Fitch Upgrades GM's and GM Finanical's IDRs to 'BBB-'; Outlook Stable

June 18, 2015 01:34 PM Eastern Daylight Time

CHICAGO--(BUSINESS WIRE)--Fitch Ratings has upgraded the Issuer Default Rating (IDR) for General Motors Company (GM) to 'BBB-' from 'BB+'. In addition, Fitch has upgraded GM's unsecured revolving credit facility rating and its senior unsecured notes ratings to 'BBB-' from 'BB+'. The Rating Outlook for GM is Stable.

Fitch has also upgraded the Long-term IDRs and senior unsecured debt ratings for General Motors Financial Company, Inc. (GMF) and its affiliates to 'BBB-' from 'BB+' and the Short-term IDRs for GMF and its affiliates to 'F3' from 'B'. The Rating Outlook for GMF and its affiliates is also Stable.

A complete list of rating actions follows at the end of this release.

KEY RATING DRIVERS - GM

The upgrade of GM's ratings reflects the ongoing fundamental improvement in the company's core business over the past several years. At the same time, recent events pertaining to last year's recalls have given Fitch increased confidence that the company has the financial flexibility to navigate the remaining issues while maintaining an investment-grade credit profile. Fitch expects the profitability of the GM's key North American business to remain on track to meet the company's 10% EBIT-Adjusted margin target in 2016 due to a combination of pricing strength, positive vehicle mix and further operational efficiency improvements. Outside North America, Fitch expects GM's European operations to approach the company's 2016 break-even target despite weakness in Russia, while GM's Chinese joint ventures (JVs) will remain an important source of cash for the company, even with slowing growth and heightened competition in the Chinese market. Compared with its position prior to the last recession, GM today has a much lower breakeven level, stronger liquidity, lower leverage and a much more competitive global product lineup.

GM's leverage remains low for its rating category, despite its issuance of $2.5 billion in senior unsecured notes last fall and the company remains in a strong net cash position. Fitch expects the company's liquidity position to remain strong, especially given its $20 billion minimum automotive cash target. Free cash flow (FCF) will be pressured in the near term by recall-related cash expenses, but over the longer term, Fitch expects FCF to grow on pricing improvements and operational efficiency. GM continues to be one of the most globally diversified auto manufacturers, with a strong position in most major and emerging auto markets that helps to shield it from region-specific weakness. The funded status of the company's pension plans declined somewhat in 2014 as interest rates fell, but it remains much stronger than it was prior to the last recession, and de-risking activities have made them less sensitive to changing interest rates. Overall, Fitch believes the company's operating profile and financial position are strong enough to allow the company to weather the industry cycle without jeopardizing its investment-grade status.

RECALLS

Several recent developments have lessened Fitch's concerns regarding follow-on cash costs related to GM's 2014 ignition-switch recalls. The company's victim compensation program has cleared through many of the submitted claims, and Fitch expects the program will be substantially complete by the end of 2015. The program remains on-track to fall within the $400 million to $600 million range originally estimated by the company when it was announced. Fitch views the compensation program favorably, as it is likely to expedite payments to victims that might otherwise have gone through lengthy litigation processes with uncertain outcomes.

Another positive development is the recent ruling by the bankruptcy court upholding the shield that protects GM from prepetition claims. Although the court ruled that plaintiffs could appeal the ruling, Fitch views the continuation of the bankruptcy shield as a credit positive, as it protects the company from lawsuits related to accidents that occurred prior to GM's 363 sale. Exact figures are not yet clear, but Fitch expects a meaningful number of lawsuits may be dropped as the ruling leads some prepetition accident claimants to accept compensation from the victim compensation program. As of April 20, 2015, there were 144 lawsuits outstanding related to deaths or injuries in vehicles that were later recalled. Presumably, a portion of these suits were the result of prepetition accidents. Fitch expects that any lawsuits that continue forward will not be resolved for a considerable period of time.

A federal criminal investigation related to the ignition switch recall is still underway, and Fitch expects the company will eventually be subject to a significant fine from the U.S. Department of Justice (DOJ). Although the amount and timing of a settlement with the DOJ are not clear, Fitch expects a settlement could potentially be reached in 2015. Based on similar cases with other automakers, Fitch estimates the fine could be in the $1 billion to $2 billion range, although it is reasonably possible that it could be higher. Fitch believes GM's substantial liquidity position, including its $20 billion minimum automotive cash target, will provide it with sufficient financial flexibility in the case of a large fine without jeopardizing its ratings.

