GE downgrade lays ground for breakup

(breakingviews.com) -- General Electric's credit rating has finally been cut. S&P has lowered the conglomerate's rating, which has been triple-A since 1956, to double-A-plus.

This shouldn't affect its financing cost - markets have ignored the rating for some time. But the conglomerate's top rating was a big reason for keeping its industrial and finance arms together.

The strength of the industrial business theoretically allowed the financial arm to raise debt more cheaply, allowing it to thrive. The downgrade guts this rationale.

The downgrade has been a long time coming. GE (GE, Fortune 500) had maintained a high overall rating because of the steady cash thrown off by the industrial side of its business.

But its finance division has been struggling for some time. Its problems caused S&P to slice its estimate of GE's creditworthiness.

GE's cost of funding probably won't change much. The credit default swap spreads on the finance unit recently ballooned to levels consistent with much lower credit ratings, meaning the market is ignoring the ratings agencies' still-Pollyannaish estimates.

Nonetheless, there's a risk - if its ratings fall below double-A-minus, it would be forced to post additional collateral to its counterparties.

Despite this, GE's rationale for keeping the industrial and finance businesses together is now much weaker. Granted, S&P thinks the stand-alone finance unit would only merit a single-A rating, so splitting up would probably force it to pony up more collateral on its trading positions.

That could be painful, though it is unlikely to pose as a significant a threat to GE Capital's business since it doesn't have massive derivatives portfolios like, say, American International Group (AIG, Fortune 500).

There is one other rationale for keeping the two businesses together. GE may say it has an easier time selling turbines and jet engines if it can offer attractive financing to customers.

But GE Capital's ability to provide cheap debt has been undermined by the market's lack of confidence in its rating. GE has no more excuses for keeping these businesses together.