GE Treated Like a ‘Leper’ as Investors Punish Shares (Update1)
By Rachel Layne and Craig Torres
March 5 (Bloomberg) -- General Electric Co. investors are treating the company as though it’s on the verge of failing ahead of a potential cut in its top-level AAA rating.
“It’s a leper right now,” said Marilyn Cohen, president of Envision Capital Management Inc. in Los Angeles, who oversees $180 million in fixed-income assets and no longer own GE bonds. Bankruptcy “seems improbable, but we’ve seen improbable things happen,” Cohen said.
GE, which just posted its third-highest annual profit ever, has lost about $264 billion in market value in 12 months. Yesterday it fell a fourth straight day to the lowest closing price since November 1992, feeding a surge in options volume and credit-default swaps. Investors are punishing the shares on a presumption, which the company disputes, that GE Capital will need more outside funding to cover potential writedowns and losses in real estate, consumer credit cards and leasing.
The run underscores how stock investors may have lost confidence in companies with finance operations -- even those like GE that own industrial businesses, still predict a profit, and operate with some degree of backing from the U.S. government. While federal commercial paper liquidity backstops and debt guarantees since October have prevented the type of creditor panics that sank Bear Stearns Cos. and Lehman Brothers Holdings Inc., a former Federal Reserve official says the programs haven’t made a convincing case for stock investors.
“Creditors are being bailed out everywhere but equity owners are not,” said William Poole, president of the St. Louis Federal Reserve Bank until March 2008. “What that does is create cascading weakness because you can’t raise any equity capital.”
Confidence in Managers
Investors unwilling to be calmed by the federal guarantees also aren’t taking comfort from GE’s managers. Chief Executive Officer Jeffrey Immelt, Vice Chairman Michael Neal and other directors bought stock as a show of faith this week. Immelt bought 50,000 shares and Neal, who also oversees GE Capital as its chief executive, bought 125,000 shares over two days. Each day the shares closed lower. GE shares trading in Germany fell 2 percent to $6.56 as of 10:13 a.m. local time.
“Our company’s reputation was tarnished because we weren’t the ‘safe and reliable’ growth company that is our aspiration,” Immelt, 53, said in his yearly letter to shareholders dated Feb. 6. “I accept responsibility for this. But, I think the environment presents an opportunity of a lifetime.”
GE, the biggest maker of jet engines and power turbines, cut its dividend Feb. 27 for the first time since 1938 to save $9 billion a year.
Lowering the dividend was necessary but also “a reputational blow to GE and an income hit to long suffering shareholders,” wrote Citigroup Inc. analyst Jeffrey Sprague, who has a “hold” rating on the stock, in a March 1 note to clients.
Debt Ratings
GE may soon lose the top-level AAA debt ratings it has held for decades. Standard & Poor’s Corp. in December said GE had a 1- in-3 chance of losing its top designation within two years, and S&P kept GE’s “negative” outlook unchanged after the dividend reduction. Moody’s Investors Service put GE on review in January and, after the dividend cut, said it would keep studying GE’s debt for a possible lower rating.
While Immelt has said he’s prepared to run GE with less than a AAA, analysts including Richard Hofmann of CreditSights Inc. in London say bondholders are concerned that the company may split off all of GE Capital, sending the unit’s ratings lower and causing them to lose money.
‘Pure Speculation’
GE spokesman Russell Wilkerson repeated yesterday that there are no plans to separate GE Capital, and the company dismissed as “pure speculation” that there is any need to raise outside funding for the finance arm for now.
“It’s a spiral happening here both on the stock and credit side that could spur more dramatic strategic action, and a lot of bond holders are concerned that action could be a spinoff of GE Capital,” Hofmann said. “We’ve weighed the pros and cons and think the window has passed for that and it’s unlikely.”
The parent company carried GE Capital on its books at about $53 billion at the end of 2008, its annual filing with the U.S. Securities and Exchange Commission shows.
