Our Terms of Service and Privacy Policy have changed.

By continuing to use this site, you are agreeing to the new Privacy Policy and Terms of Service.

Breaking Views

GE Capital's bad-loan bet

A look at the leveraged loans slice of its portfolio raises questions about whether GE's finance arm will need to squirrel away more cash.

EMAIL  |   PRINT  |   SHARE  |   RSS
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all CNNMoney.com RSS FEEDS (close)
By Robert Cyran and Rob Cox, breakingviews.com

(breakingviews.com) -- Does General Electric need to put aside more cash to handle bad loans at its finance arm? GE says it doesn't -- it even insists it has higher loan loss reserves than the biggest US banks. But investors aren't fully convinced. And a look at just one small slice of GE Capital's $650 billion of assets suggests why they are right to be skeptical.

The company's reserves against losses in its $38 billion of leveraged loans are around 1.2% of its book. GE estimates these losses will probably peak next year at around 1.9% or slightly less. But this prediction, which would imply GE Capital just needs to set aside another $266 million or so, seems too low when judged against the market.

The average leveraged loan currently trades around 81 cents on the dollar, according to S&P Leveraged Commentary and Data. If marked to market, GE's debt portfolio might trade close to that level too, based on the distribution of credit ratings on those loans.

While some of the 19 cents on the dollar discount the market now attaches to the average leveraged loan may be a function of illiquidity, a large chunk is the market's way of suggesting defaults will be far greater, overall, than the 1.9% that GE is banking on.

Now, it's true that GE's portfolio may be of higher quality than the broader market. If the firm's boasts about its superior credit management skills are to be believed, it probably has fewer dud loans. The company also claims it is "willing to work longer and harder to recover full value" - even if rivals like Goldman Sachs (GS, Fortune 500) or JPMorgan (JPM, Fortune 500) aren't widely known for letting borrowers off the hook easily.

So assume for the sake of argument that GE's leveraged loans have only lost half as much of their value as the average. That still would suggest potential losses of some $3.6 billion -- or eight times its current reserves.

That may not seem like a big deal. After accounting for reserves already taken, it would amount to just 5% of the finance arm's total shareholders' equity. But if investors apply similar arithmetic to the other $600 billion-odd of assets on GE's books the losses would clearly start to add up.

GE may prove naysayers -- and the market -- wrong by riding out the downturn and the credit cycle, and getting most of its borrowers to make good on their commitments. But with one small, but important, piece of the puzzle already looking wonky, shareholders can be forgiven their wariness for now. To top of page

Company Price Change % Change
Bank of America Corp... 28.73 -0.11 -0.38%
Twenty-First Century... 34.88 2.13 6.50%
General Electric Co 17.64 -0.12 -0.68%
Ford Motor Co 12.46 -0.17 -1.35%
AT&T Inc 37.74 -0.30 -0.79%
Data as of Dec 14
Index Last Change % Change
Dow 24,508.66 -76.77 -0.31%
Nasdaq 6,856.53 -19.27 -0.28%
S&P 500 2,652.01 -10.84 -0.41%
Treasuries 2.35 -0.00 -0.13%
Data as of 1:55am ET
More Galleries
8 cool things cars of the future will do The coolest features that tease the future of driving, from windshield projections to never needing to park again. More
The best gadget gifts for 2017 A holiday gift guide for anyone who wants to spread some techie joy. More
14 awesome toys for the holiday wish list From a DIY Star Wars Droid to a new Hatchimals toy and interactive Fingerlings, these products are worthy of a coveted spot on holiday wish lists. More
Worry about the hackers you don't know 
Crime syndicates and government organizations pose a much greater cyber threat than renegade hacker groups like Anonymous. Play
GE CEO: Bringing jobs back to the U.S. 
Jeff Immelt says the U.S. is a cost competitive market for advanced manufacturing and that GE is bringing jobs back from Mexico. Play
Hamster wheel and wedgie-powered transit 
Red Bull Creation challenges hackers and engineers to invent new modes of transportation. Play