Fitch Affirms GM & General Motors Financial's IDRs at 'BBB-'; Outlook Revised to Positive
Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) for General Motors Company (GM) and its finance subsidiary General Motors Financial Company, Inc. (GMF) at 'BBB-'. The Rating Outlook is revised to Positive from Stable. A full list of the rating actions follows at the end of this release.
KEY RATING DRIVERS - GM
The revision of GM's Rating Outlook to Positive from Stable reflects Fitch's expectation that the company's credit profile will continue to strengthen over the intermediate term as the profitability of its global product portfolio increases, while the company maintains low leverage and strong automotive liquidity. The Positive Outlook is also supported by a significant number of recall-related settlements accomplished over the past year, which has removed a significant amount of uncertainty related to those legacy issues. GM's plans to allocate virtually all available post-dividend free cash flow (FCF) toward share repurchases is a concern, but the company is committed to its automotive cash liquidity target of about $20 billion, investing in its business and maintaining strong credit metrics, which provides Fitch with comfort that it will remain disciplined in cash allocation priorities.
GM's leverage remains low for its rating category, at 0.8x on an EBITDA basis, despite the issuance of $2 billion in senior unsecured notes in February 2016. Fitch expects the company to remain in a significant net cash position over the long term. FCF after dividends will be pressured in 2016 by increased capital spending and $2 billion in discretionary pension contributions that were funded with the February 2016 debt issuance. Including the discretionary pension contributions, Fitch estimates 2016 FCF will be less than $1 billion. Over the intermediate term, Fitch expects FCF to grow substantially on higher global production volumes and increased operational efficiency. GM remains one of the most globally diversified auto manufacturers, with strong positions in most major and emerging auto markets, which helps to protect it from region-specific weakness. The funded status of the company's pension plans is considerably stronger than it was prior to the last recession, and de-risking activities have made them less sensitive to changing interest rates.
GM's ratings also incorporate the risk that growth at GMF and changes in the financial subsidiary's leverage profile could put some pressure on the parent company. GMF's asset base continues to grow rapidly as it increases its penetration in prime lending and retail leasing. The financial subsidiary's leverage is currently lower than some key peers, but it has increased as it has borrowed to fund asset growth, and Fitch estimates leverage is likely to increase further over the next several years. Similar to financial services operations of other manufacturers, higher leverage increases the potential that GM would need to step in to provide support to GMF in the event the subsidiary faced a negative liquidity event.
In a downturn, Fitch expects that GM would experience a significant cash outflow due to its inherent operating leverage, working capital profile and capital expenditure needs. However, Fitch expects that the company's automotive cash target of about $20 billion, along with availability on its primary revolvers, which have a total capacity of $14.5 billion, would provide the company with sufficient financial flexibility to withstand a severe decline in demand. GM also has discretion over a portion of its planned capital deployment, which could further relieve liquidity pressures in a downturn. Actions the company could take include suspending share repurchases, delaying certain capital expenditures, limiting discretionary pension contributions, and holding its dividend payments flat. Additionally, changes in GM's business profile over the past seven years have put it in a stronger position to withstand a downturn. These include a much lower break-even sales level in the U.S., significantly more competitive passenger car offerings, increased use of global platforms, and the improved profitability of its non-U.S. operations.
NEW TECHNOLOGIES AND MOBILITY INITIATIVES
Although most of GM's technology and mobility initiatives are unlikely to have a material impact on the company's financial performance for at least several years, Fitch views GM's investments in these areas positively and believes the company is well positioned to compete if new technologies alter personal transportation over the next decade. However, uncertainty over the future competitive and technological landscape introduces significant risks as well. In particular, a number of potential competitors, including startups and technology companies from outside the traditional auto sector, are actively working to disrupt the existing automotive business model, and GM, along with other mass-market auto manufacturers, could face significant challenges in the face of a rapidly changing business environment.
