GE Goes From Laggard to Leader in Swap Drop: Corporate Finance
General Electric Co. (GE)’s finance arm is pulling away from the biggest U.S. banks in the eyes of credit traders, signaling an end to more than three years of repression for declining profits during the financial crisis.
The cost to protect the debt of GE Capital Corp. with credit-default swaps narrowed to 135 basis points yesterday, or 52 basis points less than the 187 basis-point average for the six biggest U.S. lenders, according to data provider CMA. Stamford, Connecticut-based GE Capital’s swaps reached 1,037 basis points in March 2009, 660 basis points wider than the banks, the data show.
Chief Executive Officer Jeffrey Immelt’s plan to shrink GE Capital’s balance sheet and boost industrial earnings at the world’s largest maker of jet engines and diesel locomotives is bolstering the firm’s perceived creditworthiness. Debt issuance will slow this year as the unit turns to funding sources such as deposits, including $7.5 billion acquired from MetLife Inc. in December, GE said in an investor presentation.
“The company is focusing its efforts on more profitable businesses and it’s working,” said Richard Familetti, senior portfolio manager at New York-based Ryan Labs Inc., which manages $4.5 billion, including some GE bonds.
Banks, hedge funds and other money managers had bought and sold credit swaps that protect against a default on a net $10.7 billion of GE Capital obligations as of March 12, more than any other corporate issuer, according to the Depository Trust & Clearing Corp., which runs a central repository for the market.
GE Capital, which leases commercial aircraft, lends to consumers and mid-size businesses and finances energy projects around the world, accounted for $45.7 billion in revenue last year, or 31 percent of GE’s total, according to its annual report filed with the Securities and Exchange Commission. That compares with $66.3 billion of financial revenue in 2007, a 39 percent share.
“During the financial crisis, General Electric was viewed solely as a financial company, and its industrial element was somewhat discarded,” Marc Pinto, head of corporate bond strategy at Susquehanna International Group, said in a telephone interview. “The market was concerned about tail risk and that the financial side of GE could really hurt it. When that risk went away, the picture started to improve.” Susquehanna International is a New York-based broker-dealer.
Andrew Williams, a spokesman for GE, declined to comment on trading in the company’s swaps.
GE Capital has $280 billion of corporate bonds outstanding, including $61.8 billion maturing before the end of this year, Bloomberg data show.
Yields on GE Capital’s bonds are falling relative to those of large banks. Its $2.75 billion of 4.65 percent notes due in October 2021 traded at 107.2 cents on the dollar at 9:24 a.m. in New York to yield 3.75 percent, according to Trace, the bond- price reporting system of the Financial Industry Regulatory Authority. That’s 22 basis points, or 0.22 percentage point, less than JPMorgan Chase & Co.’s $3 billion of 4.35 percent debt due in August of the same year, which yields 3.97 percent.
The gap in spreads reached 34 basis points on March 9, the most since GE Capital’s bonds were issued five months ago, the data show.
The cost to protect GE Capital debt against losses using swaps fell yesterday to the lowest in more than eight months after the Federal Reserve said all but four of the biggest 19 U.S. lenders passed stress tests that simulated an economic downturn.
GE Capital contracts declined 3 basis points yesterday to the lowest since July, according to data from CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. A basis point equals $1,000 annually on a contract protecting $10 million.
The swap rally may reflect investors who use GE contracts as a proxy to bet on credit risk in the financial sector, taking advantage of the ease of trading its swaps, according to Jesse Rosenthal, an analyst at CreditSights Inc. in New York who said it’s “too soon to tell” if it’s decoupling from big banks.
The relative opacity of GE Capital’s earnings means it’s fair that its swaps trade wider than industrial rivals such as United Technologies Corp. and Honeywell International Inc., said Marilyn Cohen, president of Los Angeles-based Envision Capital Management Inc.
“I find it still to be somewhat of a hedge fund in drag,” Cohen said. “It’s very important that one understand exactly how a company is making money, and I find that difficult with GE Capital.”
‘Plenty of Cash’
The stress results bolstered confidence that GE Capital, which wasn’t included in the tests, would be cleared to resume a payout to its parent that would free up cash to return to shareholders, Julian Mitchell, an equity analyst at Credit Suisse Group AG, wrote in a note to clients. JPMorgan, the largest U.S. lender, and Wells Fargo & Co., the most valuable, were among banks that boosted dividends and share buybacks after the results were announced.
The Fed, which took over as GE’s regulator last year, must conclude a review of the finance arm’s business before the dividend can be resumed. The payment of almost half of GE Capital’s earnings reached as much as $8.6 billion before it was suspended after the 2008 financial and economic crisis.
“They throw off plenty of cash to fund their operations,” said Scott Kimball, a portfolio manager at Taplin Canida & Habacht LLC in Miami, which manages $7 billion.
Restoring the dividend would mark a fresh step in GE’s recovery from the crisis, when it raised $15 billion in equity, including $3 billion through a sale of preferred stock to Warren Buffett’s Berkshire Hathaway Inc., and cut its quarterly dividend to shareholders for the first time in more than 70 years to preserve cash.
“Investors took it for granted that GE Capital was well- capitalized and making good investments, but when the market started to turn, investors realized they didn’t know as much about their business as they wanted to or needed to,” Pinto said.
GE redeemed Buffett’s investment in October and has increased its dividend four times since July 2010. GE Capital is reducing reliance on debt markets for its financing, instead turning to deposits and debt backed by mortgages. Those sources accounted for 21 percent of GE Capital’s funding as of last year’s third quarter, compared with 12 percent in 2008, the company said in a Dec. 6 investor presentation.
‘Plenty of Things’
Ending net investment, a measure of GE Capital’s size that excludes non-interest-bearing liabilities and cash, may fall to as low as $425 billion at the end of this year, the company has said. That compares with $525 billion at the end of 2008. GE Capital profit fell to $7.84 billion in 2008 from $12.2 billion a year earlier, then slid to $1.36 billion in 2009.
Spreads on GE Capital swaps widened on Aug. 29 to 51 basis points more than the average of JPMorgan, Bank of America Corp., Citigroup Inc., Wells Fargo, Goldman Sachs Group Inc. and Morgan Stanley, CMA data show. That was the most since July 2010. By Nov. 30, GE fell to 80 basis points less than the banks, the biggest advantage on record, and hasn’t been higher since.
“GE has done quite a bit both in terms of transparency and in improving its balance sheet,” said Dan Coker, a senior research analyst at Moody’s Analytics in New York. “The market for financials in North American has seen some tightening and the market for industrials has done well as well, but GE Capital has also done plenty of things to bring about the tightening of spreads.”