General Electric amassed $115 billion of debt on a reputation as one of the U.S.’s safest borrowers. But revelations of losses and questions about its accounting have brought financial markets to a pivotal moment.
GE had a sterling triple-A credit rating as recently as 2015. This month, investors have pummeled its bond prices into junk territory. Once a giant issuer of ultrasafe commercial paper, it now relies on $41 billion in revolving credit lines from more than 30 banks — the corporate finance equivalent of a wallet stuffed with credit cards.
GE stock has lost about half its value in 2018 and ratings firms in recent weeks cut its credit rating to BBB-plus, three notches above junk. GE’s various bonds have tumbled about 5% to 18% since late October, according to MarketAxess, showing that some investors expect further downgrades. Trade in derivatives protecting against a GE default also surged on buying from banks and bond funds.
Newly installed Chief Executive Larry Culp is selling parts of the company to raise cash and slash debt, including Tuesday’s announcement that GE would sell a $3.7 billion stake in Baker Hughes, a GE Co. , which sent GE’s shares up 7.8%.
A slide below investment grade by GE—a name many Americans associate with safe and boring investing—could reshape the junk-bond market. GE has so much debt that it would become about one-tenth of the $1.2 trillion market, according to data from Fitch Ratings. The shift also would force fund managers to question how well they understand the risk in their investments and potentially hurt prices for other high-yield debt.
“It’s a relatively systemic company,” said David Meneret, founder of hedge fund Mill Hill Capital, which has been betting against GE by using credit-default swaps, or CDS, since July. “It would be extremely concerning to have that much paper moving from investment grade to high yield.”
Bond investors say they are selling in part because GE’s complex financial reporting makes it hard to analyze if more unexpected losses will be revealed, triggering another sudden downgrade. The company is considering breaking out financial performance of individual subsidiaries to provide greater transparency to investors, a person familiar with the matter said.
GE management aims to recapture a single-A credit rating through divestitures and by refocusing on its power and aviation manufacturing businesses. The company’s share price still implies $72 billion of market capitalization, according to FactSet.
GE became a bond-market titan in the late 1990s when its triple-A credit rating helped it borrow cheaply to fund manufacturing and to raise money for its financing arm GE Capital to lend. The company has cut debt from a peak of $336 billion in 2009 but lost its triple-A rating in 2015.
Its bonds remain widely held by insurers, pensions and mutual funds, many of which have ratings requirements that force them to sell bonds rated below investment grade. A short-term bond fund operated by Vanguard Group owned $1.4 billion in GE bonds as of October, representing 2.4% of its assets, according to data from Morningstar Inc. The fund can invest no more than 5% in junk debt, a spokesman said. MetLife Inc. owned about $300 million in June but has since reduced its holdings, which now make up a fraction of 1% of its investments, a company spokesman said.
Bond prices began their recent fall in late October when the company disclosed $22 billion in unexpected charges tied to its power unit, after reporting a $6 billion shortfall in insurance reserves in the first quarter. GE’s bonds have been the most actively traded in the U.S. corporate-debt market over the past two weeks with more than $10 billion changing hands, according to MarketAxess.
Some bondholders are purchasing credit-default swaps, which pay out if GE defaults, to protect themselves, while hedge funds are buying the swaps in a bet that they will rise in value as the company’s fortunes worsen. Prices of GE CDS roughly doubled in November and the dollar amount of swaps outstanding quadrupled to $836 million, the highest amount of any corporate borrower in the world, according to IHS Markit and DTCC Data.
Wall Street banks with lending commitments to GE also are buying CDS to protect loans to the company, according to people familiar with the trades. Banks account for about 10% of the recent GE CDS transactions, one of the people said.
The recent downgrades made borrowing through commercial paper more difficult for GE and the company is increasingly drawing on $41 billion of credit lines provided by more than 30 banks to fund itself, according to its quarterly earnings report. GE’s lenders include Citigroup Inc., Goldman Sachs Group Inc. and Morgan Stanley , according to its 2017 annual report.
“We currently are using $2 billion of these facilities as well as the commercial paper market for general intraquarter working capital needs,” said GE’s Treasurer Jennifer VanBelle.
The more GE borrows from the banks, the more CDS they will buy, pushing the cost of the swaps higher and increasing the perceived risk of default, Mr. Meneret said. Current CDS prices imply a default risk over the next five years of about 16%, almost twice the approximately 9% risk implied at the end of October.
The sharp moves in GE debt and derivative prices reflect concerns that further losses or cash shortages may be revealed, investors said.
“There is significant potential for negative credit surprises as GE proceeds with its ‘comprehensive review of assets,’” said David Sherman, founder of Cohanzick Management LLC, which is selling short GE bonds in a mutual fund and a hedge fund it manages. Short sellers borrow securities and sell them with plans to repurchase the instruments at lower prices in the future to close out the trade, pocketing the difference.
Another popular bearish trade is to sell short GE’s $5.5 billion in preferred shares, a debtlike instrument that pays a 5% annual dividend. GE can halt that payment as long as it pays no dividend on its common stock. The company slashed its common-stock quarterly dividend to one penny in November.
Warlander Asset Management LP, a hedge fund seeded by Appaloosa Management LP’s David Tepper, is one of the funds shorting the preferred shares, people familiar with the trade said. A spokesman for Warlander declined to comment.
Bonds continued their slide Wednesday. Asset sales might boost GE’s stock in the short term but “we believe a downgrade happens anyway,” said Mill Hill’s Mr. Meneret.
Corrections & amplifications
GE disclosed $22 billion in unexpected charges tied to its power unit in October after reporting a $6 billion shortfall in insurance reserves in the first quarter. An earlier version of this article incorrectly stated the company reported $28 billion in unexpected charges in October. (Nov. 14, 2018)
Source: The Wall Street Journal