By Ronald Fink
General Electric has long sought to shed its image as a cyclical company, and the US financial crisis made the task even more critical, thanks to the company's continued dependence on finance. But at no time has the challenge been more evident, perhaps, than during the European debt crisis.
Prices of credit default swaps (CDS) written against the company's finance subsidiary, GE Capital, have been far more volatile than those of its peers during the recent turmoil over European sovereign debt, according to a report published this morning by analysts at the research firm, CreditSights.
The analysts noted that spreads in prices of five-year credit swaps tied to GE Capital's debt varied last week, when investors fled European debt before eurozone member nations agreed to bail out its weakest economies, by as much as 81 basis points, and at one point last Friday hit 250 bps. While the analysts said swaps of other financial companies had also experienced big ups and downs during the turmoil, they noted that the volatility of spreads on those tied to GE Capital was "far in excess" of that of its peers.
The analysts noted that while GE Capital's exposure to European markets is significant, this fails to explain the extra volatility in the spreads of swap prices over those of GE Capital's debt.
"We question whether the volatility in spreads is justified by fundamentals alone," wrote CreditSight analysts Adam Steer, David Hendler, Jesse Rosenthal and Peter Simon.
They pointed out that GE Capital's parent maintains a AAA rating and that the subsidiary's cash flow and earnings are improving.
About $16 billion, or 20 percent, of GE Capital's total exposure to commercial real estate lies in Europe. Nevertheless, they think potential losses there are "manageable" even if the company cannot extend the terms of debt set to mature this year and next.
The analysts conceded that GE Capital's exposure to European consumers may be more troublesome. At $71 billion, that segment accounts for almost half of GE's total consumer portfolio. The analysts described GE Capital's exposure there as "one of the more sensitive areas of the portfolio to a systemic downturn."
Even so, CreditSights observed, GE Capital's consumer lending is focused on the stronger European countries, so that would mitigate any losses in that segment.
And while the analysts are concerned about prospects for GE Capital's $40 billion portfolio of commercial loans and leases in Europe, especially in aircraft, CreditSights noted that the relative youth of the company's fleet should limits its downside there.
Finally, the analysts noted that GE Capital's currency risk appears to be hedged, and while its hedges may not work as well as expected, that would be no less true for other financial companies.
All of that leaves the analysts to conclude that investors see GE Capital as a bellwether for systemic risk despite its efforts to lessen its dependence on finance, and are thus shorting its credit by buying CDS against the likelihood of its default.
Noting that GE Capital is "a high-quality, large bellwether issuer, with very liquid CDS," the analysts concluded that it is "a prime candidate to be the market's go-to hedge against systemic risk."
And while CreditSights said the volatility of GE Capital's swaps may thus be due to "technical factors" instead of fundamental ones, such a distinction is small consolation to management and others looking for GE to become more of a growth vehicle.
As the analysts conceded, the possibility that the industry is in for tighter regulation may subject GE Capital to still more pressure going forward than would be expected based on its fundamentals alone.
CreditSights says that pressure could ease once investors realize that GE Capital, unlike traditional banks, isn't subject to capital reserve requirements. But the picture may not change much after all if regulators, as some experts expect, begin to require reserves for non-banks as well.
Whatever the outcome of regulatory reform, the CreditSights report shows that GE management still has a long way to go convince investors it is more than a conglomerate with heavy exposure to on-going trouble in finance.