Fitch Downgrades GE and GE Capital to ‘BBB’ Outlook Stable
APR 13, 2020 - 7:00 am
Fitch Ratings has downgraded the long-term issuer default ratings (IDRs) for General Electric and GE Capital to ‘BBB’ from ‘BBB+’. The rating outlook is Stable. Fitch has downgraded the companies’ short-term IDRs to ‘F3’ from ‘F2’.
KEY RATING DRIVERS
Downgrade: The downgrade of GE’s ratings reflects Fitch’s expectation that improvements in the company’s credit profile will be constrained by the economic impact of the coronavirus pandemic. Free cash flow (FCF) is likely to weaken materially in 2020 and Fitch estimates leverage will remain elevated compared to peers in the industrial space despite ongoing debt reduction. The progression of the pandemic and the timing of an eventual economic recovery are uncertain, complicating GE’s efforts to increase profitability and strengthen its balance sheet. As of Dec. 31, 2019 debt/EBITDA as calculated by Fitch was 6.4x and FFO leverage was 4.3x.
Stable Outlook: The stable outlook reflects GE’s near-term financial flexibility that is supported by $20 billion of cash proceeds from the recent sale of the BioPharma business. Fitch still anticipates that over the next several years GE will realize improving operating results, but there is room at the current rating level if improvements are delayed due to the pandemic. The company continues to make progress in restructuring the Power segment and reducing corporate costs.
The ratings reflect Fitch’s assumption that a reduction in GE’s leverage will be slower than originally anticipated due to a weak economic environment in the near term, low margins in the Power and Renewable Energy businesses through 2021 before restructuring and production of the Haliade-X wind turbine contribute to better results and significant short-term challenges in the Aviation business. GE Aviation has reduced its workforce in response to low demand. Fitch expects that much of the demand will recover by sometime in 2021, but there is a risk that a full recovery is several years away. The workforce reductions are intended by GE to cut costs by $500 million-$1 billion.
Low FCF: Fitch estimates FCF in 2020 will become negative compared to positive FCF of more than $4 billion in 2019. The decrease reflects the impact of the coronavirus outbreak on GE’s end-markets, particularly Aviation that generates the majority of GE’s FCF and offsets negative FCF in the Power and Renewable Energy segments. Fitch’s concerns about weak FCF could be addressed over time as GE generates stronger segment margins and cash requirements decline related to working capital, pension contributions and supports for GE Capital.
Cash Deployment: GE is using proceeds from asset dispositions to reduce debt and leverage, although Fitch believes the timing could be delayed while GE holds higher cash balances during the coronavirus outbreak. GE intends to sell its interest in Baker Hughes and use proceeds to reduce debt, but low oil prices have reduced the value of GE’s stake, which could delay a transaction.
Other possible uses of cash include contributions to underfunded pension plans, contributions to GE Capital, and reductions in factored receivables. Fitch’s calculation of industrial debt includes factored receivables and a hypothetical equity injection to GE Capital.
Rating Strengths: GE’s long-term performance is supported by the Aviation business, which generates high margins and has broad technological capabilities including additive manufacturing. Other strengths include GE’s global presence, well-established market positions and substantial services revenue. Services generate solid margins and typically are less cyclical than GE’s equipment revenue, although part of this business will be pressured in the near term as a result of the coronavirus pandemic. GE is smaller as a result of asset dispositions but is still large relative to most peers.
Support for GE Capital: GE’s credit profile takes into account support needed for GE Capital, primarily related to long-term care contracts at GE Capital’s legacy reinsurance business. GE plans to make another contribution to GE Capital in 2020 but at a smaller amount than the $4 billion in 2019, roughly in line with the insurance statutory funding. GE Capital is not expected to return to break even until 2021. Synergies between GE and GE Capital are primarily associated with GECAS, the aircraft leasing business. Fitch believes there is a risk of support required for GE Capital beyond 2020 related to the insurance business.
Linkage with GE Capital: Fitch’s ratings and financial measures for GE’s industrial businesses (GE Industrial) consider GE Capital on an equity basis. GE Industrial debt excludes GE Capital debt assumed by GE that is offset by an intercompany receivable from GE Capital for the same amount. The ratings for GE Capital reflect support from GE.
Fitch-calculated debt at GE is adjusted to include a hypothetical equity injection to GE Capital of approximately $4 billion at Dec. 31, 2019 that would reduce GE Capital’s debt/tangible equity to 3.0x. The target ratio reflects the large relative size of the aircraft leasing portfolio within GE Capital’s total receivables portfolio and risks around estimating liabilities at the insurance business. The adjustment for a hypothetical equity injection incorporates Fitch’s criteria for rating nonfinancial corporates, under which Fitch calculates an appropriate debt/equity ratio for captive finance businesses based on asset quality, funding and liquidity.
