankruptcy. Sellers are now demanding and getting upfront payments for the contracts on Thursday, as concerns mounted about the potential impact of a strike. Swap prices typically decline when credit worthiness improves, and rise when it worsens. Sellers of default protection start demanding payments upfront for the insurance to compensate for increased concerns about a company's creditworthiness.
GM's five-year credit default swaps traded on Thursday with upfront payments of 17 percent of the amount insured. Let's say, for example, a five-year $100,000 (principal) GM bond was selling on the market last Thursday for $69,000. In a credit-default swap, a buyer typically pays an annual fee (17 percent of the principal of the bond) and gets the full amount insured ($100,000) if the borrower defaults. In return, the swap seller gets the defaulted loans or bonds ($69,000) and any remaining portion of the swap fee ($17,000) after insurance against default was bought.
Swaps are a leveraged investment representing an obligation made by one company to secure the declining value of another company's assets through the commitment of shares. Made famous by Enron, this method of hedging a company's declining assets can help to inflate the value of a troubled company by hiding losses. Furthermore, the volatile nature of the stock market, if devaluations in price of a securing company like GM occurs, would result in a commitment of more shares, thus further diluting GM's share value.
Staying afloat while building liquidity If optimizing profits isn't currently achievable, then keeping bad news to a minimum may be the current modus operandi. Good news, even if just for the short term, can influence shareholders' and the market's perception, especially if it generates immediate cash.Several strategies undertaken by GM to improve current liquidity, even if at the expense of overall profitability, include:
* GM announced earlier this month that its autoworkers accepted a healthcare restructuring proposal that will save nearly $2 billion annually. The agreement is subject to court approval. This good news came coincidentally the same day that the UAW threatened job action at Delphi's Lockton, NY plant. Strike or not, the agreement with its auto workers will contribute to GM's cash-flow going forwards.
* GM continues to convert dealer vehicle inventory into current cash, at prices just over dealer cost. GM recently announced a "Red Tag" sale, which will combine employee pricing with a windshield red tag price, to run through Jan. 3, 2006. GM is offering discounted prices on most Buick, Chevrolet, GMC and Pontiac 2005 and 2006 models, while Cadillac, Saturn, Saab and HUMMER also are running special year-end programs for cash sales or those financed through GMAC. In the short run, liquidity and cash may well result. But GM posted tremendous vehicle sales numbers while piling up a record quarterly loss in the third quarter this year.
* GM has also previously stated it intends to sell a majority stake in its profitable GMAC subsidiary, which could provide more than $10 billion cash to help stem the bleeding. However, no deal to consummate the sale has occurred yet.
In the long run, if more issues than the restatement of income are substantiated - such as if the SEC uncovers more serious accounting problems or if obligations to Delphi Corp. are significant - or should other serious issues arise, there could be much more trouble for not only GM, but also the automotive industry and U.S. economy as well.
(Sources: SEC, GM, PBGC, Merrill Lynch, Bank of America, Fitch, S&P, Moody's)
