GE Capital: We'll Make Money in '09


Seeking to reassure investors about projected profitability at General Electric's finance arm, executives cite the unit's strong liquidity

Editor's Note: An earlier version of this story said that a rating change by Moody's for GE was likely before Mar. 27. This has been corrected to the end of April.

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 was made during a meeting for investors on the state of GE Capital and was designed to reassure investors that there were no hidden problems in the unit.

Although some investors have been raising questions about whether GE should split off its finance unit, GE CFO Keith Sherin, who is leading the session with a team of at least 15 GE Capital executives, also reiterated the company's commitment to the unit. He also noted that liquidity was strong and restated the position that the company sees no need to raise external capital.

GE Capital CEO Mike Neal stressed that the company has been in its financial businesses for decades, that it holds senior, secured loans, and that it underwrites its loans to hold them. GE Capital, he noted, is a "main street" and "middle market" lender.

Weathering the Storm

"To give our investors further assurance and recognizing the uncertainty of the current climate, we have stress-tested GE Capital Finance using assumptions consistent with the Federal Reserve's base case and a more severe adverse case, which contemplates unemployment peaking at 10% and gross domestic product declining by more than 3% in 2009," Neal said in a press release prepared for the session.

"Even under this more severe case, which would potentially cause our losses and impairments to increase significantly, GE Capital Finance would still essentially break even and not require additional capital."

GE shares gained 2.2%, to 10.55, in early afternoon trading.

The detailed presentation is a far cry from the brief earnings releases issued under Immelt's predecessor, Jack Welch, and delves 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.

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 lurked on GE's books. When it comes to financial stocks, says Scott Lawson, a portfolio manager with Westwood Holdings, "if in doubt, people sell."

A Moody's Downgrade, Too?

How much the new disclosures will quell those doubts remains to be seen. Following Standard & Poor's downgrade of GE's vaunted AAA credit rating on Mar. 12, a rating change by Moody's is also likely before the end of April. While GE shares rallied on the S&P rating change, which was not as deep as some expected, any negative outlook from Moody's will leave uncertainty surrounding the stock. In addition, as the company outlined in the meeting, a worsening commercial real estate market, unemployment picture, and consumer credit environment could raise potential losses in the unit.

A key test will be whether the greater disclosure brings back investors like Mark Phelps, president and CEO of W.P. Stewart. A year ago, Phelps' funds, which concentrate investments in a limited number of stocks, had one of the biggest bets on General Electric stock at the time, according to Morningstar, at about 7% of holdings. Last summer, Phelps and his team decided to sell the stake because of poor earnings quality—he was concerned about last year's first-quarter earnings miss following GE's inability to make real estate sales—and the limited clarity into GE Capital's portfolio.

"We just couldn't really get a view of how bad the exposure would be in terms of potential losses," Phelps says. "There was just no clarity."

Would he reconsider with greater disclosure? "You never say never. I think there are some other issues in terms of quality we'd have to get over as well, but it is still a good set of businesses."

McGregor is BusinessWeek's management editor. Der Hovanesian is Banking editor for BusinessWeek in New York.

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