GE Capital Opens the 'Black Box'

In a six-hour session for investors, the company's financial-services unit lays out a variety of earnings scenarios

By Jena McGregor and Mara Der Hovanesian

General Electric (GE) said on Mar. 19 that it continues to expect its financial-services unit to be profitable in the first quarter and for all of 2009. The statement, made during a marathon meeting with investors on the state of GE Capital, was designed to reassure investors that there are no hidden problems in the unit.

Although some investors have been questioning whether GE should split off its struggling finance unit, GE's chief financial officer, Keith Sherin, who led the session with a team of at least 15 GE Capital executives, reiterated the parent company's commitment to GE Capital. He also restated that the company sees no need to raise external capital, even in the company's worst-case models.

Weathering the Storm

GE executives, who stressed the company's secured loans and originate-to-hold approach, laid out three scenarios of how loan losses, provisions, and other economic factors would play out across its various businesses, which range from consumer mortgages in Eastern Europe to commercial real estate and equipment financing. These scenarios included the outlook GE initially framed in December and two outcomes that use guidelines from the Federal Reserve, which assume unemployment of 9.3% and 10% and declines in gross domestic product of 2% and 3%, respectively.

In the best case, the company said, loan losses and impairments would reach $10.6 billion, with earnings for the unit at $5 billion. The worst "adverse" case, meanwhile, could result in $18.4 billion in losses and impairments, with earnings for the unit flat. Sherin also stated that the ratio of assets to tangible common equity, a closely watched measure of financial strength, would be at least 6%, even in the worst scenario.

While analysts attending the event appreciated the further disclosure, some weren't clear where GE stood in terms of its outlook. "We're not in the prediction business," said GE Capital's chief executive, Mike Neal. "We're just trying to be informative based on different ways you might think about the environment we're in." Executives noted that things had worsened since its initial outlook and were much closer to the mid-range scenario.

Distorted by Tax Credits

Some analysts also questioned whether the "adverse" conditions were too rosy, with Morgan Stanley (MS) analyst Scott Davis calling the worst of the three "more like a base case if macro conditions stay on the current downward path."

In addition, some investors and analysts noted that GE Capital's earnings would benefit from tax credits, eroding the quality many investors look for. "Their whole tax situation is anomalous," says Peter Sorrentino, portfolio manager for Huntington Funds. "It's not real income…. I would rather stick with real numbers, not play the tax-credit game."

The six-hour, 176-slide presentation, which for the first time delved extensively into GE's commercial real estate and consumer mortgage businesses, is a far cry from the brief earnings releases issued under CEO Jeffrey Immelt's predecessor, Jack Welch. And it dove even deeper than did a lengthy December investor meeting devoted to GE Capital.

Investors have long called the financial-services side of GE's business a black box, with far less disclosure than traditional banks. However, in the era of cheap money and housing bubbles, investors didn't worry as much about the unit's transparency. But as credit tightened amid the financial crisis, shareholders became increasingly wary of what lurks on GE's books. When it comes to financial stocks, says Scott Lawson, a portfolio manager with Westwood Holdings (WHG), "if in doubt, people sell."