LONDON -- European financial markets reacted calmly on Friday to Standard & Poor's decision to slash billions of dollars in debt from General Motors and Ford Motor Co. to "junk" status.
European auto stocks at one point were the worst-performing sector but recovered to be in line with other sectors, while corporate bond markets dipped by relatively little despite the cuts, which came sooner than many had expected.
S&P late on Thursday cut its rating on GM by two notches to BB and Ford by one notch to BB+. The agency warned of brutal competition pressures and declining sales of the automakers' most profitable vehicles.
The move will curb the routes to funding available to the two firms, which between them have some $453 billion of debt outstanding.
"The timing is a surprise, and I think the Ford downgrade may also be a surprise to a lot of investors," said Willem Sels, credit strategist at Dresdner Kleinwort Wasserstein in London.
"The combination of the two downgrades is unprecedented in terms of size, so there needs to be a significant reshuffling of portfolios," Sels said.
The initial fallout was limited. Bonds of GM and Ford fell by around 5 percentage points in New York, with GM's euro bonds extending losses to be down around 8-9 percentage points in Europe on Friday. Both stock prices were hit hard in New York, GM dropping 5.91 percent and Ford by 4.53 percent.
In Europe, on Friday there was little spillover to other sectors.
"I am a bit relieved that there wasn't a more dramatic reaction on the market," said Bernhard Jeggle, credit analyst at Landesbank Baden-Wuerttemberg. "It certainly had something to do with the fact that this step was largely expected. Only the timing was basically still up in the air. Moreover the bonds had already priced in an even greater rating downgrade."
European auto stocks were under limited pressure, with German-U.S. DaimlerChrysler down 1.5 percent and Volkswagen little changed on the day.
Italy's Fiat, already rated in "junk" territory, suffered however, with its stock down just over 2.0 percent its bond due 2011 down 3 percentage points. A trader said that the reaction was as expected as Fiat's stock and bonds have become very volatile.
TIMING RAISES QUESTIONS
The key question on the downgrades related to timing, with even the day of the announcement raising some eyebrows.
"It's ironic this happened on Ascension Day," said Gary Jenkins, head of credit strategy at Deutsche Bank. "From a serious point of view that means a lot of Europe was out," he said. "Maybe the market doesn't take the full brunt of this until next week in the sense of turnover."
Analysts at HSBC said S&P's actions were at odds with its previous statements.
While a downgrade for GM was not a surprise, HSBC's analysts argue it is difficult to reconcile S&P's statement in mid-March that the rating could tolerate several quarters of weak cash flow with a two-notch downgrade less than two months later.
"What S&P did with Ford is even more puzzling," they said. On April 8 S&P changed its rating outlook on Ford to negative with almost identical language to that on GM, and then downgraded under a month later.
"We believe the lack of catalyst, based on all publicly disclosed information, for the Ford/FMC (Ford Motor Credit) downgrades highlights an astonishing lack of credibility on the part of S&P's auto analyst team," HSBC said.
Rival ratings agencies Moody's Investors Service and Fitch Ratings still rate GM and Ford low in investment-grade territory.
The high-yield bond market, still relatively young in Europe, now faces the prospect of playing host to two massive borrowers.
The iTraxx Crossover index, a barometer of sentiment in the European high-yield market, blew out 40 basis points to 360 basis points late on Thursday but was at around 345 basis points early on Friday.
Suki Mann, credit strategist at Societe Generale, said in a note that there is around 19 billion euros ($24.6 billion) of Ford and GM debt due to mature in more than one year, while the high-yield market currently totals some 56 billion euros.
High-yield bond indices, however, are constructed on a so-called constrained basis, meaning that "junk" bond buyers are not forced to mop up all of the new paper entering the market as the exposure to any one name in an index is limited.