The backbone of much of GM's work in mobility is its 20 years of experience with its OnStar communications system, which can serve as a platform for various forms of vehicle communications. The company has also consolidated many of its various technology initiatives under its mobility platform. GM's initiatives cover a wide range of mobility issues, from automated driving to ride sharing and car sharing. Compared to some of its competitors, GM has been more oriented toward acquisitions and investments to acquire access to various technologies, which will help to accelerate its progress in these areas. Investments have included its $500 million investment in Lyft, Inc., the acquisition of most of the assets of defunct ride-sharing company Sidecar Technologies, Inc. and the acquisition of Cruise Automation, Inc., a specialist in autonomous-driving technologies.
A key issue facing GM for the past two years has been the significant number of investigations, lawsuits and settlements that resulted from the recall of 2.6 million vehicles with faulty ignition switches in 2014. Over the past year, the company has made significant progress in addressing many of the outstanding issues stemming from the recalls, including completing its victim compensation program, reaching a deferred prosecution agreement with the U.S. Department of Justice, settling a class-action shareholder lawsuit and settling over half of the personal injury claims that were outstanding in various other lawsuits.
Although many of the most significant claims against the company have been addressed, a large number remain outstanding, including those alleging diminished vehicle value as a result of the recalls. However, Fitch believes the company has sufficient financial flexibility to manage the remaining claims without negatively impacting its ratings, especially given that any future payments will likely be made over a multi-year period.
AUTOMOTIVE LIQUIDITY STRONG
Fitch expects GM's automotive liquidity (both cash and revolver capacity) to remain strong, which will provide the company with a substantial cushion in the event of an unexpected downturn. GM continues to target an automotive cash balance of about $20 billion, despite automotive cash falling below this level to a little under $19 billion at March 31, 2016. The lower automotive cash level was mostly due to seasonality and the first quarter 2016 (1Q'16) Lyft investment, and Fitch expects automotive cash will rise back to at least the target level in future quarters. However, even with the lower cash balance at the end of 1Q'16, GM's automotive cash exceeded its debt by about $7 billion. Fitch continues to believe the $20 billion automotive cash target is sufficient to allow the company weather a moderate to severe downturn without a need for borrowing.
In addition to its automotive cash, GM amended and extended its two primary revolvers in May 2016, reducing the capacity on the three-year revolver to $4 billion from $5 billion and increasing the capacity on the five-year revolver to $10.5 billion from $7.5 billion. GM also extended the maturity dates for the three- and five-year revolvers to April 2019 and April 2021, respectively. The incremental $2 billion net increase on the two facilities' capacity is a credit positive, as is the $3 billion increase to the longer-term five-year facility, which will serve to provide increased liquidity access over a longer period.
FREE CASH FLOW GROWTH
After the effect of $2 billion in debt-funded discretionary pension contributions, Fitch expects GM to post positive automotive FCF after dividends in 2016 of less than $1 billion, which will result in an FCF margin of less than 1%. Excluding the discretionary pension contributions, Fitch estimates GM's 2016 FCF margin would be closer to 2%. GM expects capital spending to run at about $9 billion annually through 2019 as the company makes significant investments in new platforms and powertrains, but after 2019 capital spending should decline as the company benefits from the long-lived nature of its investments.
Despite higher capital spending over the next few years, Fitch expects annual automotive FCF to grow substantially in 2017 and beyond, driven by increased profitability and lower pension contributions. Fitch expects GM's automotive FCF margins to run in the low-single-digit range over the intermediate term, equating to a Fitch-estimated post-dividend FCF in the $4 billion to $4.5 billion range. FCF will be supported by dividends from the company's Chinese joint ventures (JVs). JV dividends, primarily from China, totaled about $2 billion in 2015, and Fitch expects JV dividends could provide about that level of cash annually over the intermediate term.
In 2015, GM announced a capital allocation plan that includes investing in its business, maintaining strong credit metrics and returning remaining available FCF to shareholders in the form of share repurchases. Concurrently, GM announced a $5 billion share repurchase program that was to run through the end of 2016. In January 2016, GM added an incremental $4 billion, for a total of $9 billion, to be repurchased through the end of 2017. In conjunction with the share repurchase announcements, the company reiterated its $20 billion automotive cash target. Although the company's shareholder-friendly activities are somewhat aggressive, Fitch is comfortable that GM's commitment to its automotive cash target and strong credit metrics mitigates the possibility that repurchases will lead to the company holding too little liquidity to provide for sufficient downside protection.