The downgrade of GE Capital’s ratings and the revision of the Rating Outlook to Stable from Negative reflect the linkage to the ratings and Outlook of its parent, GE. Fitch views GE Capital as a core subsidiary of GE, primarily driven by the explicit guarantee provided by GE with respect to all of GE Capital’s outstanding debt. This view is also driven by strategic alignment between the two entities, shared branding and the fact that GE Capital is wholly owned by GE.
Beyond these support driven considerations, Fitch also considers GE Capital’s leading franchise in the aircraft leasing space, sufficient liquidity and solid funding flexibility, which are counterbalanced by the company’s elevated leverage compared to stand-alone finance companies, reliance on wholesale funding sources and the cyclicality and residual value risk inherent in aircraft leasing. Fitch also believes there is the potential for higher than previously expected capital contributions to the run-off insurance operations (North America Life and Health, or NALH), in light of the recent and significant decline in interest rates and equity markets due to the global spread of the coronavirus.
Fitch expects GE Capital to maintain is market leading position in aircraft leasing, which represents the majority of the captive’s assets. As of Dec. 31, 2019, GE Capital Aviation Services (GECAS) had more than 1,700 owned, managed and committed aircraft serving 225 customers in 75 countries, making it one of the world’s largest aircraft lessors. Fitch revised its global aircraft leasing sector outlook to Negative from Stable on March 16, 2020 to reflect the unprecedented decline in global air traffic caused by the coronavirus pandemic. Fitch subsequently took negative rating actions on all stand-alone aircraft lessors on March 23, 2020 with the largest stand-alone players placed on Rating Outlook Negative. Absent abatement of the virus in the near-to-intermediate term and/or material sovereign intervention, there could be widespread lease deferrals/defaults, airline bankruptcies, aircraft repossessions and impairments, which would further pressure the credit profiles of all aircraft lessors.
In January 2018, GE announced that GE Capital will make a statutory contribution of $15 billion to its legacy long-term care, structured settlement and life insurance businesses over seven years to account for increased claim expectations, which have been and will be funded by available liquidity, asset sales and future earnings by GE Capital and support from GE. The insurance charge recognized higher estimated losses at GE Capital’s insurance business, particularly for long-term care policies, which reduced the value of GE Capital and its long-term capacity to pay dividends to GE. GE Capital provided $2.0 billion and $1.9 billion of capital contributions to its insurance subsidiaries in 1Q20 and 1Q19, respectively, and expects to provide further capital contributions of approximately $7 billion through 2024, consistent with its plan. Fitch expects recent interest rate and market volatility resulting from the global spread of the coronavirus could result in additional reserving actions by GE Capital to its insurance businesses.
GE Capital’s leverage ratio, defined by Fitch as gross debt to tangible equity (shareholder’s equity including preferred equity less goodwill and intangible assets) was 4.1x as of Dec. 31, 2019, down from 6.4x at YE18 and 7.8x at YE17, as proceeds from asset sales were used to repay outstanding debt. Fitch expects tangible leverage to remain around 4.0x over the medium term, which is elevated relative to similarly rated stand-alone finance and leasing companies. Fitch believes GE will continue to provide capital contributions to GE Capital to maintain leverage at appropriate levels relative to the asset mix.
GE Capital generated net losses in 2015-2019 due to costs associated with the exit plan implemented in 2015, the reserve charge in NALH, elevated interest costs related to excess debt and a $1.5 billion reserve charge stemming from a settlement with the U.S. Department of Justice in regards to WMC Mortgage Corporation. GE Capital narrowed its losses in 2019, reporting net segment losses of $0.3 billion, an improvement from a loss of $2.2 billion in 2018. Results in 2019 were primarily driven by a $1.0 billion pretax charge associated with the annual insurance premium deficiency review, lower gains on the sale of aircraft and engines, lower tax benefits and slower receivables growth, which were partially offset by lower impairments, lower excess interest charges and benefits from U.S. tax reform and other tax law changes.
The Long-Term IDRs for GE Capital International Holdings Ltd., GE Capital International Funding Co. and GE Capital US Holdings, Inc. are linked to GE Capital’s Long-Term IDR. The Long-Term IDR for GE Capital EFS Financing Inc. reflects the guarantee provided to the entity by GE Capital and thus GE.
The Short-Term IDRs for GE Capital Global Holdings, LLC and GE Capital Treasury Services LLC have been downgraded to ‘F3’ from ‘F2’, reflecting the rating linkage with GE. GE Capital Treasury Services LLC issues commercial paper (CP) guaranteed by GE, which is used to fund short-term working capital needs of GE Capital’s operations. The CP rating is equalized with the short-term IDR.
The senior unsecured debt ratings of GE Capital International Funding Co. and other GE Capital subsidiaries are equalized with GE Capital’s Long-Term IDR and reflect the largely unsecured funding profile and Fitch’s expectation of average recoveries in a stressed scenario as well as parent guarantees provided by GE.
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