S&P Fires A Shot Across GE's Bow (GE)

Ge_logoStandard & Poor’s issued a report that is being taken a “downgrade-light” by many traders.  S&P has revised its outlook on General Electric Co. (NYSE: GE) and units including GE Capital Corp. to negative from stable.  Be advised that it is still maintaining its “AAA” long-term and “A-1+” short-term counterparty ratings on GE.  While this is about GE and its GECC ratings, S&P has essentially noted a one-in-three chance that GE could lose its “AAA” rating.

The outlook revision on GECC’s parent, General Electric Co. (GE) andaccordingly on GECC, reflect concerns relating to GECC.S&P believes that GECC’s earnings deterioration in 2009 and 2010could be greater than previously assumed.  The outlook revisionreflects the continuing risks posed by GECC’s reliance onconfidence-sensitive wholesale funding.

S&P also noted, “A key rating factor in the ‘AAA’ rating remains GECC’s ownership by GE
(AAA/Negative/A-1+). Excluding the potential for additional supportfrom GE, we have always viewed GECC’s hypothetical standalone creditprofile as being weaker than ‘AAA’; our current assessment is ‘A+’.”

It further notes, “GECC’s pretax earnings from continuing operationshad accounted for about one-half of GE’s consolidated total earningsduring 2005 through 2007, although management is now targeting a morebalanced 30% to 40% contribution level.”

The research noted that GECC is still subject to the credit cycle andnoted widespread earnings weakness, delinquencies, charge-offs and more.

For the positives, GECC is noted as being significantly better creditquality than peers and noted that the company is now pursuing a numberof steps to reduce financial risk.

But S&P noted, “we believe there is significant additional downside in 2009 and 2010.”

Here is the guts that relate to the heart of the matter: “The outlookon GE and GECC is negative, indicating that we believe there is atleast a one-in-three possibility of a downgrade within the next twoyears. We believe GECC will experience significantly higher creditcosts in 2009 compared to those in 2008 and sharply lower earnings fromits real estate operations.”

It also notes: “If we thought net earnings in 2009 would besignificantly lower than management’s current forecast (i.e., netincome of $5 billion), we could reassess the rating. Our view of GECC’scredit profile would be adversely affected if, in our opinion, GECCwere not on track toward meeting management’s stated targets for,increased liquidity, reduced financial leverage and reduced reliance oncommercial paper. Conversely, GECC’s credit profile would benefit ifits earnings recovered significantly in conjunction with demonstratingprogress in lowering the risk of its funding and capitalization.”

S&P treaded softly here by leaving an out for a return to “stable”in its call:  “We could revise the outlook to stable if it appears thatGE’s industrial businesses will perform better in 2009 and 2010 than weexpect (including substantial excess cash generation after thedividend) and GECC’s earnings will recover significantly in conjunctionwith demonstrating progress in lowering the risk of its funding andcapitalization.”

Wall Street got spooked on this.  In fact, a one-in-three chance isbeing taken as a “downgrade-light” viewpoint.  To show this further,GE’s stock has been down all day and shares are down over 6% at $16.23.

Our take on is this is rather simple.  We believe that S&P issaying it will continue to endorse GE under the current financial planwith a “AAA” rating.  But it is signaling that it will take furtheractions and possible downgrades if GE’s overall outlook diminishes muchfurther in 2009 or beyond.  This is not a hard line in the sand beingdrawn, but S&P is showing that it is willing to tell everyone ithas a stick that can be used to draw a line in the sand.

Jon C. Ogg
December 18, 2008