CREDIT METRICS STRENGTHENING
Fitch expects GM's automotive EBIT margins to run in the 5% to 6% range over the intermediate term, which are low relative to general industrial companies, but solid for an auto manufacturer. Margins are likely to be pressured by ongoing weakness in the South American market and continued challenging conditions in Europe, where industry overcapacity will continue to weigh on profitability. Fitch expects North American margins to run around 10%, which is strong by historical standards, as the company continues to benefit from consumers' preference for light trucks and SUVs in a low fuel price environment. However, slowing industry demand growth in the U.S. increases the risk of intermediate-term margin declines.
GM's automotive credit profile continues to strengthen, and Fitch expects the improvement to be sustainable over the intermediate term. Fitch expects EBITDA leverage (debt/Fitch-calculated EBITDA) to remain below 1x over the next several years, even in a moderating demand environment. Actual EBITDA leverage was 0.8x at March 31, 2016. Funds from operations (FFO) adjusted leverage, which was 1.6x at March 31, 2016, is likely to remain low as well, although variability in FFO could cause more volatility in this metric. GM made $1.5 billion of its planned $2 billion in discretionary pension contributions in the first quarter of 2016, which decreased FFO and increased the FFO adjusted leverage metric by 0.3x.
The funded status GM's pension plans has improved significantly over the past six years, in part due to the company shifting its U.S. salaried plan to an annuity in 2012. At year-end 2015, the company's global pension plans were underfunded by $21 billion on a GAAP projected benefit obligation (PBO) basis, leading to a funded status of 78%. The company's U.S. plans were 85% funded, with an underfunded position of $10 billion. GM contributed a total of $1.2 billion to its global pension plans in 2015. In 2016, the company plans to increase its contributions significantly, to about $3 billion, including the $2 billion in discretionary contributions mentioned above. Expected contributions in 2016 include $947 million in contributions to non-U.S. plans and $71 million to U.S. non-qualified plans.
--U.S. industry light vehicle sales total about 17.5 million units in 2016 and global sales rise in the low-single-digit range.
--Beyond 2016, U.S. industry sales growth plateaus at around 17 million per year, the Chinese market grows at a low- to mid-single digit rate, Western Europe continues to improve and South America slowly improves, but other developing markets are uneven.
--Over the intermediate term, GM's revenue growth is tied primarily to global volume growth and modest price increases, while global market share is held about constant.
--Automotive EBITDA margins rise over the next several years as global production volumes grow, the company makes continued progress on cost efficiencies, and profitability rises with new model introductions, while spending on mobility initiatives, as well as increased vehicle technology investments put some downward pressure on margins.
--Capital spending runs at about 6% of automotive revenue over the intermediate term.
--The company allocates all available post-dividend FCF to share repurchases.
--The company maintains a target automotive cash balance of about $20 billion, augmented by about $14 billion of automotive revolver availability.
KEY RATING DRIVERS - GMF
The affirmation of GMF's IDRs and senior unsecured debt ratings are 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, improving asset quality, and adequate liquidity.
IMPROVING ASSET QUALITY
As a result of securing GM's lease exclusivity in 2015 and subvented loan exclusivity in 2016, the launch of a retail prime product in the U.S. in 2014, and the acquisition of Ally Financial's international operations (IO) in 2013 and China JV in 2015, overall asset quality for the captive has improved considerably with subprime loans declining to 17% of total earning assets as of March 31, 2016, from over 80%, at the end of 2012. Similarly, the Ally IO acquisition, along with significant organic growth in originations, particularly in North American leasing, has resulted in substantial growth in GM's earning assets to $64 billion at the end of 1Q'16, up 52% from $42.2 billion from the prior year period. Roughly 84% of GMF's earnings assets related to financing new GM vehicles, as the company continues to transition to a full-service captive following GM's acquisition of AmeriCredit in 2010.