In addition to the personal injury and death lawsuits outstanding at April 20, 2015, GM also had 129 class-action lawsuits pending in the U.S. and Canada alleging economic losses due to declining vehicle values as a result of the recalls. The company disputes these claims, and Fitch believes it could be at least several years before the economic-loss cases are resolved.

CAPITAL ALLOCATION STRATEGY

In March 2015, GM announced a capital allocation and share buyback strategy that will significantly increase cash returns to shareholders, including $5 billion in share buybacks to be completed by year-end 2016 and about $5 billion in dividends to be paid over the same period. After 2016, the company expects to return substantially all of its free cash flow to shareholders. As part of the announcement, the company reiterated its intention to maintain a minimum automotive cash balance of $20 billion.

Fitch views the minimum cash target as a key piece of the initiative, as it provides the company with an adequate liquidity cushion in the event of a downturn. Fitch expects if free cash flow is weaker than expected, GM will adjust its share repurchase activity to keep cash at the $20 billion target level. Automotive cash falling below the $20 billion level for a prolonged period could lead to a negative rating action.

UPCOMING UAW NEGOTIATIONS

The labor agreements between the United Auto Workers (UAW) union and each of the Detroit Three expire in mid-September 2015, and negotiations on the next contract will formally begin in July. Although the ultimate outcome is difficult to predict, Fitch does not expect a significant decline in GM's profitability as a result of any new agreement. Fitch also does not expect any prolonged labor action stemming from the negotiations. Although there are difficult issues to be addressed, such as the cap on 'Tier 2' employees and their compensation level, Fitch believes the union and the company are generally aligned in their desire to keep the company financially viable. However, any significant deterioration in relations between the company and the union during the negotiation process that results in a prolonged labor action could be a credit negative.

CONSOLIDATION

Fiat Chrysler Automobiles N.V. (FCA) recently approached GM about a potential merger. However, GM has been clear that it is not interested in a transaction with FCA. Although FCA has reportedly tried to build support for a merger among some of GM's investors, it appears that the potential for a transaction is waning. Fitch would view a combination of GM and FCA as a credit negative for GM, given FCA's weaker financial position and credit profile, as well as the limited benefits that would accrue to GM from a merger with FCA. Given GM's lack of interest in a merger and reports that FCA is now looking at other potential partners, Fitch views the likelihood of a GM merger with FCA as remote, and GM's ratings are therefore currently unaffected by FCA's merger interest.

RESTRUCTURING ACTIVITIES

Over the past year, GM has made progress on its various global restructuring initiatives, including the closure of its plant in Bochum, Germany in late 2014. The company continues to move forward on its plan to remove the Chevrolet brand from Western Europe, as well as its downsizing of operations in Southeast Asia. The company also remains on-track to end auto production in Australia in 2017 as well. In the first quarter of 2015, GM announced that it will change its business model in Russia, which will include closing its St. Petersburg plant and focusing its sales on the Cadillac brand, as well as certain high-end Chevrolet models. As of March 31, 2015, GM had about $1.1 billion in remaining reserves related to its various restructuring initiatives. Over the intermediate term, Fitch expects these initiatives to result in improved profitability in GM's global operations, including approaching break even in Europe in 2016.

CHINESE OPERATIONS

GM's Chinese operations, conducted through unconsolidated JVs, continue to perform well despite a slowing auto market in the country. They remain important to GM's credit profile as a key source of cash for the company. Although GM had a slight market share loss in China in the first quarter of 2015, it nonetheless continues to hold a significant share of the Chinese market, at a company-estimated 15.1% in the quarter of 2015 and 14.8% for the full-year 2014. Fitch expects the recent introduction of the Buick Envision into the growing Chinese SUV segment will help to support GM's market share in the country over the intermediate term. GM's equity in the earnings of its Chinese JVs totalled $2.1 billion in 2014, and Fitch estimates dividends from the Chinese JVs comprised the majority of the $1.8 billion in dividends received from JVs in the period. Fitch expects competition in the Chinese market to become more intense as overall sales growth slow and as the product offerings of the indigenous Chinese manufacturers continue to improve. Government regulations favoring indigenous brands will also contribute to heightened market competition.

