As I said before new CEO Flannery is going to use Q4 2017 to clear the decks and take any possible charges they may have to take so he can start fresh in 2018. The below is one of those actions. To be clear, this is in no way “good news” but I’d rather have it now than Q2 2018. A situation like that would almost be a Hancock at AIG scenario where it got to the point investors never truly believed he had a grasp of what was happening and were alway waiting for the other shoe to drop.
The Filing:
Item 2.03 Creation of a Direct Financial Obligation or an Obligation under an Off-Balance Sheet Arrangement of a Registrant.On January 15, 2018, General Electric Company (“GE”) entered into unsecured revolving credit facilities with three separate banking organizations, with initial aggregate principal commitment amounts of up to $5 billion, $4 billion and $4 billion, respectively (each, an “Operating Line”). Each of the Operating Lines matures on January 15, 2020, and any borrowings under the facilities are repayable prior to such date, in whole or in part, without premium or penalty at the election of GE. Extensions of credit under each of the Operating Lines may be utilized by GE for working capital or any other general corporate purposes. Each of the Operating Lines is also subject to mandatory repayment provisions and commitment reductions in connection with specified incurrences and issuances of debt and equity by GE or its subsidiaries, as well as with a portion of industrial business disposition proceeds. At this time, GE has made no borrowings under the Operating Lines.Item 8.01 Other Events.On January 16, 2018, GE provided an update on the previously reported review of premium deficiency assumptions related to GE Capital’s run-off insurance business (North American Life and Health (“NALH”)). With the completion of that review, and of NALH’s annual premium deficiency test, GE recorded an increase in future policy benefit reserves of $8.9 billion and $0.6 billion of related intangible asset write-off for the fourth quarter of 2017. This will result in a $6.2 billion charge ($7.5 billion upon remeasurement under tax reform) on an after-tax GAAP basis to GE’s earnings in the fourth quarter of 2017.As a regulated insurance business, NALH is subject to a statutory accounting framework for setting reserves that requires the modification of certain assumptions to reflect moderately adverse conditions and other differences from the reserve calculation under GAAP. Under that framework, we estimate that GE Capital will need to contribute approximately $15 billion of capital to NALH over the next seven years. GE Capital plans to make a first capital contribution of approximately $3 billion in the first quarter of 2018 and expects to make further contributions of approximately $2 billion per year in each of the six following years, subject to ongoing monitoring by NALH’s primary regulator, the Kansas Insurance Department. GE Capital plans to fund the capital contributions with its excess liquidity and other GE Capital portfolio actions and does not expect to make a common share dividend distribution to GE for the foreseeable future.GE also announced that it plans to take actions to make GE Capital smaller and more focused, including a substantial reduction in the size of GE Capital’s Energy Financial Services and Industrial Finance businesses. Those actions are estimated to result in goodwill and other asset impairment charges of approximately $1.8 billion on an after-tax basis in the fourth quarter of 2017.
General Electric says it is considering breaking itself up. The problem is that GE’s parts might be worth a lot less than even the company’s sharply diminished value today.
Investors who thought the shoes had stopped dropping at GE found out Tuesday that they were deeply wrong as the company announced it would take a $6.2 billion charge in its fourth quarter and set aside $15 billion over seven years to bolster insurance reserves at its legacy insurance unit, GE Capital.
The disclosure served as a stark reminder that, while the company has shed enough of the opaque financial unit to get it off the government’s list of “systemically important financial institutions,” or SIFIs, the mostly industrial company remains on the hook for past problems and tens of billions of dollars in borrowings at GE Capital.
Aside from shedding the restrictive SIFI tag, one benefit of pruning GE Capital might have been a sense of transparency. After all, a company that bashes metal and makes tangible things is, in theory, far easier to understand than the sort of financial “black box” that caused so much angst during the financial crisis.
Except that might not be the case, given the odd mismatch between GE’s profit and cash flow in some recent years. Then there is the fact that a big chunk of GE’s industrial receivables are held by GE Capital and the industrial company has guaranteed much of the debt from when GE Capital was a far larger operation.
Investors were conspicuously slow to make a bet on a possible bargain in GE’s shares in November and December despite the fact that they were 70% cheaper than their all-time high near the beginning of the century, when “Neutron” Jack Welch was running things. More recently, though, the notion that new chief executive John Flannery had kitchen-sinked GE’s financial situation had begun to gain traction and the stock was up 7.5% year-to-date before Tuesday’s fresh tumble.
While the situation seems to be a far cry from the crisis the company faced in 2008, when it was effectively bailed out by the federal government as it propped up the commercial paper market, a bigger cash cushion would reassure investors that the company can handle deep problems today. Mr. Flannery did little to disabuse the market of that notion amid talk of a breakup on Tuesday.
What GE’s units might be worth is an open question, though. A sum-of-the-parts analysis conducted by Cowen analyst Gautam Khanna in November suggested the broken-up company would be worth about $13 a share—well below the current $18. That valuation included GE’s large, unfunded pension liability and “dis-synergies” given shared branding and technology. With Tuesday’s announcement, that valuation would be even lower.
One recently rumored source of cash is GE’s oil-field services subsidiary, which merged with Baker-Hughes just last year. GE currently owns a roughly 62.5% stake in the publicly traded entity, and any purchase or sale will be complicated, requiring the approval of an independent committee. Furthermore, because the oil-field services business has been seen as on the chopping block since Mr. Flannery’s shocking guidance cut in November, its shares have been under pressure, lagging behind peers. The same discount might apply to almost any unit.
All of this is happening during an economic boom when GE’s tax rate has been cut. If GE’s problems become acute, any postmortem may conclude that Mr. Flannery missed an opportunity back in November by slashing the dividend in half instead of eliminating it. Just the second cut to the conglomerate’s payout since the Great Depression—the first being in the aftermath of the financial crisis when GE really did face an existential crisis—it serves to preserve some $4 billion in cash.
To put that into perspective, though, GE Capital paid about that amount to the parent company in dividends last year, and that has now been suspended.
GE always has the option of eliminating the dividend completely, but the cumulative psychological fallout would have been far less had it done so in one fell swoop back in November. After Tuesday’s alarming revelation, it would savage confidence in the company at a time when many are wondering what other problems might lurk.