ANALYSIS-Investors fret over GE Capital, as GE shares slide

Published: 04 Mar 2009 18:05:32 PST

* Wall Street worries finance reserves too low

* GE argues it is not like a typical bank

* Investors wonder if another shoe to drop

BOSTON/NEW YORK, March 4 - General Electric Co investors have one big worry these days: Is its hefty GE Capital finance arm -- the main reason for a 2008 profit drop -- poised to handle the worst economic downturn in decades?

Analysts and investors have pounded the U.S. conglomerate's shares to their lowest level since the early 1990s this week as they wrestle with the question of whether the finance operation -- which a few years ago represented half of GE's profits -- is adequately prepared for a surge in defaults by increasingly unemployed consumers and tottering mid-sized businesses.

The fear is that GE's planning for the unit, which anticipates a 42 percent fall in profit and rising defaults, may not be sufficiently bearish.

"It's not as if the world has confidence in any security, but this team has managed to just shatter investor confidence by continually being more upbeat than they deserve to be," said Charles Ortel, managing director of securities research firm Newport Value Partners in New York, which does not hold a position in GE shares.

Investors fear GE Capital's reserves for losses are too low in comparison with the top U.S. banks.

For its part, the Fairfield, Connecticut-based company, which is the world's largest maker of jet engines and electricity-producing turbines, argues that the comparison is not a fair one since GE Capital's business model is different from that of most banks.

"GE Capital is a secured lender and our loss rates have historically been below those of competitors with unsecured loan portfolios," said Russell Wilkerson, a GE spokesman, in an e-mail. Having a secured position means that GE has the option of seizing the goods it finances in the event of default, allowing it to resell the merchandise and recoup some of its losses.

Wilkerson also noted that GE Capital's reserves are at historic highs in absolute dollar terms.

RESERVATIONS ON RESERVES

GE has taken several steps this year to protect GE Capital, including shifting $9.5 billion of equity into that unit and cutting its corporate dividend by 68 percent, which will save the parent company about $9 billion a year.

"We expect both the commercial and the consumer delinquencies to continue to get worse in 2009, but we are well reserved for that," Chief Financial Officer Keith Sherin told investors in January.

The weakest points in its credit portfolio are its exposure to U.S. consumer spending, primarily through private-label credit cards, and its U.K. mortgage business.

But the steps GE has taken have not stemmed the slide in GE shares.

"GE Capital is now confronting the prospect that a downward trend in fundamental performance, fueled by weakening end markets and magnified by severe liquidity constraints, could potentially lead to an extended period of steadily lower earnings," wrote Sterne Agee analysts Nicholas Heymann and Matthew Kelley in a note to clients.

Sterne Agee, which rates GE a "sell," said GE Capital has set aside less money to cover bad loans than its peers among the top U.S. banks, with GE Capital holding $5.3 billion of reserves at the end of 2008, representing 1.4 percent of its total receivables, compared with 2.5 percent for the top 10 U.S. banks by assets.

Stock analysts, including Deutsche Bank's Nigel Coe, believe GE's $5 billion 2009 earnings target for the finance arm is overly optimistic. He also estimates that GE Capital's reserves against bad loans are not adequate in light of the sharply deteriorating economy.

"The longer the recession goes on, the deeper unemployment goes, the more that what's left of the consumer portfolio is going to bleed out; there's no question about it," said Peter Sorrentino, senior vice president and portfolio manager at Huntington Asset Management, which owns GE shares.

'ANT BITES' OR A BOOM?

Still, given the diversity of GE's financial operations -- from managing credit cards for U.S. retailers to leasing aircraft to investing in commercial real estate -- Sorrentino said he regarded it as unlikely that anything less than implosion of a major customer could knock GE Capital off the rails to the extent suggested by GE stock's 60 percent fall since the start of the year.

"There's got to be an awful lot of ant bites out there to accumulate to this kind of pain," Sorrentino said. "If all of a sudden some major airline went down and shoved all their planes back on GE aircraft, I would think, 'Boom, that's it.'"

That is the essence of the dilemma facing GE investors: Do they believe there's a major land mine hidden in GE Capital that they do not yet know about? The comparison that leaps to mind for some on Wall Street is with American International Group, a huge insurer that seemed rock-solid until it was stricken by bad investments last fall and had to turn to the U.S. government for billions of dollars of support.

"You could have what happened to AIG happen to this company in a moment," said Ortel, of Newport Value Partners.

Others are more confident.

"I don't believe that GE is anywhere near the type of predicaments that AIG or Citigroup or Bank of America are. They are in much worse straits than GE is. It's being thrown into that same basket," said Doug Ober, chairman and chief executive of Adams Express Co in Baltimore, which owns GE shares.

"We feel comfortable that GE Capital is under control and does not have potential huge losses buried."