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Fitch Sees Grim 2009 Outlook for U.S. Auto Companies

December 9, 2008

CHICAGO -- The combination of a deepening U.S. recession and the effects of the credit crisis are expected to produce a further decline in 2009 automotive industry sales volumes from already-depressed 2008 levels, Fitch Ratings said today.

Fitch Rating projects that industry sales volumes will decline approximately 10.7 percent in 2009, decreasing from an estimated 13 million until this year to 11.6 million light vehicles.

The first half of 2009 is expected to absorb the brunt of this decline, with a sharp decline of 25 percent to 30 percent from 2008 levels, with the second half producing flat to modestly higher sales levels in comparison with second-half 2008 recessionary levels.

"Fitch's economic forecast of a 1.2 percent decline in U.S. GDP in 2009, and an increase in the unemployment rate to 7.8%, is the backdrop for Fitch's retail automotive demand projection," Fith said in its reports. "Furthermore, the rationing of credit by the financing arms of the Detroit Three to the highest-quality borrowers, as well as tightened lending standards by alternative financing providers, will play a role in reducing industry sales to a level even below actual demand."

Domestic fleet sales are also expected to decline further in 2009 as a result of reduced volumes from daily rental and corporate fleets, as well as pressures on state and municipal budgets. The peak-to-trough industry sales decline of approximately 35 percent is expected to exceed the downturn of the early 1980s.

In the second half of 2009, steps taken by the federal government to support financial institutions and to improve market liquidity could improve retail financing availability to those consumer segments where demand exists. High unemployment and weak economic conditions, however, will mute any material recovery in industry volumes until well into 2010.

International operations of Ford and GM are also coming under increased pressure as a result of the global downturn, reducing the potential for cash repatriation and increasing the likelihood of operating losses in certain regions.

"The recent operating, financial, and product plans put forward by the automakers highlight a number of challenges that will shape the prospects of the Detroit Three in 2009 and 2010," wrote Fitch. "The role of the UAW is a key one, and is expected by Fitch to focus largely on the terms of the recent VEBA health care agreement, rather than wage rates. The original intent of the VEBA agreement -- to separate the financing of health care benefits for retirees from the fate of the manufacturers -- was not achieved due to the high component of debt issued by Ford and GM to finance the trusts. The UAW's willingness to defer VEBA financing obligations of the manufacturers indicates that the timing and amount of these payments is expected to be a major negotiating point, one in which the federal government could also play a role. This also emphasizes the clear incentive for the UAW to continue negotiating wage and benefit agreements outside of bankruptcy."

The expected benefits to the automakers from the two-tier wage agreement (established in the 2007 contract) have not been realized, and Fitch said it expects that modest direct wage reductions, even if achievable through negotiations, will not materially change the automakers' cost profiles. "That being said, benchmark wage and benefit rates in the industry have recently been established in the bankruptcy court (for Dana and Delphi), and have been extended to companies outside of bankruptcy (American Axle), indicating that wage pressures will certainly be on the table as part of a solution, in or out of bankruptcy," wrote Fitch.

Although it appears that temporary government aid will be forthcoming for the Detroit Three, Fitch said there remains much uncertainty regarding the amount, structure, timing and other terms of this assistance. Fitch has previously stated its view that if General Motors were to file for bankruptcy, industry revenue pressures resulting from the immediate GM price discounting that would occur, as well as the resulting cost and supply issues associated with turmoil in the supplier base, would force Ford to follow at some point thereafter.

In the event of a Chrysler bankruptcy, liquidation is seen as the likely outcome, with a limited impact on industry pricing. "Although a Chrysler bankruptcy would have repercussions throughout the supply base and on Ford and GM's costs and production schedule, it is unlikely that a Chrysler bankruptcy would produce the same chain reaction as would a GM bankruptcy," wrote Fitch.

Fitch said it believes that a bankruptcy at GM would result in widespread production shutdowns across the supplier base, threatening production at all U.S. auto assembly plants, including those of transplant manufacturers. At Sept. 30, 2008, Fitch estimates that GM and Ford had in excess of $21 billion in domestic, short-term trade payables, and the inability to make timely payments on any portion of these obligations would have crippling repercussions throughout the supply chain. On the other side, the inability or unwillingness of suppliers throughout the chain to supply trade credit would be the primary catalyst for a bankruptcy at one of the Detroit Three.

"It is unclear how GM's plan to reduce debt by half ($30 billion) would be achieved in a scenario where the threat of imminent bankruptcy is removed by the provision of federal loans or loan guarantees," wrote Fitch. "Over the longer term, reduced earnings and cash flow generation capacity at GM and Ford draw into question the companies' ability to support their current leveraged capital structures without a restructuring or significant new capital."

Under the proposed terms of financial assistance to the Detroit Three, the role of the federal government in shaping the industry will be greatly enlarged. Direct governance, when combined with regulatory and legislative initiatives, indicates that government initiatives will play a major role in shaping and/or defining industry investment and demand over the near and long term.

"The combined effects of the economic cycle and the credit crisis have further impaired the competitive position of the Detroit Three versus the transplants," noted Fitch. "Even though transplant manufacturers are also experiencing 30%+ declines in monthly sales rates, the ability and willingness of transplant suppliers to offer zero-percent financing highlights the significant capital advantage enjoyed by these manufacturers - a competitive advantage that will translate into continued market share gains for the transplants in 2009."

Over the longer term, capital constraints at the Detroit Three have deferred product programs and will continue to restrict R&D/capital investment, which will clearly affect the companies' long-term competitive position during a period of rapid change in technology and product development.

"In terms of product investment, there is little question that future product plans will migrate even further toward fuel-efficient, alternate-fuel and smaller vehicles," noted Fitch. "The range of technologies and product segments to be brought to market over the next five years by global manufacturers creates even more uncertainty about the ability of any individual manufacturer to establish a sustainable competitive advantage in terms of technology, product niche or margin."

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