By Jason Simpkins
Managing Editor
Money Morning
With concerns about General Electric Co.’s (GE) financing arm weighing heavily on the minds of investors, the company is trying desperately to assure the public that GE Capital Corp. will survive the economic downturn.
In just the past month, GE had its credit rating cut by Standard & Poor’s and was forced to cut its dividend for the first time in 71 years.
GE slashed its quarterly dividend by 68%, from 31 cents a share to just 10 cents a share. And 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.
GE stock has lost nearly three-quarters of its market value over the past year, and there has even been speculation that the American icon would need to seek federal financial assistance. At the root of all of this has been mounting concern about the losses and uncertainties associated with GE Capital.
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 –a 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 earlier this month.
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 still 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 early this month.
“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.
Heymann estimates GE Capital’s 2009 profit will be $900 million.
GE Captial’s ‘Deep Dive’
Hoping to allay investor anxiety over GE Capital, GE hosted an informal presentation at New York’s 30 Rockefeller Plaza. GE Chief Financial Officer Keith Sherin called the meeting a “deep dive” into GE Capital’s financial position.
GE Capital President Michael A. Neal conceded at the meeting that the company would likely not deliver the $5 billion in 2009 profits it projected in December.
Instead, the company offered two different profit projections based on economic projections from the U.S. Federal Reserve. The first projection assumes unemployment in the United States averages 8.4% this year, and the economy contracts by 2%. In this, the Fed’s base case, GE Capital’s profits will be between $2 billion and $2.5 billion.
The second scenario assumes that unemployment averages 8.9% in 2009, and the economy contracts by 3.3%. In that case, GE Capital would break even for the year.
While the unemployment rate already stands at 8.1%, Neal said he expects GE will be profitable in the first quarter and the whole year.
“The world has gotten worse – you know that, I know that,” Neal said. “We think as we go through it that the economy operating in March is closer to the Fed base case.”
To bolster his case, Neal pointed out that GE Capital continues to hold onto the loans it originated, rather the selling them off.
Peter Sorrentino, who helps manage $15 billion at Huntington Asset Advisors in Cincinnati, agrees.
“GE does not have to sell assets in these situations,” Sorrentino said on Bloomberg TV. “A lot of the property that they’re invested in, they basically control, so they can ride it out. As long as they’ve got the cash flow to cover vacancies, they can ride this out, they’re not a forced seller.”
In addition to being more liquid, GE Capital purports to be less leveraged than most other financial institutions.
“We don’t do bad acronyms like CDO’s or SIVs,” Neal said, referring to collateralized debt obligations and structured investment vehicles.
GE executives also are quick to point out that GE Capital is not a home mortgage lender in the United States.
Still, analysts remain skeptical.
"The main question that remains is, can the company earn its way through elevated losses on the portfolio without having to raise equity capital," wrote Nicole Parent, an analyst with Credit Suisse Group AG (ADR: CS). "Uncertainty around the magnitude and timing of the losses at (GE Capital) make that difficult to assess."
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