GE's Loans Foreshadow Future Performance

When General Electric reports earnings on Monday, investors should focus on shifts in its consumer lending business.
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FAIRFIELD, Conn. (TheStreet) -- General Electric's (GE) - Get Report first-quarter results, scheduled for release on Friday, will shed light on the actions the company has taken to recover from the global economic meltdown and cure its ailing financial unit.

GE shares have gained 23% this year, making it the third-best performing stock in the

Dow Jones Industrial Average

, which has advanced 6.3%. Still the shares have fallen 44% during the past two years. While the stock hit a 52-week high of $18.60 on April 6, it hasn't traded for more than $20 since November 2008.

GE's finance division has caused a lot of misery for the company. Excluding the financial services business, GE's net earnings fell 7% in 2009. Net earnings from the financial services business plunged 80% in 2009.

GE was hit by the same problems as major lenders such as

Citigroup

(C) - Get Report

and

Bank of America

(BAC) - Get Report

. Unlike the banks, GE lacks a traditional banking business to offset these declines. Big impairments on its loan book have damaged GE, but the company doesn't seem to be scaling back in its consumer loan segment to prevent future exposure to adverse credit events.

Portions of the GE's balance sheet are indistinguishable from those of Citigroup and Bank of America. As of Dec. 31, GE had $41.7 billion in bond investments on its balance sheet, $3.3 billion of which is from residential mortgage-backed securities and $2.7 billion is from of commercial mortgage-backed securities. These securities lost a combined $3.1 billion in 2008 and 2009. While these are substantial numbers, they pale in comparison to the loans on the books that GE originated in mind numbing sizes.

GE had $140.95 billion in commercial lending and leasing receivables on its balance sheet at the end of 2009, a 12% decrease from 2008. These are mainly loans to customers to allow them to buy expensive GE products and offer low default rates. GE also held more than $133 billion in volatile consumer receivables, comprised of non-U.S. mortgages, revolving lines of credit and auto loans. These loans fell half as fast at 6.3% than commercial receivables.

GE's rapidly shrinking commercial loan book is making its overall portfolio more risky. GE won't be able to stabilize its financial services business until it can reduce its exposure to consumer credit. Bank of America and Citigroup proved to be poor at gauging the credit worthiness of consumers, so it's ridiculous for anyone to expect GE to fare any better. This is a business it never should have been in the first place.

Having a financing unit gives GE an advantage over competitors because it allows customers to buy multimillion dollar pieces of equipment on credit, but the company got into trouble by extending into consumer markets they didn't fully understand. Delinquency rates from equipment financing climbed from 1.2% in 2007 to 2.8% in 2009, despite being hit by the worst financial crisis in 70 years. Consumer financing delinquencies, on the other hand, jumped from 5.4% in 2007 to 9% in 2009.

Analysts expect GE's earnings to decline to 16 cents a share from 26 cents. Revenue is projected to fall 3% to $37.1 billion. Investors should be listening carefully to the company's debt and loan positions.

The company's industrial businesses will probably contribute more heavily to earnings than other units. GE's wind turbine division is helping it stay ahead in the developing green-energy industry, so investors should instead focus on the company's financial position.

When the company reports on Friday look for information about the GE's debt load, loan book and plans for the financial arm. The company has averaged financing charges of about $23 billion over the past three years and the vast majority of that financing is being used to service the financial unit, which has accounted for about 95% of the interest costs over the past 3 years. If the company appears to be shrinking its debt load it could be good news for the company because it probably indicates that the loan book will also be shrinking.

GE is highly sensitive to interest rates because it constantly needs to borrow at the prevailing rates, so it's reducing its exposure during a time when rates will likely climb. It is important to determine if the shrinking is coming from the commercial or the consumer segments.

GE should maintain its large commercial division because it encourages industrial sales, but it would be smart to exit consumer financing. Spinning off consumer lending and getting back to making products would be the best news, but investors should be happy if GE reduces its consumer loan exposure.

-- Reported by David MacDougall in Boston.

Prior to joining TheStreet Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level III CFA candidate.