By Don Miller
Even though it just posted its third-highest annual profit ever, investors hammered shares of U.S. industrial giant General Electric Co. (GE) last week on a triple play of bad news:
- Its first dividend cut in 71 years.
- Speculation over a possible credit-ratings downgrade.
- And growing worries that the once-unthinkable was becoming possible – a corporate bankruptcy that would put GE on the growing list of onetime Corporate America heavyweights that are now taking government bailout money.
GE's biggest worries revolve around the company's gigantic financial-services unit, GE Capital Corp., and whether it has adequate capital to counter an expected rise in delinquencies on its loans. Investors are also concerned about GE Capital's accounting methods and how the company is valuing its vast real estate portfolio.
"Probably the biggest controversy surrounding GE right now is what the fair value of (GE Capital's) $661 billion is if/when a write-down to fair value should occur," BernsteinResearch analyst Steven Winoker wrote in a note to clients last week, Reutersreported.
Investors voted with their feet last week as GE shares were pounded – leaving the stock down 59% for the year. GE has lost about $266 billion in market value in the last 12 months.
And some Wall Street analysts think investors are right to abandon ship.
"We think investors have rightly questioned managements' forecast and planning assumptions that continue to seem too optimistic and out-of-step with the environment,"
Merrill Lynch & Co. (MER) analyst John Inch wrote in a note to clients.
GE Vice Chairman and Chief Financial Officer Keith Sherin said Thursday that he sees no need to raise additional capital, and noted that the company's financial-services businesses expect to be profitable in the first quarter of 2009 and all year, Bloomberg News reported.
Sherin also said GE will host a GE Capital investor meeting later this month to examine the "hot spots in the company, including real estate, U.S. consumer [finance], global mortgage with a focus on U.K. home lending, and central and eastern Europe exposure."
But many Wall Street analysts – already questioning GE Capital's valuations of its real estate and other holdings – are watching GE's comments with a skeptical eye.
GE could be overestimating the value of some of it real estate portfolio, said BernsteinResearch's Winoker. Winoker calculates that the company's real estate equity is worth about $20 billion, rather than the $32.7 billion GE estimated at the end of 2008. If that were true, that would represent an overestimate of more than 60%.
GE Capital has vast real estate holdings in the United States and around the globe, making it an important cog in GE's operating results. Overall, GE Capital accounted for about 47%, or $8.6 billion, of GE's total profits of $18.1 billion last year. The company projects the unit will earn $5 billion this year.
GE has stakes in 8,000 properties in 2,600 cities worldwide, including office buildings, warehouses and apartments. About 71% of those properties are located outside the United States.
In Europe, GE has $22 billion worth of real estate assets. About one-third of that was real estate debt and non-performing loans at the end of the second quarter of last year, according to its Web site.
"They spent a huge amount of money in real estate," James S. Corl, who oversees distressed real estate investments at Siguler Guff & Co., told Bloomberg. "They paid a full price for what ends up being a lot of mediocre real estate."
Profit at GE Real Estate dropped by $1.1 billion, according to GE's annual report. GE's real estate profits probably have further to fall, as occupancies and rents continue to drop.
"Did we end up with too much exposure in certain areas during the credit bubble? Maybe, a few," said GE Chief Executive Officer Jeffery Immelt in his annual letter to shareholders, released March 2. "Today, I wish we had less exposure to commercial real estate and U.K. mortgages."
Real Estate Accounting – "Look Out Below"
Meanwhile, how the company accounts for its real estate holdings has raised eyebrows on Wall Street. GE values its properties at the price it paid for them, depreciating the values over time, rather than periodically marking them to their current market value – the latter practice known as fair-value accounting, or "marking to market."
GE Capital "has staunchly defended its long-term hold position for real estate assets, allowing it to carry positions at historical cost (and depreciate those values over time), rather than marking-to-market, which we imagine could turn into a ‘look-out-below'-type exercise in the current climate," wrote CreditSights Inc. analysts Richard Hoffman in a March 3 note to investors.
"We conservatively believe there could be 5% to 13%, or $4.3 billion to $11.0 billion, of cumulative losses/write-downs in the commercial real estate portfolios," Nicholas P. Heymann, an analyst at Sterne Agee, a Birmingham, Ala.-based brokerage, and a long-time follower of GE, wrote in a note to investors last week.
"Furthermore, our analysis of the commercial real estate portfolio indicates the company's holdings are concentrated in markets that are early in the credit deterioration/vacancy cycle," Heymann wrote.
Credit Rating Under Review
Moody's said Jan. 27 that it's evaluating whether to lower GE's rating, which typically takes about 90 days. GE cut its dividend Feb. 27 for the first time since 1938, saving $9 billion a year.
GE would be subject to an $8.2 billion collateral call if its rating was lowered to "A+2", BernsteinResearch's Winoker wrote in last week's client note. A much deeper cut – to "BBB+" – means GE would be looking at an additional payment of $2.9 billion.
Winoker also noted that, while he thinks GE will need to mark down the value of its financial portfolio over time, a large-and-immediate write-down is unlikely.
"We think such write-downs, if needed, would be spread over several years, which will lessen the need for equity [infusions], but [which] will hurt long-term earnings," he said.
Inch, of Merrill Lynch, also considers it unlikely GE would have to raise additional capital. But he warned that if the situation changes, GE could find it difficult to raise much money in the equity markets, due to its low stock price.
If GE Capital did face a funding crisis, Inch believes the U.S. government may bail it out to block a bankruptcy filing or a spin-off, considering the lender's huge role in the U.S. financial system.
News and Related Story Links:
GE shares up after analysts say big writeoffs unlikely
General Electric Pays Price for Real Estate, Debt Investments.
- Money Morning News Analysis:
By Relaxing "Mark-to-Market" Rules, Has the U.S. Switched Off its Financial Crisis Early Warning System?