General Motors® and Ford®, two icons of American industry, got a wake-up call last week when their debt was downgraded to “junk” status by Standard and Poor’s® (S&P). Both companies have seen sales hurt as consumers have shunned their “fuel economy challenged” SUVs in the face of smaller, lighter and more fuel-efficient offerings from competitors.

S&P® found a number of areas of concern that called into question the creditworthiness of GM® and Ford bonds. Besides falling SUV sales, both auto makers have had difficulty cutting costs, and reducing excess manufacturing capacity, and both have failed to boost efficiency necessary to keep up with competitors.

Longer-term problems resulting from under-funded pensions and obligations for retiree medical liabilities continue to raise concerns and could impede future profitability, according to the rating agency.

S&P is one of three rating agencies that evaluate corporate debt and provide ratings on debt for investors. The other two rating agencies, Moody’s® and Fitch®, as of this writing have not yet downgraded the debt to “junk.”

The impact of the downgrades will have a rippling effect through the financial markets. With a drop in the rating to double-B, or two notches below S&P’s lowest investment grade, portfolio managers who may not hold bonds rated less than investment grade will be forced to sell the automaker bonds.

All of the above puts pressure on the price of existing bonds, pushing prices down and raising yields. Immediately after the announcement last Thursday, GM’s 8.375 percent bonds due 2033 fell $5.50 to $73.50 per $100 in face value, yielding 11.573 percent, according to MarketAxess®, an electronic trading system for corporate bonds. A bond trading below $80 per $100 in face value is generally considered to be “distressed.”

More speculative investors may find these yields attractive, but not without risk. A Standard & Poor’s credit rating is a current opinion of the creditworthiness of an obligor with respect to their financial obligations. The Standard & Poor’s credit rating takes into consideration all aspects of the creditworthiness of the issuer. Like FICA scores used by mortgage lenders and banks to determine consumer creditworthiness, these ratings serve as a guide to investors, who in turn set market prices and yields by what they are willing to pay for a particular bond.

The highest rating issued by S&P is an AAA (Moody’s Aaa). S&P considers the obligor’s capacity to meet its financial commitments as extremely strong. One rung below is AA (Moody’s Aa), considered “quite strong.”

Investment grade ratings continue down through A to BBB (Moody’s A to Bbb). A BBB rated bond is considered a medium grade investment bond, with the issuer exhibiting adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation.

Ford and GM bonds were rated before the S&P changes last week. When they were downgraded to the BB level they became less than investment grade and were considered by S&P as having significant speculative characteristics. These obligations are likely to have some quality and protective characteristics, but face large uncertainties or major exposures to adverse conditions.

Ratings go down to B, CCC, CC and C. B ratings recognize more risks but acknowledge that the obligor currently has the capacity to meet its financial commitment on the obligation.

Ratings of CCC (Moody’s Ccc) or lower indicate the issuer is currently vulnerable to nonpayment, and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitment on the obligation.