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Ford Motor Company
Ford's Improved Credit

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By JustMee01
December 14, 2009

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I was looking over the trading pattern of the preferreds the other day and a change in the F-S trading pattern these past few months really seems to highlight Ford's improved credit worthiness. In broke its pattern back in August and acquired a premium to common. In addition, the "distressed" yields are now gone, and F-S is trading much more in step with yields of the entire asset class, despite the suspension. I'll apologize for blabbering. What follows is a long read... After Al pointed out the other day how well F-S has run, I took another look at how its been trading. This was also prompted in part by my looking at preferreds again the other day and noticing how far they've run as a group overall. You need to really accept some extraordinary risk right now to get high yields. The systemic risk that was present has been largely priced out of the asset class, and the market is a lot different than it was a few short months ago.

Mulling over those preferreds, I noticed something that's interesting regarding F-A and F-S. One of the reasons I bought into Ford was to follow its turnaround and watch the shares' behavior over the process. It's been an education following the different elements of the capital structure as they've changed their trading patterns over the course of Ford's recovery. When GM and Chrysler were starting their death march in the height of the credit crunch, both F-A and F-S were tracking toward their historical lows. "Ford was next", said the Market. That November, as the dominoes fell, F-S dumped to historical lows and F-A tracked it toward the bottom. Being senior debt, F-A held up substantially better, but coming out of the trough, both pretty much ran together and behaved as a proxy for common. There was so much risk that the company's quarter by quarter performance was the primary driver, and everything behaved much like equity. Forget subordinate issues like F-S, even senior unsecured debt (F-A) was pricing default. That November bottom was looking like a dead cat bounce.

You can see this pretty clearly, when you look at A series and S series preferred spreads relative to a preferred index or ETF.. Because tracking fixed income products by price can be misleading due to differences in coupon, they're more accurately tracked by directly comparing yield. Relative risk that the market is pricing into a security can be estimated by comparing the spread between its yield and some other benchmark (the "spread" is just the simple arithmetic difference between the two percentage yields). For example, inflationary risk can be estimated by comparison of long and short Treasury yields, often the 30 and 2 year issues. Systemic corporate risk can be evaluated by comparing Treasury yields to an index of corporate yields of similar maturity, and so on.

In this case, I was interested in the spread between the Ford securities and other preferreds, so I picked an ETF designed to track preferred stocks: ticker PFF. In late February, early March of 2009, preferreds were dropping and yields were expanding as a class as a result of reemerging concerns of the as-yet unabated credit crunch. Ford of course, was no exception, but yields rose even higher due to the greater risk relative to the broader market. F-A and F-S were almost hand-in-hand at this point, with relatively similar yields that were progressively converging:

http://picasaweb.google.com/pezhorn/UntitledAlbum#5414765859118703554


The spreads ranged between 30 and 35 percent over the estimated yield of PFF; an incredibly wide spread that reflected severe risk. Then the tender came in March. The tender offer set a floor for the senior unsecured debt and F-A recovered fairly rapidly, changing that pattern completely. F-S spreads ballooned to 50% due to the suspension, and F-A spreads tightened to a range of 4 to 5% above the index yield. Clearly, divergent risk was being priced for the two in early 2009, mostly due to Ford's tender setting a floor for the unsecured debt:

http://picasaweb.google.com/pezhorn/UntitledAlbum#5414765863322473410
(the inset is an axis expansion of the post-July data)

That trend continued until common picked the F-S shares up. Immediately post-suspension, F-S crashed to its conversion value (2.8249 times common). For a very short period of time, it even fell below that value, as everyone rushed out of the shares. That established a new trading pattern, in which F-S basically tracked common. As the tender reached completion and Ford retired a chunk of debt on the cheap and drove market share gains with new product, common rose and F-S followed. If you follow their percentage gains from that point, F and F-S traded virtually hand-in-hand through to the beginning of August, as common pushed S up, and a slight conversion value premium that resembled pre-tender levels gradually reemerged:

http://picasaweb.google.com/pezhorn/UntitledAlbum#5414765859898736626

Then a change occurred again as Ford's operations improved. F-S uncoupled from F, and progressively acquired a wider premium to its conversion value from August through to the present. The spread between the conversion value and its trading value has widening considerably. That premium could be the result of speculation that Ford will renew the distribution. It could be due to the accumulation of deferred payments, although it's hard to believe that the $3.25 tacked onto the shares could be responsible for the healthy $10 premium that F-S has reached. At any rate, there seems to be a fundamental change in F-S trading patterns that started in August.

When you look at the preferreds as a group, I think you can see a hint at what might be driving F-S right now. The preferred market's tide has raised all ships. That August timepoint correlates with the start of a rise in preferreds as a group. Simultaneously, much of the corporate bankruptcy risk is out. It seems that Ford's a survivor and holders of F-S are going to get paid. As a result, the potential for non-payment has virtually been priced out of the shares, altogether. As a class, the majority of preferreds are now yielding 7-9%. Only deeply distressed securities are yielding higher. The spread between a distressed share and its benchmark is a good indicator of perceived risk. At the height of risk in March, that spread relative to PFF peaked at 50% for F-S, and 30% for F-A. At the beginning of July, with the preferred market recovering and high yields being pretty much picked over, the survivors were being bought up and those spreads tightened to 8 and 5%, respectively. What changed in August was that common retreated, while F-S held steady. Why?

Over that same time period, F-S appears to have held up based predominantly on its yield going forward. Spreads tightened further, with both F-S and F-A yielding 2% over PFF's TTM yield. That yield, roughly 9% for the pair, is not at all out of the ordinary for a distributing preferred in the current market. In short, it seems like the market is pricing in an eventually guaranteed resumption and pricing F-S like a distributing preferred. An alternative explanation for F-S rising this month could be some speculators picking it up ahead of its ex-div date hoping for the cash this quarter, making the current trend temporary. If this were the case, we should retrace soon as the shares pass the current ex-div date. But, the coincidence of the F-A and F-S yields' convergence is interesting.

What's next? No one knows obviously, but it will be interesting to see if F-A and F-S yields cross after this convergence. Convertible debt usually trades at a premium to conventional issues. It will also be interesting to see if the premium to common holds or erodes, especially if common shows any weakness again. Either way, it's been interesting to own these complex shares in these complex times...

Peter