NEW YORK -- The huge debt of General Motors and its finance arm will likely slide to junk status this year, forcing asset sales and a cut in GM's dividends, Merrill Lynch said on Thursday.
The downgrade of a combined $200 billion in unsecured debt to junk territory would be unprecedented in capital markets, and investors should "expect a bumpy ride," Merrill said in a report.
"Our concern is that GM's (market) share losses could accelerate in an increasingly competitive marketplace," Merrill said. "We find little reason to believe this erosion of fundamentals is reversible."
GM, the world's biggest automaker, has seen its debt ratings tumble to the lowest investment grade from a top triple-A rating in 1981.
Standard & Poor's warned last week it could cut GM to junk at any time after the automaker said profits this year could be as much as 80 percent below previous forecasts.
Successful new product launches could help GM's financial picture, but not enough to prevent a cut to junk status, which is likely in three to six months, Merrill said.
S&P and Fitch Ratings rate GM one notch above junk, while Moody's Investors Service rates it one notch higher.
BUCKLING UP FOR A BUMPY RIDE
"We understand fully what the challenge is in our automotive business -- it's in North America, and we are addressing that aggressively," said GM spokesman Jerry Dubrowski. Other parts of GM's business are performing on or better than expectations, he said.
Dubrowski said a downgrade would not be that significant for the automotive business because it does not need to borrow or refinance significant amounts of debt in the near future.
Finance arm General Motors Acceptance Corp. has been preparing for a downgrade by shifting to secured financing, he said.
GM's bonds and shares have been pounded in recent weeks on worries that the automaker would not be able to overcome soaring costs and foreign competition.
GM has been shrinking its work force as it loses market share, so it now has about 2.4 retirees for every active employee in North America, making pensions and retiree health care an "immense burden," Merrill said.
GM has relied on its finance arm, GMAC, for its earnings since 2001, so a downgrade to junk could put earnings at risk if GMAC's borrowing costs rise, Merrill said.
Yields on GMAC bonds, which move in the opposite direction to price, are already so high that issuing unsecured debt is likely "prohibitively expensive," Merrill said.
GMAC EARNINGS SEEN AT RISK
GM has enough cash and short-term investments to handle the immediate impacts of a downgrade, but GMAC would likely lose access to the commercial paper market, and debt sales targeted to individual investors could be restricted, Merrill said.
GMAC could meet funding needs through mid-2006 with cash or asset sales, but after that, it would need to rely more on the secured, or asset-backed, market, Merrill said.
Greater use of the secured market would hurt GMAC's earnings power over time and carry "meaningful risk" for GMAC's unsecured bondholders, Merrill said.
In the asset-backed market, loans GMAC makes to customers are used as collateral for its own financing. Relying more on that market would reduce the revenues GMAC now makes from loans kept on its balance sheet, Merrill said. Over time, unsecured bondholders would be in a weaker position because they would have less cash supporting their bonds.
To raise capital, GMAC will likely sell or spin off its mortgage and insurance businesses, but its auto financing business likely cannot be separated because it is vital to the auto operations, Merrill said.
GM's Dubrowski said he is confident GMAC can sustain recent levels of profitability.
"GMAC has had 10 years of consecutive earnings growth even as the credit ratings have now declined to their lowest level on record," he said. GM itself has only about $30 billion of debt, with less than $1 billion coming due over the next two years, he said.