GE: What's Working, What's Not

Includes: C, COA, FLE, GE, MER, THO, WGO
by: Judy Weil

Five key quotes from General Electric's (NYSE:GE) Business Update call:

GE Capital still operates in many sectors:

GE Capital has [completed] $120 billion of new financings to US companies, projects, municipalities; $245 billion on new credit extended to US consumers; opportunistic deals this year with both Merrill (MER) and CitiBank (NYSE:C); contributed to support all major US airlines, auto companies… In restructuring finance: Middle market commercial lending, equipment, aircraft financing, health care, fleet leasing, very strong positions in all of these markets in the US and of course strong positions in these markets globally as well.

We’re going to accelerate the loss provisions in the fourth quarter and also be at the high end of the loss provisions in 2009… Approximately 70% of this additional fourth quarter charges will be associated with the Financial Services business.

Tightening its loan criteria significantly:

We’ve exited several high-risk business lines and we’ve reduced volume significantly in some higher risk consumer finance areas. Now across the entire portfolio for the entire year of 2008 and back into 2007, we’ve tightened our underwriting parameters to reflect these deteriorating credit conditions.

We lowered initial credit lines for new customers. We eliminated or reduced credit lines for inactive and active cardholders and raised approval cut-off scores.

We exited the motor home and marine segments of our sales finance business that were under stress.

What's the worst that could happen:

US consumers… represent about 7% of total assets. We’re assuming 8.5% unemployment by year-end 2009 which will drive approximately $4 billion of pre-tax losses in our plan for 2009, which is about a 20% increase from where we think we’re going to end 2008.

Our downside case is that unemployment reaches 9% by year-end 2009 which would add roughly $800 million in additional pre-tax losses.

The UK mortgage business is 4% of our portfolio and in 2008 home prices fell 17% and we’re assuming another 15% decline in 2009. That results in an expectation of about $600 million of losses in 2009, up approximately 90% from 2008.

Our downside case is a 20% home price decline next year which in combination with the 2008 experience would mean 37% decline over that period of time. That is equal to the largest peak to trough cycle that we’ve seen in the UK housing market in the last 20 to 25 years and it would add about $200 million in additional pre-tax losses.

Our real estate debt and equity [inaudible] represents 14% of our portfolio. Next year we expect average cap rates to increase 50 to 100 basis points resulting in approximately $500 million of losses and equity impairments and that would be up roughly $220 million from where we think we’re going to end 2008.

The downside case is 200 basis point increase in cap rates with the highest historical cap rates by asset type which would increase loss and impairments by another $400 million of pre-tax.

And finally GECAS our aviation leasing business which is 7% of the portfolio. In our base case we assume global traffic will be down 1% to 2% and that at least one major airline will liquidate and that we think results in approximately $300 million of pre-tax losses and impairments next year.

The downside case assumes 3% traffic decline and just to put that into perspective, the worst decline we’ve ever seen in a 12-month period was 2.5% and that was post 9/11. We also add that not just one but two major airlines would go into liquidation. And in that downside scenario, credit costs and impairments would increase $250 million to about $550 million.

Which government programs it’s using and how they’re working:

We’re using the commercial paper funding facility… It’s a program that’s helpful for issuers as well as investors and since its launch we’ve seen investors extending the duration of CP that they buy because they’re confident of a bid for their paper.

TLGP opens up access to a whole new market for us; investors who have traditionally bought government and agency bonds… We believe TLGP will reopen the markets for financial institutions… Many issuers began coming to market under the new program as soon as it was announced last week.

One program that we’re not participating in is the TARP program. We’ve raised $15 billion in common and preferred equity and that money... is available if GE Capital needs it to hit its target leverage.

Market stabilization:

When the reserve fund first broke the [buck] back in September, many money funds suffered some huge redemptions causing many to request early buyouts of long-dated CP. But we’ve seen that those requests now have really diminished.