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Saturday, 21 October 2017

Double A surprise

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General Electric had been a constant feature of the Triple A landscape for many years. Its recent downgrade to Double A might have spelt disaster for the company, but it does not appear to have caused the forced selling and downward spiral that sometimes follows such action. Instead investors have welcomed the clarification and breathed a collective sigh of relief that things were not worse. Timothy Sifert reports.

General Electric finally fell from its theoretically significant Triple A rating in March when S&P lowered downgraded the credit a notch to AA+ before Moody’s struck with a two-notch relegation to Aa2. The move was certainly not welcome for the conglomerate. But now that it has a stable credit outlook, investors value the implied stability.

In many ways, it was a godsend for GE.

GE reached a 52-week low on March 4 of US$5.73 as uncertainty about GE and, in particular, GE Capital, its struggling lenders, drove investors away from the once stalwart credit. Since then shares have rallied to around US$13.00 apiece. Yields on its most actively traded bonds also tightened by about 100bp.

The immediate improvement in the company’s stock and bond position after the downgrades in part reflects the pessimism about GE that preceded it. The company had been forthright about its own woes, apparently leading investors to believe that the rating agencies would be more severe on decision day. When it came, the downgrade was a relief. Crucially, it showed how highly investors value concrete information in this market, even if it is not completely positive.

But there could be worse to come. Despite GE Capital's success in the government-backed capital markets, it is still perceived as the problem. While GE's industrial business has indeed been weakened by the economy, it was specifically GE Capital's financial woes that drove the decision to downgrade. In fact, Moody’s said that GE Capital as a standalone would carry a mid-Single A rating.

GE said that the impact of the new ratings would be minimal. It has already met more than 90% of its 2009 long-term debt needs and lowered its commercial paper outstandings to US$60bn from the US$88bn it owed in the third quarter of 2008.

"As we have previously said, we are prepared to fund the company as a Double A, but we will continue to run GE with the disciplines of a Triple A company, which means low leverage, high liquidity and strong risk disciplines," said Jeff Immelt, chairman and CEO, at the time of the downgrades. "While no-one likes a downgrade, this review and rating reaffirms the relative strength of the company."

Before the downgrade, a Citigroup report estimated that should long-term credit ratings go below AA– (two notches below the current AA+) or the short-term rating fall below A1+/P1, GE would have to pay US$8.1bn to support guaranteed insurance contracts. If short-term ratings fall below A-1/P-1, the company will be forced to retire US$3.8bn in CP and access to the Fed's commercial paper funding facility will be cut off.

Yet this year GE (and GE Capital) have not performed as poorly as expected. For the first quarter it recorded a profit of 26 cents a share, beating Deutsche Bank’s expectations by four cents. Yet by its own long term standards the company’s performance is sub-standard: earnings from continuing operations were US$2.8bn, down 35% from the first quarter last year, while revenues were US$38.4bn, down 9% year over year.

No guarantee necessary

Investors have been concerned about GE’s prospects for some time. Early this year the company sought to put to rest speculation that its GE Capital division wasn’t viable. In fact GE Capital became the first issuer backed by the Temporary Liquidity Guarantee Program (TLGP) to price an offering in the unguaranteed market since the bond backstopping program started in November.

In January, after starting the New Year with a US$10bn guaranteed deal, it hit the tape an SEC-registered 30-year fixed-rate global MTN issue. GECC and its bankers answered investors demand for FIG long bonds and priced the deal with a nice concession. Not since American Honda's two-part US$1.25bn offering on September 24 2008 had there been an unguaranteed FIG-type issue. That came at 387.5bp over Treasuries for an Aa3/A+ rated deal.

Despite the eventual downgrades, the deal was a significant vote of confidence for GECC. "They're a wholesale funder," a syndicate official said at the time of the trade. "Financing is their lifeblood. They wanted to prove that, without a guarantee, they could still borrow. It's a sign that the bond market is in repair."

That deal, along with the billions of other financings, has put the company in good financial stead. As of the March 19 it had completed 93% of its long-term debt funding. GE cut its dividend, which will save US$9bn over 18 months. And it still has about US$60bn of capacity under the TLGP programme.

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