LIQUIDITY AND FCF

Fitch expects GM's liquidity position to remain adequate despite the company's recent announcement that it will return virtually all of its FCF to shareholders. In particular, the company's $20 billion minimum automotive cash target, which Fitch believes is sufficient to cover the company's cash needs in the event of an unexpected downturn, mitigates the risk to creditors from the share repurchases. Fitch also expects that if cash costs tied to last year's recalls are higher than expected, the company will adjust its share repurchase activity accordingly to maintain a cash balance of at least $20 billion. In addition, GM has access to two corporate unsecured revolving credit facilities, a $5 billion facility that matures in 2017 and a $7.5 billion facility that matures in 2019. As of March 31, 2015, GM had used $0.5 billion of the total availability for letters of credit, leaving about $12 billion of revolver capacity available. Combined with $22 billion in automotive cash, cash equivalents and marketable securities, GM had over $34 billion in total liquidity at March 31, 2015.

Automotive FCF (as calculated by Fitch) was ($1.5) billion in the 12 months ended March 31, 2015. Included in this figure is about $1.1 billion in preferred dividends and a redemption premium related to the company's Series A preferred stock, which was fully redeemed in December 2014. Fitch expects FCF to remain under pressure, and likely negative, in 2015 as a result of cash costs tied to the 2014 recalls, as well as higher dividends and restructuring costs. Fitch also expects capital spending in 2015 to run at about $9 billion as the company increases its product investments. The company has estimated that it will spend about $1.2 billion in cash on recall-related repairs in 2015, and Fitch expects much of the currently-estimated $550 million to $600 million in Victim Compensation Program settlements to be spent in 2015 as well. As noted above, there also is the potential for a recall-related settlement with the DOJ in 2015. After 2015, Fitch expects FCF to turn positive as the company puts the much of the recall-related costs behind it and as it begins to see the benefits of its restructuring actions.

CREDIT METRICS

GM's profitability continues to improve, and the company appears to be on-track to reach its 10% EBIT-adjusted target (as calculated by the company) for 2016 in North America. On an LTM basis as of March 31, 2015, Fitch calculates that GM's North American EBIT-adjusted margin would have been 9.2% excluding $1.0 billion of recall-related charges recorded in the second quarter of 2014. As it nears its 2016 target, GM is closing the North American profitability gap with its major mass-market competitors, an issue that has been a concern to Fitch in the post-recession period.

Fitch's calculated EBITDA margin for the full company's auto operations in the LTM ended March 31, 2015, was 6.5%, excluding $1.2 billion of global recall charges in the second quarter of 2014. The company's automotive leverage remains low for the rating category, despite its issuance of $2.5 billion in incremental debt in the fourth quarter of 2014. As of March 31, 2015, EBITDA leverage (automotive debt/Fitch-calculated EBITDA) was only 1.1x, and funds from operations (FFO) adjusted leverage was 1.2x. GM ended the first quarter of 2015 with $9.1 billion in automotive debt, primarily comprised of senior unsecured notes, non-U.S. bank borrowings, non-U.S. private note placements and capital leases. With $22 billion in automotive cash at March 31, 2015, the company was in a strong net cash position of $13 billion. Along with its substantial liquidity position, GM's low leverage contributes to the company's relatively strong financial flexibility.

PENSIONS

With the substantial net improvement in the funded status of GM's pension plans over the past several years, the company's contribution requirements have declined. In 2015, GM has no required contributions to its U.S. plans, although it expects to contribute $70 million to its non-qualified U.S. plans. Outside the U.S., where a substantial portion of the company's pension obligations are in unfunded plans, the company expects to make contributions of $1.1 billion in 2015. GM continues to shift the allocation of its pension plan assets to reduce the plans' sensitivity to interest rate changes, and it is unlikely that the company will have any required contributions to its U.S. plans over at least the next several years.

KEY ASSUMPTIONS

--Global light vehicle sales rise in the low-single digit range annually over the next several years.

--GM's revenue grows over the intermediate term on a combination of global industry growth and modest price increases, while its global market share remains close to the current level.

