November 28, 2017 / 7:34 PM / a year ago

Fitch Downgrades GE to 'A+/F1'; Outlook Negative

(The following statement was released by the rating agency) CHICAGO, November 28 (Fitch) Fitch Ratings has downgraded the Long- and Short-Term Issuer Default Ratings (IDRs) for General Electric Company (GE) and GE Capital Global Holdings, LLC (GE Capital) to 'A+' and 'F1' from 'AA-' and 'F1+'. The Rating Outlook is Negative. A full list of ratings follows at the end of this release. KEY RATING DRIVERS GE Industrial The downgrade of GE's ratings considers the deterioration in the company's operating and financial performance including a slower return to higher margins and stronger free cash flow than previously anticipated by Fitch. GE's performance is being affected by secular changes in the Power segment's gas turbine business that has reduced long term prospects for growth. Fitch believes the company will maintain a strong balance sheet and a high level of financial flexibility which considers a smaller albeit sizeable GE Capital, but more in line with the new rating. GE is becoming less diversified as it realigns its businesses, but overall diversification remains meaningful. The Negative Outlook incorporates concerns about the pace at which GE returns to stronger free cash flow (FCF); the extent of restructuring required to reduce the company's cost structure and increase margins in the Power, Renewable Energy and Oil & Gas segments; and structural changes at the Power segment including industry overcapacity, the growing role of energy efficiency, and a shift toward renewable energy. GE has identified several actions that should improve its operating performance, but the implementation could occur over an extended period and Fitch believes there are numerous execution risks. Cash flow available to the industrial business will be reduced through at least 2018 by the suspension of dividends from GE Capital while it reviews its insurance reserves. The Outlook could return to Stable if GE executes its plans to realign its business portfolio and rebuild profitability. Other important developments to stabilizing the Rating Outlook include achieving a lower cost structure in the Power business within the next one to two years, realizing positive FCF after dividends in 2018 with solid prospects for further improvement, reducing leverage from levels which Fitch expects could increase in the near term before improving in 2019, reducing net investment in contract assets, and maintaining competitive positions in GE's industrial markets. Fitch still views GE's overall enterprise risk as relatively low, reflecting its global presence,, broad product portfolio, strong market positions, and substantial services revenue which generates solid margins and typically is less cyclical than GE's equipment revenue. GE's large scale and access to capital markets provide considerable financial flexibility to execute its operating strategies. The ratings could be downgraded if EBITDA margins do not improve meaningfully after 2018, restructuring in the Power business is ineffective or FCF after dividends does not increase as anticipated by Fitch. However, Fitch believes the downside rating risk is limited to one notch due to support and flexibility provided by strong operating performance in the Aviation and Healthcare segments, GE's increased focus on cash generation, margin growth across GE's business excluding Power and Oil & Gas, reputational benefits of a strong financial position in the company's global industrial markets, and the importance of access to Tier 1 commercial paper markets and competitive funding for GE Capital. Fitch views GE's dividend cut and reduction in share repurchases as positive developments for its credit profile that will increase the company's financial flexibility. Dividends were high relative to GE's earnings and FCF following the GE Capital exit, and the dividend cut brings GE's payout ratio closer to other large, highly rated industrial peers. A more disciplined approach to cash deployment, including spending on digital technology and capex, should support the company's financial flexibility as it considers planned asset dispositions and future capital structure. GE plans to reduce the number of board members to 12 from 18 including the nomination of three new members, not including the addition of a representative from Trian Fund Management in 2017. Fitch estimates FCF after dividends in 2017 could be negative by as much as $6 billion - $7 billion, well below the original estimate of approximately negative $1 billion. The reduction reflects large cash usage in the Power business and for contract assets which is expected to represent a $5 billion net use of cash in 2017. In 2018, Fitch estimates FCF after dividends will become positive at approximately $1 billion - $2 billion due to the planned 50% reduction in common dividends, lower capital expenditures and pension contributions (excluding a planned $6 billion debt funded contribution), lower cash usage for contract assets, and benefits from ongoing restructuring. Fitch expects FCF after dividends should continue to improve after 2018. FCF in 2018 will be negatively affected by the suspension of dividends to GE from GE Capital. These dividends totaled $4 billion in 2017 year to date, of which Fitch includes $1 billion in its calculation of FCF. Fitch does not assume any dividends from GE Capital in its estimates of future FCF for GE. Dividends from GE Capital were suspended while GE Capital reviews the adequacy of reserves at its insurance business related to long term care liabilities which GE expects to complete by the end of 2017. Fitch views as credit neutral GE's plan to issue $6 billion of debt to pre-fund pension contributions to the GE Pension Plan in 2018. The debt funded contribution would accelerate the timing of contributions over the next three years but does not materially affect the total amount of contributions. The net pension liability remains large relative to other industrial peers. At the end of 2016, GE's pension plans were underfunded by approximately $31 billion (67% funded) on a projected benefit obligation basis (72% funded excluding the unfunded GE Supplemental plan). GE closed the GE Pension Plan to salaried employees at the beginning of 2011 and to all employees at the beginning of 2012 Restructuring and other items totalled approximately $4 billion in the first nine months of 2017, including GE's share of restructuring at BHGE, compared to $3.6 billion in all of 2016 shortly after Alstom was acquired. Roughly $2 billion of costs in 2017 will be cash which is contributing to weak cash flow. GE targets a net reduction in structural costs of more than $1 billion in 2017 and $2 billion in 2018. Restructuring should support future margin improvement, particularly in Power and Oil & Gas. Excluding these segments, GE's other businesses collectively realized a margin improvement of 250 bps in the third quarter of 2017. 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 incorporate support from GE. Under Fitch's criteria for rating non-financial corporates, Fitch calculates an appropriate debt/equity ratio of 5x at GE Capital based on solid asset quality, sufficient liquidity and strong funding profile. Actual debt/equity as measured by Fitch is slightly under 5x, so no adjustment is needed to reflect hypothetical support from GE to GE Capital. GE Capital The IDRs for GE Capital and its rated subsidiaries are linked to and equalized with those of GE, reflecting Fitch's view that GE Capital is a core subsidiary of GE, as defined under Fitch's 'Global Non-Bank Financial Institutions Rating Criteria.' This view is supported by the fact that GE Capital remains a key and integral part of certain of GE's industry verticals, shares its branding with the broader GE organization and benefits from explicit guarantees of its existing financial obligations. In addition, GE Capital is a wholly-owned subsidiary of GE and operates in the same jurisdictions as GE. Credit strengths of GE Capital on a standalone basis include its strong franchise; market leading position in aircraft lending and leasing; established positions in energy finance and industrial finance; experienced management team; adequate liquidity and manageable commercial paper balances; and strong funding flexibility, given a high proportion of unsecured debt. Credit constraints on a standalone basis include reliance on wholesale funding sources; cyclicality and residual value risk inherent in certain of GE Capital's activities, particularly aircraft leasing; and reduced regulatory oversight. After March 30, 2017, GE Capital's non-U.S. activities are no longer subject to supervision by the U.K. Prudential Regulation Authority. This followed the June 28, 2016 announcement that the Financial Stability Oversight Council in the U.S. rescinded GE Capital's designation as a Domestic Systemically Important Financial Institution. GE Capital verticals include GE Capital Aviation Services (GECAS), which provides aircraft operating leases and aircraft loans, GE Energy Financial Services (EFS), which invests in energy-related structured and project finance, and GE Industrial Finance (IF), which offers working capital solutions and trade payables services. As the largest vertical, GECAS had approximately $38.9 billion in assets as of Sept. 30, 2017, representing 25.1% of total assets, but generated $259 million in earnings in 3Q17 or 86.6% of vertical earnings. GECAS has a strong market position and was the largest aircraft lessor by fleet count, with 1,995 aircraft in operation or on order and 254 customers as