Rarely in investing is an event forecast with such certainty.
Later this year, it is said, General Motors will lose the critical investment-grade debt rating from at least one rating agency.
A rating below investment grade, known as “junk,” would be an onerous designation for the world’s biggest carmaker.
“I do not believe that General Motors has a financial profile of an investment-grade company,” said professor Edward Altman of the Stern School of Business, an authority on credit ratings.
“The bonds are trading now as if they were junk status.”
Corporate debt securities have become popular. In the latest three- and five-year periods, junk bond funds outperformed most stock funds.
Some companies happily finance themselves by issuing bonds rated “junk” from the outset. But the prospect of General Motors falling into the junk status with about $50 billion of securities is not trivial.
“If it goes to the junk market, it would represent 10 percent of the junk market,” said Gregory Nassour, a fixed-income fund manager of the Vanguard Group, a major holder of GM debt.
GM debt currently represents more than 2 percent of the universe of investment-grade debt tracked by a widely followed Lehman Brothers bond index.
Its sudden exodus from the Lehman index would change the character of the index, which is mimicked outright or used as a benchmark by hundreds of mutual funds and other investment portfolios.
If you follow the perils of General Motors, you need to understand the sideshow as well as the main event.
The great complexity of valuing corporate debt securities has led to conventions, such as credit ratings and bond indexes.
The three debt rating agencies, Standard & Poor’s, Moody’s Investors Service and Fitch Ratings, owe their reputations to slow deliberation. Only S&P rates GM on the cusp of junk.
Reliance on ratings and indexes intensified after massive bond explosions in 2002 by Enron, WorldCom and others.
But many portfolios have long required that bonds be automatically shunned if they lose their investment grade.
Purveyors of bond indexes follow the same rule, although Lehman Brothers plans to relax the rule for its high-grade index.
On July 1, Lehman will add a third rating service, Fitch, to its review and throw a company out only when two of the three rating agencies, rather than one, declares “junk” status.
Most of the GM bonds are held by potential forced sellers who would act if Lehman or even just one rating agency pulled the trigger. Who would buy?
Many junk bond funds would avoid the heavy exposure to GM implied by the looming weight of GM in the junk market.
But investors unconstrained by bond market conventions might be eager buyers, once GM is stripped from the Lehman index.
If GM’s fortunes improve in the years ahead, active managers could more readily outperform the benchmark.
The outcome depends on GM, not on sellers of indexes or rating services. The forecast of a GM downgrade by two rating agencies is not unanimous.
“That’s not a scenario we are envisioning,” said Craig Hutson of the independent bond analysis firm Gimme Credit.
Nonetheless, GM faces a self-fulfilling prophecy by a bond market obeying its own rules.
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E-mail Bill Barnhart at yourmoney@tribune.com.
