Derivatives counterparties shun Ford and GM

Few banks are now willing to enter derivatives trades with Ford and General Motors, leaving the struggling car manufacturers exposed to further risk.

The auto companies have been particularly hard hit by the financial crisis and the drop in consumer spending, and as a result their credit ratings have been reduced to junk status. Rating agency Standard & Poor's downgraded General Motors from CCC+ to CC with a negative outlook on December 4, while Ford's rating was reduced to the same level on March 4. This has meant that banks have become more wary of entering into derivatives trades with them.

In its annual report filed on February 26 with the Securities and Exchange Commission, Ford stated: "The global credit crisis and deterioration of our credit ratings have significantly reduced our ability to obtain derivatives to manage risks."

Meanwhile, General Motors revealed in its filing on March 5 that "most derivatives counterparties have already been and may continue to be unwilling to enter into transactions with the company due to its credit rating".

They both said that if they could not hedge their positions then large unfavourable changes in foreign exchange rates, commodity prices or interest rates could badly affect their businesses.

Their situation is unlikely to change in the short term, according to Standard & Poor's.

"We believe the [default] risk will remain high for all three Michigan-based automakers for 2009 and 2010 because of the dismal state of industry demand and other industry problems, such as the potential for supplier failures," said the rating agency in a statement from March 4.

Both are among the largest reference entities for credit default swaps (CDSs), and if one of them goes bankrupt it could have significant effects for the CDS market. According to data from the Depository Trust & Clearing Corporation's trade information warehouse, the gross notional amount of CDSs as of March 13 written on General Motors was $37.8 billion, while there was $35.1 billion written on Ford.

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