North America lease originations increased to $6.7 billion in 1Q'16, up 123% from $3 billion in 1Q'15, driven by the lease subvention on GM brands, which began in the first half of 2015. Likewise, GMF's end of period lease balance was $24.4 billion at March 31, 2016, up 174% from $8.9 billion at March 31, 2015. Leasing involves additional risk for GMF as it further exposes the company to residual value impairment. Fitch expects GMF to conservatively assess residual values, particularly in the current market where used car values remain at elevated levels and are expected to moderate over the next few years due in part to an expected increase in supply from off-lease vehicles.
Earning assets are expected to continue to grow at a robust pace over the near term, albeit at a less rapid pace than the last couple of years, as GMF continues its 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.
PROFIT MARGINS COMPRESS AS ASSET QUALITY IMPROVES
GMF's profitability is solid driven by growth in earning assets, but margins and return ratios have gradually compressed reflecting the shift in the loan origination mix from higher-yielding, higher-risk subprime loans to lower-yielding, lower-risk prime and commercial loans. This trend is partially offset by an improvement in operating expense efficiency driven by a higher prime credit mix and servicing scale.
Net income increased to $164 million in 1Q'16, up 9% from $150 million in the first quarter of 2015, 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 loss provision and operating expenses. Revenue net of interest expense for the period grew 66% over 1Q'15 whereas expenses grew 80% over 1Q'15 primarily driven by increased leasing expenses (depreciation) and expenses associated with the transition of GMF to a full-service captive.
Pre-tax margin continued to compress to 10.7% in 1Q'16, down from 15.5% in the year ago quarter, primarily driven by the mix shift toward prime lending. Fitch expects GMF to remain solidly profitable through the remainder of 2016, although pre-tax income growth is expected to be modest as the company continues to incur expenses related to its captive strategy implementation which should produce market share gains. Further, margins should continue to moderate reflecting the mix shift toward lower-yielding assets, pricing pressure from increased competition, normalization in used car values/consumer behavior, and higher interest expense due to a shift toward a higher mix of unsecured funding.
SOLID CREDIT PERFORMANCE
GMF's credit performance has remained fairly stable in recent years despite the shift in the portfolio toward prime assets, and Fitch expects continued crosscurrents as credit degradation driven by a softening in used car prices and portfolio seasoning is partially offset by the continued mix shift toward prime quality loans and leases. Retail auto net charge-offs were 1.9% 1Q'16, up slightly from 1Q'15 but flat with full year 2015 and 2014 levels, as the seasoning effect from recent loan growth has been more than offset by the mix shift toward prime loans and leases.
On a consolidated basis, delinquencies were 4.5% and 5.8% in 1Q'16 and 2015, respectively, compared to 4.8% and 5.9% in 1Q'15 and 2014, respectively. Improved credit performance, particularly in the U.S., has been influenced by improved recovery rates on repossessions due to elevated 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. The net charge-off rate on retail auto loans in North America was 2.5% in 1Q'16, down slightly from 2.6% in 1Q'15 despite the drop in recovery rate to 54% from 58%. Likewise, the 30+ day delinquency rate also declined to 6.1% in 1Q'16 from 7.2% in 1Q'15.
IMPROVING FUNDING PROFILE
GMF's funding profile and diversification has steadily improved over the past few years, with increasing utilization of the unsecured debt markets. Still, the company remains reliant on secured debt for a meaningful portion of its funding, with approximately 54% of funding in the form of ABS debt and secured revolving (warehouse) facilities as of 1Q'16. Unsecured debt increased to 46% of total funding in 1Q'16, from 37% in 1Q'15 and 24% in 1Q'14. Fitch expects unsecured debt as a percentage of total debt will continue to increase toward 50% of GMF's funding, which Fitch views favorably.
