Digging Deeper Into Ford Credit

Jun.25.13 | About: Ford Motor (F)

In my last Ford (NYSE:F) article, I provided an introductory course on Ford Credit. In summary, I talked about why Ford Credit is a very important part of the company and how it helps the company accomplish its goals in more than one way. I urge all current and potential Ford investors to take a look at that article. Also, the first 2 articles of my Ford series studied Ford Europe and Ford South America, Asia, Pacific and Africa and they may serve the investors well. Now it's time to dig deeper and learn more about Ford Credit.

One of the most important items when studying Ford Credit is Ford's credit rating. The company's credit rating determines its creditworthiness and it can play a role in how much the company can take out in loans and how much it has to pay in interest payments. During the recession, Ford's credit rating was deep in the junk territory. All of the company's assets (including its blue oval logo) had to be used as collateral in order for the company to be able to borrow money from banks and other institutions. Since then, a lot has improved in the company. The chart below shows the improvements in Ford's credit ratings between January of 2010 and September 2012.

There are four nationally recognized institutions providing Ford with a credit rating. These institutions are DBRS, Fitch, Moody's and S&P. DBRS' long term ratings are as follows (from best to the worst): AAA, AA, A, BBB, BB, B, CCC, CC, C, D. Anything above A is considered good credit and anything below B is considered highly speculative and highly risky. The company's short term credit ratings are as follows (from the best to the worst): R-1, R-2, R-3, R-4, R-5, D. Anything below R-4 is considered to be highly speculative and risky. Having said that, Ford's long term debt was rated as B, its short term debt was rated as R-5 with stable outlook in January 2010. Translated to plain English, DBRS thought Ford's long term debt was highly speculative with a lot of uncertainty, and it thought that Ford's short term debt was well below adequate credit quality. The outlook was stable, meaning that changes to these ratings weren't likely anytime soon. By September 2012, Ford's long term debt was rated as high BB, its short term investment was rated R-3 and outlook was Stable. In plain English, Ford's long term debt is almost investment-grade, short-term debt makes the investment grade and changes to these ratings are unlikely in the near future.

Fitch's credit ratings also follow a similar pattern as they go in this order: AAA, AA, A, BBB, BB, B, CCC, CC, C, RD, and D. AAA refers to excellent credit and D defers to almost certain default. Back in 2010, Ford's long term debt rating was B+ with a positive outlook and in 2012, the company's long term debt rating is BBB-. Basically, Ford's long term debt was upgraded from "highly speculative" to "good credit quality" in Fitch's terms. During the same period, the company's short term debt was upgraded from B to F3. Fitch's short term ratings go in this order (from the best to the worst): F1, F2, F3, B, C, RD, and D. Basically, Ford's short term debt was upgraded from "speculative short-term quality" to "fair short-term credit quality." The outlook is stable.

Moody's' upgraded Ford's long term debt from B3 to Baa3, meaning it moved from being "very highly speculative-high risk of default" to "medium-risk investment grade." Ford's short term debt moved from NP to P-3, in other words, from "not prime" to "acceptable ability to repay short-term obligations." Update: Moody's upgraded Ford last month to BBB-.

S&P's rating scale is very similar to that of DBRS. The long term credit ratings are (from the best to the worst): AAA, AA, A, BBB, BBB-, BB+, BB, B, CCC, CC, C, and D. In 2010, Ford's long term debt was rated as B- with stable outlook whereas it was rated BB+ with a positive outlook by September 2012 (the long term debt of FCE bank, Ford Credit's European division is rated as BBB-).

Long story short, Ford's credit rating was improved by 1-2 notches by each credit rating agency in the last couple years. While there is still a lot of room for improvement, the company's balance sheet and future prospects look healthy enough to ensure further credit upgrades in the future. Most rating agencies saw Ford's long term debt was "junk" a couple years ago; whereas, most see it as "investment grade" right now. This is a great improvement.

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As Ford's credit ratings improve, the company will have better access to cheap credit and the company will be able to offer better loan deals to its dealers, buyers and leasers. At the moment, Ford Credit's funding sources are pretty diversified. The company's funding sources may include a number of markets, investors or channels. While some of the debt is backed by assets, a significant portion of the debt is unsecured; however, this shouldn't worry investors as Ford currently has plenty of liquidity ($19.7 billion available liquidity in addition to $31.5 billion committed capacity as of the end of 2012).

The short and long-term debt issued by the company attracts a lot of institutional and retail investors. The company also has access to international capital markets. Ford sells floating rate demand notes (Ford Interest Advantage program) in order to secure short-term funding. In addition, the company issues commercial paper in the U.S. and many international markets. Both types of debt are unsecured. In order to payback these obligations, the company relies on its current liquidity rather than setting aside a reserve-bank. This model has been highly successful over the years.

Most of Ford's funding strategy will focus on long term debt. Again, while a significant portion of the short term debt is unsecured, a large portion of the long term debt is asset-backed. As the company's credit rating improves, it will be able to get more unsecured debt at better rates. As you can see from the chart below, between 2011 and 2012, the ratio of asset-backed debt and total debt reduced from 55% to 48% as a result of improved credit ratings. In 2013, this number is expected to fall further and be somewhere between 42% and 47%.

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As I mentioned before, the company's liquidity levels look pretty healthy and the company should have no trouble covering its short-term and long-term debt obligations. At the moment, there is no need for setting up a special reserve-bank to put money aside in order to cover the short-term obligations because the company's liquidity is more than enough to cover such obligations. Last year, out of the $42.4 billion of the committed capacity, the company utilized $21.2 billion (exactly 50%).

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As Ford's balance sheet improves, so will its credit ratings. As the company's credit ratings improve, it will have access to better rates and more markets. At the moment, the company's liquidity levels are very healthy and the default risk is limited. Ford Credit continues to be an important part of Ford and it continues to contribute to the company's success in more than one way: 1) it allows dealers to put cars in the lot, 2) it allows buyers/leasers to afford the great cars Ford produces, and 3) it generates additional net income for the company.

In my next Ford article, I will cover the future of not only Ford but the entire automobile industry. I promise that the next article will be more fun to read.

Disclosure: I am long F. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.