--Profitability increases over the intermediate term as global production volumes grow, the company makes further progress on cost efficiencies, and variable profit increases on new model introductions.

--Capital spending runs at about 6% of revenue, reflecting the company's more-aggressive investment plans.

--Dividends rise over the next several years, consistent with the company's plan to return cash to shareholders.

--Share repurchases total an aggregate of $5 billion in 2015 and 2016.

--After 2016, GM maintains an automotive cash balance of about $20 billion, with free cash flow targeted toward share repurchases.

--The company pays a Fitch-estimated DOJ fine in the $1 billion to $2 billion range in 2015.

--There are no labor actions as a result of the upcoming UAW negotiations.

KEY RATING DRIVERS - GMF

The IDRs and senior unsecured debt ratings have been upgraded as a result of the direct linkage to GM's ratings. Fitch considers GMF to be a 'core' subsidiary of GM based on actual and potential support provided to GMF from GM, an increasing percentage of GMF's earning assets related to GM, and strong financial and operational linkages between the companies. The ratings also reflect GMF's seasoned management team, improved funding profile, consistent operating performance, good asset quality, and adequate capitalization and liquidity.

GROWTH IN EARNING ASSETS

As a result of the acquisition of Ally Financial's international operations (IO) in 2013 and more recently the launch of a retail prime product in the U.S., earning assets have experienced a significant favorable shift in terms of credit composition, with subprime loans declining to 26% of total earning assets as of March 31, 2015, from over 80%, at the end of 2012. Similarly, the Ally IO acquisition, along with significant growth in originations, particularly in North American leasing, caused GM's earning assets to grow to $42.2 billion at the end first quarter of 2015 (1Q15), up 21% from $35.0 billion at 1Q14. This was despite a slight decline in the international portfolio due to a foreign currency revaluation, which outpaced international portfolio growth on a contract basis.

Lease originations increased to $3.0 billion in 1Q15, up 291% from $0.8 billion in 1Q14, driven by the increased share of GM's lease business in North America following the lease exclusivity offered on GM brands, which were rolled out between February and April 2015. The end of period lease balance was $8.9 billion at March 31, 2015, up 140% from $3.7 billion at March 31, 2014. Fitch notes that leasing is a relatively riskier strategy as it further exposes the company to residual value risk. Fitch expects GMF to conservatively assess residual values, particularly in the current market where used car values remain unusually high and are expected to moderate.

Earning assets are expected to continue to grow as GMF continues to transition to a full-service captive. Fitch will monitor the company's growth and expansion into these products paying particular attention to underwriting standards, credit quality, profitability and leverage metrics. Further, as the portfolio continue to grow, Fitch will pay particular attention to the GM's ability to support GMF as outlined under the support agreement and how the potential liability could impact GM.

OPERATING PERFORMANCE NORMALIZING

Operating performance remains solid driven by growth in earning assets, but margins and return ratios are gradually declining reflecting the run-off of higher-yielding pre-acquisition receivables and the continued shift in the originations from higher-return, higher-risk subprime loans to lower-return, lower-risk prime and commercial loans.

Net income increased to $150 million in 1Q15, up 3% from $145 million in the first quarter of 2014, driven by portfolio growth and an increase in operating lease income partially offset by a decrease in the effective yield on the earning asset portfolio and higher provision, operating, interest and leased vehicle expenses. Revenue for the period grew 23% over 1Q14 whereas expenses grew 33% over 1Q14 primarily driven by increased leasing expenses and expenses associated with the transition of GMF to a full-service captive. 1Q15 revenues do not include $28 million in equity income related to GMF's Chinese joint venture, but it is reflected in pre-tax income.

Pre-tax margin was a solid 15.8% in 1Q15, but was down from 20.2% in 1Q14, primarily due to the shift towards prime lending. Fitch expects GMF to remain solidly profitable through the remainder of 2015. However, margins are expected to continue to moderate reflecting the run-off of higher yielding assets, increased competition, normalization in used car values/consumer behavior and higher interest expense due to the shift toward unsecured funding.

