The credit-rating companies say they’re cleaning up their act. That will be a tough sell as long as they keep saying General Electric Co is AAA.
Almost two months ago, the heads of Moody’s Investors Service and Standard & Poor’s prostrated themselves before a congressional oversight committee and acknowledged that their companies had blown their reputations by giving top marks to countless mortgage-backed securities that were toxic.
The chief executive of Moody’s Corp, Raymond McDaniel, said “we know that there has been a loss of confidence in our industry,” and he pledged to do better. S&P’s president, Deven Sharma, said his company was “identifying and implementing steps to improve our processes and restore the market’s confidence in S&P’s rating opinions.”
One step would be to cut GE’s top-notch rating. Neither S&P nor Moody’s has. What I half-expected them to say during the last few weeks goes something like this excerpt from a December 2 report by Egan-Jones Ratings Co., a competitor.
“With the tsunami sweeping over the financial sector, it is unrealistic to expect that GE will not get wet,” Egan-Jones said. “GE does not look, sound or act like a ‘AAA’ and therefore is probably not a true ‘AAA.’”
Egan-Jones isn’t predicting doom. Its rating on GE is A-, six levels below AAA. That’s hardly an insult, except to a company such as GE, which long has depended on its pristine rating to keep its borrowing costs low.
Unlike Moody’s and S&P, Egan-Jones gets paid by subscribers, rather than the companies it rates. It would be just a minor exaggeration to say the only people who still insist GE is AAA are all employed by S&P, Moody’s or GE itself.
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CASH DRAIN
GE’s key industries — financial services and capital equipment — are under siege. The company needs to refinance more than $40 billion of debt by the end of 2009.
By GE’s estimates, all but about $2.6 billion of the $16 billion of excess cash it expects to generate next year will go toward paying dividends. As of September 30, before its latest stock sales, GE had just $13.7 billion of tangible shareholder equity, excluding $98.7 billion of goodwill and other intangible assets.
At $189 billion, the company’s stock-market value is down about half this year, crimping GE’s ability to raise more capital cheaply. GE raised $12.2 billion selling common shares in October at $22.25 each. Its stock now trades for 19 per cent less.
GE is paying a monstrous 10 per cent annual dividend on $3 billion of preferred stock that Warren Buffett’s Berkshire Hathaway Inc. bought in October. And GE has resorted to government guarantees to issue new debt.
CAUSE FOR WONDER
In case none of that casts doubt, GE this quarter began including a new 323-word risk-factor disclosure in its securities filings, saying there can be no assurance efforts to strengthen its capital and liquidity will be enough to keep its AAA rating.
It’s no wonder then that recent prices for credit-default swaps on GE Capital Corp, the finance arm that relies on GE’s support for its own AAA rating, implied a 32 percent chance of default in the next five years, according to Bloomberg data. Even if that’s overly pessimistic, it shows investors buying protection in this market believe the risk of default is more than slight.
GE has made a big show of affirming its commitment to maintaining its AAA ratings. The company says it has always paid a large portion of its cash flow as dividends. It avoided many of the exotic financial instruments that have crippled large banks. As for relying on federal guarantees, it says it was just seeking to level the playing field with other financial companies.
“We are a triple-A company, but when the government recognises a new class of financial-services companies with a guarantee program, that would put us at a disadvantage,” Russell Wilkerson, a GE spokesman, said.
AGAINST THE WEAK
Mighty GE can’t compete against those weaklings without government help? And here I thought AAA-rated companies didn’t need federal assistance.
The raters at Moody’s and S&P say they’re looking beyond the unfolding credit crisis and believe the company will generate strong profits and cash flow over the long term. If conditions change for the worse, they say, so might GE’s ratings.
While a 10 per cent dividend isn’t typical for a AAA credit, Moody’s analyst Richard Lane told me it’s a “short-term isolated incident in our view that was driven by the unique environment that we’re in temporarily.” As for the slim margin between projected cash flow and dividends for 2009, he says “our expectations are that the prospects for 2010 and beyond will be better than what they’re showing here.”
S&P analyst Robert Schulz in an e-mail said GE’s recent actions to raise cash, stop buying back stock, and keep its dividend unchanged are “indicative of a conservative financial policy and consistent with our rating expectations.”
What’s clear is that GE’s AAA ratings don’t reflect the company’s current financial position, as much as they do the hopes of a few analysts that the future will be brighter.
Just once it would be nice to see them ahead of the pack.