"It's the end of an era," said Bruce Greenwald, a professor of finance and asset management at Columbia Business School. Since the financial crisis destabilised GE, its chief executive, Jeffrey R Immelt, has been steadily shrinking the size of GE Capital, and in January described the downsizing of the business as a "historic pivot" in the company's strategy. In GE's most recent quarterly earnings report, GE Capital contributed just 25 per cent of its parent's total profit, down from nearly half at its peak. By 2018, GE expects financial services to contribute less than 10 per cent of its income.
On Friday, the company stated clearly why it was moving away from the business of making loans and investing in real estate. "The business model for large, wholesale-funded financial companies has changed, making it increasingly difficult to generate acceptable returns going forward," GE said on Friday when it announced its decision.
GE is not only one of America's oldest corporations, founded by Thomas Edison in 1878, but has long been lauded as one of its best managed, even as other industrial conglomerates fell out of favour. Its stock performance has languished for years, but it's still one the world's 10 largest corporations by market capitalisation, with a value of $287 billion. Based in Fairfield, Connecticut, its decision to largely get out of banking reflects the more difficult environment facing financial services companies. Despite stringent cost-cutting at many Wall Street banks, profit margins and revenue growth remain under pressure. In its most recent quarterly earnings report, Goldman Sachs reported a double-digit decline in revenue, and Citigroup, JPMorgan Chase and Morgan Stanley all reported weaker-than-expected earnings.
"Revenue growth in the banking industry is the worst it's been in eight decades," said Mike Mayo, bank analyst for the research firm CLSA. "The regulatory environment is much tougher, and it's forcing companies to rationalise their businesses."
The results are yet another reminder of an economic truism - reward correlates with risk. Regulators have squeezed risk out of the financial system by requiring banks and other large financial institutions to hold higher levels of capital, which has inevitably driven down profits, since assets sitting on the balance sheet are unlikely to generate much profit.
With GE's decision to throw in the towel on financial services, others on Wall Street are suggesting that regulators have gone too far. GE Capital's operations may survive and even prosper in the hands of new owners, but few have GE's resources to provide loans in the event of another crisis.
In his annual letter to shareholders this week, Jamie Dimon, the chief executive of JPMorgan Chase, warned that the recent liquidity problems and volatility in bond and currency markets should be seen as "a shot across the bow" to regulators. In the next crisis, he suggested, "there may be a shortage of all forms of good collateral" because bank assets that might otherwise be deployed are tied up by post-crisis capital and liquidity requirements. (A liquidity crisis occurs when there's not enough cash flow to sustain orderly markets. Large banks traditionally provide cash by acting as middlemen between buyers and sellers.)
GE's decision to part with most of GE Capital is the latest in a series of dispositions by the company. It has long said it wants to be only in businesses where it can have a significant market share and meet its profit margin targets. Last year it sold its venerable appliances division; it shed its remaining stake in NBC Universal two years ago and its plastics business in 2007. Under the direction of Immelt's predecessor, Jack Welch, GE sought to apply its management skill to dominate markets as diverse as industrial turbines, medical equipment and banking. But the decision to exit its finance operations punctuates the company's abandonment of that strategy.
Mayo, the bank analyst, said GE's decision would inevitably put pressure on other large financial companies to break themselves up. "If this works for GE, other big banks should take notice, or even better, their large shareholders should take notice," he said. For instance, Bank of America would be much better off if it spun off Merrill Lynch, and Bank of New York Mellon should sell some of its asset management boutiques, Mayo said. "The big banks can relieve the regulatory pressure by being less complex, and they can unleash value."
Regulators have drained significant profit opportunities from high finance, but many of the large banks' complaints about overregulation may be a smoke screen. "They could be taking more risks and doing more lending than they are," Greenwald said of the banks. "But they spread themselves too thin and got into too many businesses they didn't really understand. GE Capital barely survived the financial crisis."
Some smaller, regional banks continue to perform well in the new regulatory environment, as does the behemoth Wells Fargo, by focusing on businesses they understand and where they have a competitive advantage. For example, M&T Bank Corporation, based in Buffalo, in which Buffett owns a large stake, focuses almost exclusively on traditional banking services in the Northeast United States, and last year it had a profit margin of close to 25 per cent. Wells Fargo has a profit margin of nearly 28 per cent. GE's was barely over 10 per cent last year.
And Wells Fargo is trying to capitalise on GE's move. On Friday, the San Francisco-based bank, in a joint deal with Blackstone Group, the world's biggest private equity investor in real estate, said it agreed to buy GE real estate assets valued at $23 billion in a deal without any competitive bidding. "Who do you think is getting the better end of that deal?" Professor Greenwald asked, pointing out that Blackstone and Wells Fargo are focused, disciplined buyers of real estate assets.
Investors applauded GE's renewed focus on its core industrial businesses, driving the stock up nearly 11 per cent on the news. So did Greenwald. "Specialisation matters," he said. "You have to be focused."
© 2015 The New York Times News Service