By Jason Simpkins
Managing Editor
Money Morning
Standard & Poor's today (Thursday) downgraded the AAA credit ratings for both General Electric Co. (GE) and its finance arm, GE Capital Corp. - a move that underlines the continued financial struggles of one of America's largest, most iconic companies.
Standard & Poor's cut its ratings for GE and GE Capital from AAA to AA+ with a "stable" outlook. GE had held the AAA rating since 1956, the year its chief executive officer, Jeffrey Immelt, was born.
It was Immelt who, in January, said that GE generates enough to cash flow to preserve the rating as well as the company's annual dividend. But last month, GE cut its dividend for the first time since 1938. The company slashed its quarterly dividend by 68%, from 31 cents a share to just 10 cents a share. The smaller dividend payout is expected to save GE about $9 billion a year.
In December, Standard and Poor's had said that GE had a one-in-three chance of losing its AAA rating within two years. Moody's put GE under review in January and confirmed that the company's current Aaa rating is at risk.
GE's stock has tumbled more than 70% in the past year, in part because investors worry the company doesn't have enough capital to counter an expected rise in delinquencies on loans issued by its financing arm. GE Capital accounted for about 47%, or $8.6 billion, of GE's total profits of $18.1 billion last year.
One of the biggest points of contention is real estate. 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.
Of course, it's not just the volume of holdings that has investors worried, it's also the way GE values them. 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."
"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.
Winoker calculates that the GE Capital's real estate equity is worth about $20 billion, rather than the $32.7 billion the company estimated at the end of 2008. If that were true, that would represent an overestimate of more than 60%.
Profit at GE Real Estate dropped by $1.1 billion, according to GE's annual report. But the company's real estate profits probably have further to fall, as occupancies and rents continue to drop.
"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.
GE stock was up nearly 14% as of 1:35pm New York time on relief that the ratings cuts weren't steeper.
"A one-notch downgrade and 'stable' mean you can take away the ratings as an issue for the time being," Stephen Tusa, an analyst at JPMorgan Chase & Co. (JPM) told Bloomberg. If S&P had kept the negative outlook, "it would have lingered as an issue."
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