Monday, July 2, 2007

Fitch Initiates 'B+' IDR for Chrysler; Rates $12B Secured Bank Loan 'BB+/RR1'

CHICAGO--(BUSINESS WIRE)--Fitch has initiated rating coverage on Chrysler LLC (Chrysler) by assigning the following ratings:

--Long-term Issuer Default Rating (IDR) 'B+';

--$10 billion first-lien loan 'BB+/RR1';

--$2 billion second-lien loan 'BB+/RR1'.

The $12 billion in senior secured financing will be raised following the pending acquisition of 80.1% of Chrysler's parent, Chrysler Holding LLC, by affiliates of Cerberus Capital Management, L.P. The 'RR1' Recovery Rating (RR) is based on Fitch's expectation of full recovery in the event of bankruptcy. The Rating Outlook is Stable.

The rating reflects the severe competitive environment in the U.S. auto market, recent operating losses that are expected to continue through at least 2008, uncertainties regarding the extent of restructuring efforts and the pending UAW contract talks, and a deeply stressed supplier base. The Stable Outlook is based on Chrysler's market share performance since 2000, which has held up fairly well given the stiff competition and capacity expansion of transplant manufacturers as well as shifting buying patterns. The current product lineup across a number of segments, along with near-term new product introductions and a growing export market, should provide sufficient revenue support that will allow cost reductions to improve operating margins over the near term.

Chrysler has made healthy improvements in its North American manufacturing operations since its merger with DaimlerChrysler AG (Daimler). Steady improvement in such key areas as capacity utilization, production efficiency and flexible manufacturing, when combined with the company's market share performance, have limited operating losses despite an uncompetitive cost structure. As a result, Chrysler's restructuring efforts are far less dramatic than at Ford and GM, with only a single assembly plant currently scheduled for closure.

However, over-production by Chrysler in 2006, particularly in larger vehicle segments, created bloated inventories and problematic dealer relationships. Subsequent inventory reductions through the first quarter of 2007 have returned inventories to acceptable levels with an improved mix across product segments. Nevertheless, the inventory reductions were done at a heavy cost, resulting in higher incentives, higher fleet sales, operating losses, lower residual values and damage to brand image.

Consolidated operating results also disproportionately suffered from volume and price deterioration in the key pickup segment due to a cyclical decline in the housing market, heavy incentives, and tough competition from new GM and Toyota products. By the time the Dodge Ram is refreshed, the current version may be the most dated product in the market, although two pending derivatives could enhance its presence in the segment over the near term. Over the longer term, the U.S. manufacturers appear well-positioned to hold or improve their competitive position in this market, and should benefit from any eventual upturn in construction activity. Although Chrysler remains heavily exposed to larger vehicle segments, the company has been proportionately less exposed to the steep decline in mid-size and large SUV's than Ford and GM.

In the second half of 2007, key product introductions include the Dodge and Chrysler minivans, and the Jeep Liberty. Chrysler enjoys a solid market position in minivans, (although the segment remains in decline due to cannibalization by crossover vehicles), and could be poised to capture additional share as Ford and GM contract in this segment. Also supporting volumes and revenues in 2007 and into 2008 are the Jeep Wrangler, Dodge Charger and Dodge Caliber. Balanced strength across a range of new and existing products, including smaller vehicles, should allow production efficiencies achieved over the past several years to positively impact margins, despite continuing price erosion across the industry. However, large SUV products such as the Chrysler Aspen and Jeep Commander were introduced just as this segment was in steep decline.

A primary support factor for the rating is the continuing relationship between Chrysler and Daimler. In addition to a 19.9% stake that Daimler will retain in Chrysler Holding LLC, various agreements will be put in place that will cement the operating and product development ties between the two companies. Areas of cooperation include axles, a common SUV platform, V-6 engine development and more. In particular, a technology sharing agreement provides Chrysler with rights to technologies that are currently in, or designated for Chrysler products. These agreements allow Chrysler to greatly leverage its R&D efforts and capitalize on Daimler's technologies. Chrysler's access to Daimler diesel technology could provide Chrysler with a competitive advantage over the long term as the U.S. market opens to diesel applications.

Chrysler is also seeking to wring major cost reductions and efficiencies out of its production process, through parts commonality, platform-sharing, reductions in engine families, re-sourcing to low-cost countries, both alone and in partnership with Daimler. Although the synergies with Daimler have not met the levels or timeline first envisioned, efficiencies and cost savings will continue to accrue over the intermediate term.

Hourly buyout programs, salaried employee reductions and an expected UAW health care deal (similar to agreements signed by the UAW with Ford and GM) provide confidence that near-term fixed cost savings are achievable. Although Chrysler has announced $3 billion of capital spending related to powertrain products, capital spending will be reduced from heavy investment spending over the past several years.

Although liquidity is very healthy, and more than sufficient to offset near-term operating losses and restructuring costs, Chrysler remains capital constrained and lacks the scale of competitors, particularly in terms of long-term product development. The agreement with Daimler represents a critical offset to this competitive disadvantage, but does not eliminate it. Legislative and regulatory issues, including higher CAFE requirements and emission standards, present long-term uncertainties and are likely to further increase the capital intensity of the industry.

The significant revenue and margin pressures at Ford and GM will require significant changes to the UAW contract terms in order to reverse negative cash flows. Chrysler's fixed cost position are expected to benefit from changes in a number of areas including, outsourcing, use of non-union labor, work rules, job classifications, etc., through both the national contract and through continuing local agreements. Significant uncertainties remain around the results of the upcoming contract talks, and the risks of a labor disruption remain.

Given its liquidity, operating profile and the size of its healthcare liabilities, Chrysler is uniquely positioned among the Detroit-3 in its capacity to finance a final solution to its health care liabilities (along the lines of a Goodyear-style deal). Chrysler is likely to be aggressive in pursuing such a transaction, but it is uncertain that a one-size-fits-all agreement can be reached between the UAW and Ford/GM/Chrysler within the timeline of the current talks.

Chrysler's U.S. pension obligations are fully funded (on a U.S. GAAP basis), and are likely to improve further following 2007 YTD returns and an eventual re-measurement of liabilities that incorporate recent buyouts. Legacy health care liabilities remain an onerous burden on cash flow, but are likely to be reduced through an expected agreement with the UAW and through the hourly buyout program. A healthy percentage of workers accepting buyout packages are taking offers that exclude future health care and pension benefits.

The 'RR1' rating is based primarily on a stress analysis of recoveries valuing Chrysler on a going-concern basis. Fitch also analyzed recoveries against physical assets (incorporating limitations imposed by a borrowing base) and in terms of the market price implied in the current transaction. Fitch's methodology incorporated changes to assumptions on Chrysler's cost-structure, margins and other liabilities that would impact going-concern valuations under a bankruptcy scenario. Recovery values do not benefit from any values associated with Chrysler Financial, given the separate ownership structures.

Fitch's Recovery Ratings (RR) are a relative indicator of creditor recovery prospects on a given obligation within an issuers' capital structure in the event of a default. A broad overview of Fitch's RR methodology as it relates to specific sectors can be found at

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.

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