Strong Headwinds at GE Capital

Top executives at GE Capital, the finance unit of General Electric, told its annual investor meeting today that, even under the worst case scenario outlined in the government's new stress tests for banks, GE Capital should break even this year and that it is well-capitalized.

However, GE Capital, which conducted its own internal stress tests even though it is not a bank and the government is not testing its balance sheet, said it would post profit of $5 bn this year, down from $7.1 bn last year and half the $10.3 bn it posted in 2007.

Overall, GE, the parent, earned $18.1 bn in 2008, down 19% from the prior year.

Wall Street's persistent worries about GE (GE) and its finance unit have driven its stock down to record lows, a drop of 85% from its 52 week high.

GE, a bellwether stock, provides a mirror image of the downturn as its well-diversified operation has businesses in important sectors of the economy.

Problems Mount

Problems have arisen in GE Capital's real estate and consumer book. GE Capital has $230 bn in commercial real estate assets. Its consumer loan assets are $183 bn. 

About halfway through the five-hour meeting, a fire alarm went off and meeting participants were asked by GE executives to clear out for a coffee break.

"That must have been a short seller who set that off," a GE Capital executive joked to a ripple of laughter.

At the meeting, GE Capital executives gave unprecedented new detail into what Wall Street has euphemistically called the black box that is GE Capital, amidst rising questions about strains and potential time bombs at the finance unit.

GE Capital, which finances commercial real estate, consumer lending, and aircraft leasing, among other things, says its tangible common equity ratio is at 6%, better than many banks.

GE Capital executives said they expect strong headwinds to buffet its business over the next several years through 2011.

It says it will post a $5 bn profit this year, after taking $10 bn in pretax losses and impairments.

However, that's higher than what analysts had expected. Analysts had expected GE Capital would be hit with pre-tax losses of up to $9 bn in 2009.

Losses Could Rise

GE Capital says its pretax losses could rise to $18 bn and that it would just break even under the most adverse conditions in the government's stress tests. Under that scenario, unemployment would average 8.9% and the economy would shrink 3.3%.

And the finance unit estimates it faces $20 bn in pretax losses and impairments in 2010, double the $10 bn in expected pre-tax losses in 2009.

Overall, GE Capital expects a total of $40 bn in pre-tax losses and impairments over the next three years.

The company is struggling with a problematic balance sheet that has a sizable debt overhang. GE has $194 bn in short term borrowings and $321 bn in long term borrowings.

GE Capital has a total of $203.2 bn in borrowings coming due in the next four years, about two-thirds of the company's total debt; $43.5 bn is due this year alone, which is why GE Capital has been scrambling to raise capital, $45 bn worth.

GE Capital executives disclosed at the meeting that the unit has completed 93% of its long term funding needs, $42 bn of its $45 bn goal. Most of that debt is now backed by the US government.  

And while executives at the meeting made much of the fact that GE Capital does not use structured investment vehicles, much in vogue at US banks, GE Capital does use off-balance sheet vehicles.

GE Capital has $50.1 bn warehoused in off-balance sheet assets that securitize its commercial real estate, its credit card and its equipment receivables, assets that GE doesn't want to hit its weak balance sheet just yet.

It's also got another $4.9 bn in net assets and liabilities housed in variable interest entities sitting off the balance sheet.

Under new accounting rules, those securitizations would have to come back onto the balance sheet at the end of the year, which would swamp GE Capital's tangible common equity, its equity on a hard asset basis, of $39 bn.

Reportedly some of those off-balance sheet assets are hooked to interest rate swaps with counterparties that are now in trouble, such as ABN Amro.

And executives didn't give much detail on the $48 bn in net, illiquid securities GE can't readily sell, sums which would also swamp its tangible net worth.

An Upbeat Message

Overall, GE Capital executives provided an upbeat message during the worst downturn the company has seen in decades. "It's a tough market and it's getting tougher out there," a top GE Capital executive says.

However, GE Capital's chief financial officer Keith Sherin said: "We don't see a need where we would have to raise external capital."

The comments come after GE chief executive Jeffrey Immelt has said in a shareholder letter: "Today, I wish we had less exposure to commercial real estate."

GE is moving fast to reduce the size of GE Capital, slashing it down to about 40% of overall company earnings, down from 50%.

GE Capital Faces Strong Headwinds

Although GE Capital is not a bank and is not undergoing any government stress tests, the industrial conglomerate opted to apply the same standards to its balance sheet.

GE's chief executive officer Immelt has come under fire for letting its finance unit take on too many commercial real estate and consumer loan assets during the bubble. GE's annual investor meeting is scheduled for April 22^nd.

GE Loses its Triple-A Rating

GE recently lost its coveted Triple-A rating, which let it borrow cheaply in the debt markets, largely due to problems at GE Capital. That means its borrowing costs could rise.

GE Capital executives though were blunt and upbeat about the downgrade to double A last week by Standard & Poors. "The ratings outcome and the downgrade to double A an outstanding result, given that our financial portfolio is clearly under stress," Sherin said.

GE Capital Plays Down Stimulus Package

GE Capital conducted its own internal stress testing of its books using the government's measures on a downturn in GDP and a worsening unemployment outlook, among other items.

The finance unit is not however, using at all in its gauges nor is it taking into account any upside from Congress's recent stimulus packages.

A GE Capital executive says the company doesn't think the stimulus package will have much or any impact on the US economy.

Commercial Real Estate Problems

Executives did note that vacancies are rising worldwide, as rents drop up to 20% in major markets. Besides risks it still faces in commercial real estate, GE Capital said it also faces pressure from rising delinquencies in its UK mortgages and its exposures to Eastern Europe.

On its commercial real estate, GE executives said: "We will experience lower earnings thru this cycle." They added that as for its UK and Eastern loan exposures, "We expect credit losses will increase." And on the US consumer, GE Capital executives said they are preparing for a "tough cycle driven by unemployment, and are planning for higher losses." 

Bolstering the Balance Sheet

To shore up its balance sheet, GE has slashed its dividend, the first time since 1938, and is executing massive asset sales to cut GE Capital's balance sheet to as little as $400 bn in assets, from $637 bn.

The unit has also laid off 700 workers since 2007. GE says it is trying to cut its reliance on short-term debt known as commercial paper to $50 bn, from more than $90 bn last year, which will reduce interest costs.

Late last year, GE also had to raise $15 bn in equity and stopped a stock buyback plan.

The unit's executives said it is "very difficult to execute asset sales in today's market," and that the Fed's TALF program "may help."

The moves lead GE Capital to believe it will not "require external capital," including equity raises or more government money.

Overall, GE Capital says it has $92 bn in total fundings of which it says $37 bn is in cash, and $32 bn is in long term debt borrowings. It also says it has accessed $98 bn in Federal Reserve's commercial paper funding facility.

 It also says profits at NBC Universal may flat line in the first quarter due to a "weak" advertising market, and that its healthcare unit faces pressures.