SOLID ASSET QUALITY

GMF's asset quality continues to improve driven by the positive shift in the portfolio toward prime assets; however, asset quality metrics are expected to remain relatively stable for the remainder of 2015, driven by normalization in used car values and changes in consumer behavior. On a consolidated basis, net charge-offs were 1.8% and 1.9% in 1Q15 and 2014, respectively, which was stable from 1Q14 and 2013 respectively, due to strong organic and inorganic portfolio growth and the sharp shift in the quality of portfolio assets in recent years.

On a consolidated basis, delinquencies were 4.8% and 5.9% in 1Q15 and 2014, respectively, compared to 4.5% and 5.8% in 1Q14 and 2013, respectively. Improved credit performance, particularly in the U.S., has been influenced by improved recovery rates on repossessions due to robust used car values. Fitch expects recovery rates to normalize as used car values moderate from the current high levels, further supporting its view on normalizing credit trends.

IMPROVING FUNDING PROFILE

GMF's funding profile has continually improved over the past few years, with increasing access to unsecured debt markets. Still, as of the end of 1Q15, the company remains reliant on secured debt for a meaningful portion of its funding, with approximately 63% of funding in the form of ABS debt and secured revolving (warehouse) facilities. Unsecured debt increased to 37% of total funding at quarter end 1Q15, from 33% at YE 2014 and 24% at YE 2013. Fitch expects unsecured debt as a percentage of total debt will gradually increase going forward, which is viewed favorably.

ADEQUATE LEVERAGE AND LIQUIDITY

Capitalization and leverage levels have been adequately maintained to reflect the growth and riskiness of earning assets. However, leverage has increased since the IO acquisition, which is comprised of relatively lower risk assets. Leverage, measured as debt to tangible equity, increased to 6.6x at March 31, 2015 from 6.1x at year-end 2014 (YE14), and 5.8x at YE13. Management calculated leverage (earning assets to tangible equity) was 6.9x at March 31, 2015 and is expected to remain within the graduated levels outlined in GMF's Support Agreement with GM. At March 31, 2015, the Support Agreement permitted earning assets to tangible equity of up to 8.0x based on assets being less than $50.0 billion. Leverage is expected to increase over the foreseeable future as earning assets continue to grow and the prime lending platform is rolled out. At its maximum, the Support Agreement permits earning assets to tangible equity of up to 12.0x once assets exceeds $100.0 billion. Based on GMF's growth plans, however, this would be expected to coincide with continued improvement in the credit risk profile and diversity of GMF's assets as well as an increase in unencumbered assets as GMF looks to increase its unsecured issuances as a percentage of total funding

On a risk adjusted basis, current leverage is in line with other Fitch-rated auto captives, whose underlying portfolios are of higher credit quality compared to GMF's. Further increases in leverage without a commensurate decline in riskiness of the earning assets, although not expected, would be viewed negatively by Fitch.

GMF's liquidity position is strong at $10.9 billion as of March 31, 2015, including $2.1 billion in unrestricted cash, $7.2 billion of borrowing capacity on unpledged assets, $0.6 billion of borrowing capacity on committed unsecured credit lines and $1.0 billion borrowing capacity on its intercompany credit facility. Liquidity is further enhanced by GM's current decision to not take dividends out of GMF. Unsecured debt maturities are manageable with $2.6 billion of senior notes coming due in 2015.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:

--Maintaining a North American EBIT margin near 10% on a sustained basis;

--Generating positive EBIT in the company's European operations;

--Maintaining a FCF margin of 2% or higher;

--Continued growth in global sales and/or market share, especially in the U.S. and China.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

--A decline in the company's automotive cash position to below $20 billion for a prolonged period. This could be the result of a change in financial policy, a negative recall-related development, or a need to provide GMF with liquidity support.

--A sustained period of negative FCF excluding recall-related costs;

--An unexpected merger or acquisition that materially weakens the company's credit profile.

The Stable Rating Outlook on GMF is linked to that of its parent. GMF's ratings will move in tandem with its parent. Any change in Fitch's view on whether GMF remains core to its parent could change this rating linkage with its parent. A material increase in leverage without a corresponding decrease in the risk of the portfolio, an inability to access funding for an extended period of time, consistent and sustained operating losses and/or significant deterioration in the credit quality of the underlying loan and lease portfolio could become constraining factors on the parent's ratings.

Fitch cannot envision a scenario where GMF would be rated higher than the parent.

Fitch has upgraded the following ratings: