In the Monitor 100 issue, mystery writer Dexter Van Dango takes a look at the planned divestiture of GE Capital, examining the financial division’s rise from an appliance financing option to a systematically important entity, and gives his best guess as to what may lie on the hazy road ahead.
A financial tsunami with enough power and punch to change the financial services landscape forever just hit the global markets when GE chairman Jeffrey Immelt announced his plan to divest most of GE Capital over the next two years. It will be the largest divestiture in the history of the industrial conglomerate.
The same day Immelt announced that Blackstone and Wells Fargo had agreed to purchase most of the assets of GE Capital Real Estate in a transaction worth approximately $23 billion, the announcement unofficially indicated that the auction was open.
While much of the public views GE as a maker of appliances, owner of broadcasters NBC and CNBC and manufacturer of industrial plastics, the truth is, each of these former GE units have been sold in recent years — albeit GE retained 49% of the broadcasters when they partnered with Comcast. It is clear that GE is transforming itself and returning to its roots as an industrial conglomerate.
Divesting GE Capital is a natural next step and their timing couldn’t be better. According to Immelt in an interview with CNBC, “The wholesale financial model is tougher and we’re disadvantaged from the banks. It’s the perfect market to sell financial assets. There’s slow growth, low interest rates, lots of equity, people searching for yield.”
I congratulate Mr. Immelt. What took you so long?
The House That Jack Built
Nevertheless, it is hard to imagine the eventual disappearance of the largest player in the market — the 800 pound gorilla. What began as a white-goods finance company tasked with helping promote the sale of GE appliances as General Electric Contracts Corporation in 1932, evolved over the next eight decades into one of the largest and most diversified financial services companies in the world.
Sometimes referred to as part of ‘the house that Jack built’, GE Capital grew assets to $160 billion by 1995. It doubled in size by the year 2000 when assets grew to $332.6 billion, and nearly doubled again by 2008 when it topped out at a peak of $637 billion before being strangled by the impact of the credit crunch when the market for commercial paper all but dried up. At year end 2014, GECC assets were just over $500 billion, positioning GE Captial as the 7th largest bank holding company in America just behind Goldman Sachs and Morgan Stanley, and just ahead of U.S. Bancorp, Bank of New York Mellon and PNC.
Immelt had multiple reasons, but the primary underlying rationale for his decision to boot GE Capital was because it was named a nonbank systemically important financial institution — and his concern over the increased level of scrutiny and regulatory oversight that came with that designation.
According to form 10-Q filed by GE Capital with the Securities and Exchange Commission on May 4, 2015, “GE has discussed the GE Capital Exit Plan, aspects of which are subject to regulatory review and approval, with its regulators and staff of the Financial Stability Oversight Council (FSOC) and will work closely with these bodies to take the actions necessary over time to terminate the FSOC’s designation of GECC (and the new intermediate holding company, as applicable) as a nonbank systemically important financial institution (nonbank SIFI).”
Under the leadership of Jack Welch, GE Capital grew to be a reliable contributor to the parent company bottom line — contributing nearly 60% of GE’s overall profits at its peak. GE Capital had a reputation for providing consistent, predictable, reliable earnings; nipping and tucking as needed and managing — read this as manipulating — the parent company’s quarterly results. Somehow, the finance company had an innate ability to optimize the tax liability of the parent. Gary Wendt, Dennis Dammerman and Mike Neal each had magical strings they could pull from behind the curtain, much like the Wizard of Oz, to increase earnings and reduce effective tax rates.
Post-9/11, under Immelt’s watch, GE Capital continued to grow until it reached a tipping point. Wall Street analysts started to view the parent company as a meaningful player in the financial services sector and questioned whether it was still a viable industrial conglomerate. The death knell came when global capital markets froze during the Great Recession. Not unlike others at the time, GE was forced into the open arms of Warren Buffett, when Berkshire Hathaway invested billions in common and preferred stock, the latter paying Buffet a healthy 10% dividend, with the option to purchase additional shares.