LEVERAGE INCREASING AS FULL SERVICE CAPTIVE TRANSITION TAKES EFFECT
Capitalization and leverage levels have been adequately maintained to reflect the growth and riskiness of earning assets. However, leverage has increased over the last few years as GMF has increased originations as it transitions to a full service captive. Leverage, measured as debt to tangible equity, increased to 8.4x at March 31, 2016 from 6.1x at year-end 2014 (YE14). Management calculated leverage (earning assets to tangible equity) was 8.8x at March 31, 2016 and is expected to remain within the graduated levels outlined in GMF's Support Agreement with GM. The Support Agreement between GM and GMF permitted earning assets to tangible equity of up to 9.5x based on assets being greater than $50 billion but less than $75 billion. Leverage is expected to increase over the foreseeable future as earning assets continue to grow and the prime lending platform continues to take market share. At its maximum, the Support Agreement permits earning assets to tangible equity of up to 12x once earning assets exceed $100 billion, although this would be expected to coincide with continued improvement in the credit risk profile and diversity of GMF's assets.
Although several of GMF's auto captive peers operate with higher leverage, namely Ford Motor Credit Company ('BBB'/Outlook Stable) and Toyota Motor Credit Corporation ('A'/Outlook Stable), GMF's underlying portfolio is currently of weaker credit quality, which justifies the lower leverage appetite in Fitch's opinion. Further increases in GMF's leverage without a commensurate improvement in asset quality of the earning assets, would be viewed negatively by Fitch.
GMF's liquidity position is strong at $12.7 billion as of March 31, 2016, including $2.9 billion in unrestricted cash, $8.4 billion of borrowing capacity on unpledged assets, $0.4 billion of borrowing capacity on committed unsecured credit lines and $1 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 $4.3 billion of debt maturing in 2016.
RATING SENSITIVITIES - GM
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 (potentially the result of a change in financial policy, a negative recall-related development, or a need to provide General Motors Financial Company, Inc. (GMF) with liquidity support);
--A sustained period of negative FCF excluding recall-related costs or discretionary pension contributions;
--An unexpected merger or acquisition that materially weakens the company's credit profile.
RATING SENSITIVITIES - GMF
The Positive 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 has affirmed the following ratings:
--Long-term IDR at 'BBB-';
--Unsecured credit facility rating at 'BBB-';
--Senior unsecured rating at 'BBB-'.
--Long-term IDR at 'BBB-';
--Senior unsecured debt at 'BBB-';
--Short-term IDR at 'F3';
Opel Bank GmbH
--Long-term IDR at 'BBB-'';
--Senior unsecured debt at 'BBB-';
--Short-term IDR at 'F3';
--Commercial paper at 'F3';
GMAC (UK) Plc
--Long-term IDR at 'BBB-';
--Short-term IDR at 'F3';
--Short-term debt at 'F3';
General Motors Financial International B.V.
--Long-term IDR at 'BBB-'
--Euro Medium Term Note Programme at 'BBB-';
The Rating Outlook is revised to Positive from Stable for all of the long-term ratings.
Summary of Financial Statement Adjustments - Fitch has made no material adjustments that are not disclosed within the company's public filings.
Additional information is available at 'www.fitchratings.com'.
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
Exposure Draft: Global Non-Bank Financial Institutions Rating Criteria (pub. 14 Apr 2016)
Global Non-Bank Financial Institutions Rating Criteria (pub. 28 Apr 2015)
Dodd-Frank Rating Information Disclosure Form
Primary Analyst (GM)
Stephen Brown, +1-312-368-3139
Fitch Ratings Inc.
70 West Madison Street
Chicago, IL 60602
Secondary Analyst (GM)
Craig D. Fraser, +1-212-908-0310
Primary Analyst (GMF and Affiliates)
Michael Taiano, +1-646-582-4956
Secondary Analyst (GMF and Affiliates)
Richard Wilusz, +1-312-368-5459
Committee Chairperson (GM)
Robert Curran, +1-212-9058-0515
Committee Chairperson (GMF and Affiliates)
Meghan Neenan, +1-212-908-9121
Media Relations, New York
Alyssa Castelli, +1-212-908-0540
Hannah James, +1-646-582-4947