CreditSights: The Ford Waiting Game Ends, For Now
Standard & Poor's ended the waiting game on Nov. 12 when it downgraded Ford Motor Co.'s long-term debt ratings to triple-BBB minus and assigned it a stable outlook. It was no surprise that the company did not concur with the rating agency's decision and was quickly out on a conference call to respond aggressively. The good news for Ford is that the market delivered a substantial relief trade on the back of the stable outlook and what we viewed a fairly constructive commentary on the time horizon of the next (if any) potential ratings action. Ford bonds have been nothing but bid since the move. It's now worth considering how to play the name going forward.
The market has exceeded our initial expectations for the relief rally but now that the smoke has cleared we see potential for spreads to move tighter. While investors remained fixated on the name-specific risks surrounding the S&P action, the overall market tone has strengthened further and the demand for high-beta credits has grown. With the Merrill Lynch double-B index offering little more than 290 basis points and the pipeline of single-B and double-B issuance remaining surprisingly robust, Ford spreads will be easily capped at the wider level now that the risk of the "crossover" trade has been removed.
Looking at how tight Ford spreads could go before year end, we see it more as a question of the relative pick-up to its peers, General Motors Corp. and DaimlerChrysler AG, than on an absolute spread level. Ford is still trading some 45 basis points behind GM in 10-year paper. We see this pick-up as generous and believe it is in the upper end of the range that the differential is likely to carve out into next year; we see the difference will likely trade in a 30-50 basis points range.
Investors should not underestimate the degree to which the "new year" technical trade will come into play as we head into December. The extent of the spread move and the lack of selling evident in yesterday's session indicates the usual rush by fast money to capture a momentum trade, but we are a scant two weeks away from the financial year end of several of the leading brokerage houses, which normally constrains risk appetite. This suggests there could be some buying firepower in reserve and dealer desks are positioning themselves for the usual high level of corporate demand seen in January. And when that demand starts to materialize next year, the high-yielding auto sector is likely to be at the top of many investors' shopping lists.
With the macroeconomic backdrop looking increasingly positive, corporates remain the most desirable sector of the fixed income market and the hunt for yield amidst an environment of extremely tight spreads will continue to support the auto names in general.
The degree of support that this generates for Ford in particular will, of course, remain subject to the specific headlines surrounding the company and the ongoing battle for market share in what remains an extremely competitive industry. To date, the company has demonstrated a high degree of discipline and bondholder sensitivity with regard to meeting its high ongoing financing needs and we expect this sound management of technicals to continue, and that it will mitigate concerns around the heavy maturity schedule for the first quarter of 2004. If the bid is there, there is strategic sense in Ford returning to the debt markets in the first few months of next year, but they have demonstrated a degree of financial flexibility that should reassure bondholders that if there is supply it probably won't translate into pressure on spreads.
Investors in Ford have been subject to enormous volatility in recent months and such volatility does necessitate appropriate extra compensation. Looking ahead, the path is likely to be more stable but, as we wipe the sweat from our brow after this latest episode, it goes without saying that you have to earn all that extra running yield somehow. And in this case, volatility is a large part of the sticker price for the higher total return on auto securities.