As the turmoil bottomed out and the recovery began, Congress did an about-face and started down the long road of financial reform. Chris Dodd, Barney Frank and Elizabeth Warren all played vital roles. Heavily increased regulatory oversight was the end game. Once GE Capital was labeled “systemically important,” the writing was on the wall — its days were numbered!
So, what’s next? What will happen to the non-core assets and the thousands of people affected by the decision to divest GECC from the parent? Speculation is robust. Within days of the announced exit plan there were rumors that Wells Fargo was in talks to acquire the commercial lending and lease portfolio for $74 billion — that’s billion with a B, and nine zeros following the 74.
By the end of April Bloomberg reported that potential buyers were swarming like buzzards in quest of GE’s assets. Oaktree Capital Group, the world’s biggest distressed-debt investor, which oversees about $100 billion in assets, was reportedly evaluating parts of GE’s finance business. Large banks including JPMorgan Chase and U.S. Bancorp have said they will look at assets. Other suitors named in the Bloomberg piece included Blackstone Group, Mitsubishi UFJ Financial Group, Wells Fargo, SunTrust Bank, Apollo Global Management and Ares Management.
One of the most interesting revelations came from GE CFO Jeff Bornstein when he announced that GE had explored “a broad geographic spectrum” of potential buyers, including several sovereign wealth funds. According to the Sovereign Wealth Fund Institute, sovereign funds, concentrated in Europe, Asia and the Middle East, control an estimated $7.1 trillion in assets. Moreover, some pundits speculated that the wealth funds could expedite the process by avoiding rules
Already, less than a month following the announced divestiture, GE Capital has been forced to deliver retention packages to key employees in an effort to avoid the obvious talent raiding that can be expected from competitors. Stealing a team of proven originators in any given market makes for a low entry cost for banks, insurers, private equity firms and others. Expect some new names to be added to the ELFA membership roster over the next year and a half.
An Uncertain Road Ahead
Where do I think this is headed? Your guess is as good as mine. It seems unlikely that any one player, sovereign wealth funds included, can afford to take too large a piece of the pie. Instead, I see GE divvying up the business to several buyers. In mid-May the Wall Street Journal reported that GE is selling its Japanese commercial finance operation. GE already issued an IPO for Synchrony, the bundled successor to its consumer finance units. Expect the remaining shares to be sold in the open market. There is word on the street that GE will limit the number of bidders for GE Capital Sponsor Finance to 12 firms. Most people expect it to be sold within 90 days.
It is unclear to me how GE Capital’s commercial lending business, the $74 billion unit rumored to be currently assessed by Wells Fargo, will be sold. The business is made up of a bunch of companies: GE Corporate Finance, GE Healthcare Financial Services, GE Equipment Finance and GE Commercial Distribution Finance, GE Sponsor Finance and GE Franchise Finance. Equipment Finance includes its large Vendor Financial Services unit. Some pieces of that business are much more attractive than others. The NACCO Material Handling Group, Doosan/Bobcat and Ricoh Imaging businesses are three large programs and portfolios deserving premiums when sold. Other less productive relationships may be run off or sold at a discount. It is entirely feasible that Equipment, Corporate, Sponsor, Franchise, Healthcare and Distribution could each be sold to different parties.
What happens to GE Capital is ultimately yet to be seen. However, we all can acknowledge that Immelt and the GE board’s decision to break up the financial service giant is no less significant than the decision made by Judge Harold Greene, who presided over United States vs. AT&T, the antitrust suit that broke up the AT&T vertical market monopoly on the telecommunications industry in 1982. On January 1, 1984 the AT&T ‘monopoly’ was broken into seven regional Bell operating companies. Most of them are gone today with only the former Southwestern Bell remaining — now ironically named AT&T. Verizon holds the former Bell Atlantic and NYNEX, while CenturyLink has the former US West.
My point is that the original monopoly-labeled AT&T was broken into seven RBOCs, only one of which remains standing today. One might gain greater insight into the future of GE Capital by learning from the history of the former “Ma Bell” — since history tends to repeat itself. Perhaps Mother Goose said it best, “All the king’s horses and all the king’s men couldn’t put Humpty together again.”