GE's financial services businesses provided 32.3% of consolidated revenue to the parent company in 2009, so the stakes are high. Equity holders clearly feel "finreg" will have a negative effect on GE. The stock has lost 22% of its value over the last three months, more than double the 9% that the
has dropped over the same stretch. Investors are increasingly worried about how GE Capital will respond to the stricter rules that are expected to be adopted.
Financial Reform Will Hit GE
Argus analyst John Staszak acknowledged the fears behind the stock's selloff in a recent research note, but also displayed some skepticism about how well founded they are.
"Regulatory concerns, though perhaps overblown, are likely to weigh on the shares in the near future," Staszak wrote.
Credit Suisse analyst Julian Mitchell falls into the camp that the reform bill will not hurt GE in any way. He believes current analyst expectations for the GE Capital business are too low, and goes further, suggesting that: "
The parent may even be able to step back from its current 2011 commitment of $2 billion capital contribution."
Mitchell frequently compares GE Capital to regional banks throughout his report. However, the unit is currently governed by the Office of Thrift Supervision, or OTS, and is considered a thrift holding company, not a bank holding company.
The OTS was known for less restrictions and regulations. He considers peers of GE Capital to be
Bank of America
. When, in fact, GE Capital's peers are industrial banks such as John Deere Savings Bank (owned by
) and Power Capital Bank (owned by
Chris Whalen of Institutional Risk Analytics believes that the Dodd-Frank Wall Street Reform and Consumer Protection Act will change that. The Federal Financial Institution Examination Council (FFIEC) lists several GE financial entities that Whalen says will now fall under the umbrella of the
Whalen points out several ways that GE Capital will potentially be affected by the Dodd-Frank bill:
GE Capital has been supervised under the OTS, which will be merged into the Office of the Comptroller of the Currency, or OCC. Under the latest reform, GE's financial entities will be expected to comply with more strict Fed requirements commonly associated with bank holding companies (BHC).
Whalen says: "GE Capital itself engages in impermissible BHC activities. One example would be the equity investments made by GE Capital into commercial real estate deals. This is not permitted under Fed BHC rules." He also believes that capital shifts between GE Capital and GE would be restricted under Section 23A of the Federal Reserve Act, which governs transaction with affiliates.
GE Capital had for years latched onto GE's AAA rating. In March 2009, the parent was downgraded slightly to AA+ by S&P, still blessing GE Capital with one of the highest ratings amongst financial firms. Whalen believes that GE Capital will lose that piggyback status and get rated on its own merits as a bank holding company.
He believes the bank units and financial arms would get a "3" composite rating on the Fed's 1-5 scale of soundness. A downgrade would be costly to GE.
Even GE has acknowledged this, saying in its last Form 10-K filing that: "GECC could be required to repay up to approximately $3,000 million if its long-term credit rating were to fall below AA-/Aa3 or its short-term credit rating were to fall below A-1+/P-1."
Most banks and financial firms have been required to increase capital throughout the financial crisis. GE Capital has so far been able to avoid the FDIC and its demands for more capital. Whalen expects the Fed to set minimum capital requirements on GE Capital. He says: "GE operating units have been routinely starved of capital, the Fed will require GE to downstream cash equity to GE Capital and will then closely regulate dividends to the parent."
GE has already stated it would make a 2011 capital contribution of $2 billion to the unit, in addition to the maintenance payments to GE Capital. Also not helping GE Capital is the roughly 50%-70% exposure to Europe across various financial instruments. As Europe slows, it is not inconceivable that more capital may be needed to shore up these instruments.
GE Capital has claimed in the past that it is very transparent, even as questions have swirled around the portfolio and pressured the parent company's stock. The company held an investor day in March 2009 and spent hours talking to analysts about the stability of the portfolio. But in October 2009, the unit reported that earnings fell 87% amid delinquencies and writedowns.
Many analysts following the company struggle to get their arms around the details of the unit's financial condition. When in doubt, some look to those harbingers of doom, the credit default swaps, and what they're seeing is a bit scary.
"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," CreditSights wrote in May.
So far GE has only said that it has low exposure to Italy, Spain, Ireland and Greece and has not specifically laid out its exposure to other countries. But while CreditSights is convinced that GE Capital is mostly aligned with the stronger European countries, which European economy is really all that strong these days?
The most troubling item for GE is Section 113 of the Dodd-Frank bill, which gives the Fed the authority to regulate nonbank financial firms that "could pose a threat to the financial stability of the United States."
Some analysts who believe that GE will be forced to spin off GE Capital point to this section. The argument is that GE Capital is so big that its failure would hurt GE and cause instability in the U.S. Forbes ranked GE as the second-largest company in the world last year. But many analysts place that probability as low. GE is actually working to bring down the size of GE Capital, already addressing the "too big" criticisms.
On the other side of the debate, some analysts argue GE was able to dodge the stricter aspects of the reform bill, that the company effectively lobbied against any provisions hurting them. Section 113 makes it clear that it didn't. GE Capital will face more regulation and less freedom as a result of the Dodd-Frank bill.