GE Capital may be required to post as much as $12 billion if the long-term ratings are reduced four to six levels into the single-A category and short-term ratings fall below A1/P-1, Hofmann estimates based on GE’s filings. Nicholas Heymann, an analyst with Sterne Agee & Leach Inc. in New York, estimated in a note March 3 that GE may need more capital to cover losses of between $21 billion to $54 billion in the next several years.
Investors also are worried about the quality of GE Capital’s $637 billion in debt, particularly loans at its real estate division and in slowing economies such as Eastern Europe. GE’s Wilkerson said total financial assets in Eastern and Central Europe are about $26 billion.
GE’s Reserves
GE says it’s adequately reserved. The finance arm has assumed $10 billion in credit losses for 2009 and has set aside $7.2 billion in reserves, mostly in consumer finance, as it slows underwriting, the company said Feb. 10.
“GE has taken aggressive steps to strengthen the capital base and liquidity of GE Capital, weather the current economic storm and be well positioned for long-term growth,” Wilkerson said. “GE Capital’s loan loss reserves are at historic highs in absolute dollar terms.”
For stock investors, who are first in line to bear losses on bad credits, the question is how much the finance assets are worth. The recession continues to drag on, making any estimates difficult, so investors assume the worst-case scenario.
“The market is increasingly pricing these assets at liquidation values,” said Dino Kos, managing director at the New York research firm Portales Partners and a former vice president at the New York Fed. “You can’t have a financial system valued at that price.”
Working on Balance Sheet
The run on GE has continued even as Immelt says he’s improving the balance sheet and shrinking the finance arm to 30 percent of total earnings this year compared with about half in 2007. GE’s profit from continuing operations was $18.1 billion last year as its finance arm made $8.6 billion. The company has projected the unit will have a profit of $5 billion this year, above most analysts’ estimates.
After injecting $9.5 billion this quarter, GE will have added $15 billion of capital to the finance unit in the past six months to reduce its debt-to equity ratio to 6-to-1 net of cash.
In total, GE Capital now has $63 billion in equity, $34 billion of tangible equity, and $36 billion of cash, GE said yesterday. That gives GE Capital a 5.3 percent ratio of tangible common equity to assets, it said.
Federal Programs
GE is included in the Fed’s commercial-paper backstop program, has $70 billion remaining in federal bond-insurance guarantees, and has repeatedly said in presentations that it’s lending more conservatively.
The company says it’s funded 71 percent of the $45 billion in long-term debt maturing this year, more than $4 billion of that without the federal insurance. Commercial paper balances have been reduced to $60 billion.
Sellers of GE Capital credit-default swap contracts yesterday demanded 15.5 percent upfront in addition to 5 percent a year as of 4:30 p.m. in New York, according to broker Phoenix Partners Group. That means it would cost $1.5 million initially and $500,000 annually to protect $10 million of the unit’s debt from default. The price fell from a record 20 percent upfront in earlier trading.
The recent increase in credit swaps may have been exacerbated because contracts on GE Capital were often loaded up in so-called synthetic collateralized debt obligations that bet on the creditworthiness of companies, Tim Backshall, chief strategist at Credit Derivatives Research LLC, said in a March 2 note to clients.
Credit-Default Swaps
As underlying swaps increase, dealers who sold those deals need to hedge their exposure by buying protection against a sudden default, he said. Concern that GE Capital could be downgraded also may trigger unwinds of the CDOs, he said.
The Standard & Poor’s Financials index is down 45 percent this year versus a 21 percent decline for the S&P 500 index.
“Investors aren’t willing to give any company the benefit of the doubt,” said Joel Conn, who manages $100 million at Lakeshore Capital LLC in Birmingham, Alabama, and doesn’t own GE stock. “It isn’t even trust-but-verify. It is verify all up front, and maybe we will believe you.”
To contact the reporter on this story: Rachel Layne in Boston at rlayne@bloomberg.net. Craig Torres in Washington at ctorres3@bloomberg.net
Last Updated: March 5, 2009 04:18 EST |