of Sept. 30, 2017. Fitch expects GECAS's earnings to remain stable over the Outlook horizon, driven by the full suite of aviation products that it offers, including leasing and/or providing financing for narrowbody and widebody aircraft, cargo airplanes, regional jets, turboprops, and helicopters. Fitch does not expect a sale of GECAS over the near term, since GECAS complements GE's aviation business and since valuations of aircraft lessors have increased over the past year as commercial aviation industry fundamentals remain favorable. Asset quality metrics across GE Capital weakened during 3Q17, driven by impairments associated with two energy investments in EFS and impairments on four widebody aircraft in GECAS. These results are in line with Fitch's expectations, given that energy prices have still not recovered from the downturn in 2014-2015 and given weakness in certain widebody aircraft. GE Capital's leverage ratio, defined by Fitch as gross debt to tangible equity (total shareowners' equity including preferred equity less goodwill and other intangible assets) was 5.4x as of Sept. 30, 2017, which increased, in part, due to capital returned to GE over the last 12 months. Fitch expects leverage will decline to 4.0 to 4.5x over the next two years as the GE Capital Exit Plan is finalized and additional debt is repaid, at which time GE Capital plans to maintain approximately $10 billion of liquidity. Leverage as of June 30, 2017 pro forma for excess debt repayment (liquidity as of Sept. 30, 2017 in excess of $10 billion) was 4.1x. Despite recent changes to the regulatory oversight of GE Capital, the company's leverage targets have not changed as its Economic Capital (E-Cap) framework continues to be employed. While current and targeted leverage ratios are viewed as higher than Fitch's quantitative benchmarks for a standalone finance and leasing company rated 'A+', the GE guarantee on GE Capital's debt and GE's ability to provide support to GE Capital are mitigants. GE Capital's earnings and profitability ratios have stabilized after the firm incurred financial charges associated with the GE Capital Exit Plan. Vertical earnings totaled approximately $1.4 billion year-to-date through Sept. 30, 2017, compared to $1.9 billion in full year 2016 and $1.7 billion in full year 2015. Vertical earnings to average total equity were 8.0% year-to-date through Sept. 30, 2017, up from 5.3% in 2016 and 2.4% in 2015 as GE Capital has right-sized its capital base. GE Capital has paid $4 billion of dividends to GE year-to-date. GE Capital is currently completing a comprehensive review of its legacy insurance business. The review relates to premium deficiency assumptions used in GE Capital's annual claims reserve adequacy test. Until this review is completed, GE Capital will not pay any additional dividends to GE. The 'A+' 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 'A+' Long-term IDR for GE Capital EFS Financing Inc. reflects the credit support provided to the entity by GE Capital, and thus GE. The 'F1' Short-term IDR for GE Capital Treasury Services LLC is also linked to GE Capital's Long-term IDR. This entity issues commercial paper rated 'F1', guaranteed by GE, which is used to fund short-term working capital needs of GE Capital's operations. The 'A+' 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 Fitch's expectation of average recoveries. DERIVATION SUMMARY GE Industrial Fitch considers GE's overall enterprise risk level to be low despite near term challenges, and its credit profile benefits from a combination of GE's diversification, large size, high proportion of high-margin service revenue, and leading market positions. Peers such as Siemens, Honeywell and United Technologies are also well capitalized and have global scale, making them strong competitors. GE's scale and diversification historically provided more operating and financial flexibility than its peers although these advantages have been diminished, at least temporarily, by weak financial results. GE is more highly leveraged compared to other highly rated industrial peers, reflecting reduced financial performance and an increase in the company's debt in recent years as it refocused its business portfolio on the company's core infrastructure markets through acquisitions and divestitures. Capital deployment is likely to be lower for the foreseeable future as GE resets its strategy, realigns its business mix and reduces its cost structure. GE generates solid margins in certain key segments such as Aviation and Healthcare that are comparable to its stronger peers including Honeywell and United Technologies, and margins are higher than Siemens. However, GE's overall margins are lower than these peers due to the impact of challenging industry conditions in other segments. GE's finance business (GE Capital) is much smaller than in the past but is still large in absolute terms and is materially larger than Siemens' finance business. Other diversified industrial companies typically do not have substantial finance businesses. GE Capital supports GE's industrial operations, particularly GECAS which provides financing for aviation customers. However, finance operations also involve funding and other risks that can potentially lead to support required from the parent. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for GE Industrial include: --Power business results are weak through at least 2018; --GE disposes of $20 billion of industrial businesses in the next one to two years; --Margins improve materially after 2018 due to restructuring and asset disposals; --FCF after dividends as calculated by Fitch is significantly negative in 2017 but becomes positive in 2018 and improves steadily thereafter; --Common dividends are reduced 50% in 2018 and share repurchases are minimal; --Dividends from GE Capital remain suspended through at least 2018; --Leverage rises through 2018 as GE realigns its businesses. After 2018, leverage declines due to improving operating results while debt remains steady. Fitch's key assumptions within the rating case for GE Capital include: --GE Capital's outstanding debt will remain explicitly guaranteed by GE. --GE Capital will not pay any dividends to GE until its comprehensive review of its legacy insurance business is complete. --GE Capital's gross debt to tangible equity calculated by Fitch will be around 4.0x to 4.5x over the long term. --GE Capital's total assets will be approximately $130 billion over the Outlook horizon. RATING SENSITIVITIES GE Industrial Future developments that may, individually or collectively, lead to Stable Outlook include: --GE maintains expected financial policies consistent with a strong balance sheet and that are supportive of debtholders; --The Power segment restructures effectively and margins improve toward historical levels; --Acquisitions, divestitures and restructuring are carried out with limited disruption to GE's businesses; --High-margin services and aftermarket revenue remain a core part of GE's business; --Margin growth and reduced cash usage for contract assets contribute to expectations for stronger FCF after 2017 that supports GE's discretionary spending and an eventual reduction in leverage from current levels, including FFO Adjusted Leverage of 3.8x as of Sept. 30, 2017; --Total Adjusted Debt/EBITDAR declines below 3.3x and FFO Adjusted Leverage declines below 3.5x, including Fitch's adjustments for factored receivables. Future developments that may, individually or collectively, lead to a downgrade include: --EBITDA margins fail to stabilize during 2018 and improve beginning in 2019; --GE becomes significantly smaller and disposes of a large part of its industrial businesses, reducing the company's diversification; --Services generate a consistently lower proportion of revenue and profit; --GE Capital's asset quality and liquidity deteriorate, requiring GE to make a capital injection or provide other support for GE Capital; --FCF after dividends does not become positive in 2018 at approximately $1 billion - $2 billion and improve significantly in 2019 to $3 billion or more; --Weak financial results or discretionary spending for acquisitions and divestitures prevent GE from reducing leverage after 2018, including Total Adjusted Debt/EBITDAR declining toward 3.3x and FFO Adjusted Leverage declining toward 3.5x, including Fitch's adjustments for factored receivables. GE Capital The IDRs, senior unsecured ratings and Outlook for GE Capital are linked to the ratings of GE Industrial. GE Capital's ratings will move in tandem with its parent, although any change in Fitch's view on whether GE Capital remains core to its parent could change this rating linkage. Fitch cannot envision a scenario where GE Capital would be rated higher than the parent. An inability to reduce leverage following the retirement of excess debt through 2019; an inability to adequately reserve for GE Capital's legacy insurance business; inability to access funding for an extended period of time; consistent and sustained operating losses; and/or significant deterioration in the credit quality of the underlying portfolio could become constraining factors on the parent's ratings. LIQUIDITY GE Industrial GE Industrial's liquidity as of Sept. 30, 2017 included cash and marketable securities of $13.2 billion, including $4.8 billion of cash at BHGE. Most of GE's cash is held outside the U.S. and is subject to income taxes if repatriated. Some cash ($3.3 billion excluding BHGE at Sept. 30, 2017) was subject to currency controls. Average cash and debt balances are higher than reported at quarter ends due to GE's use of commercial paper, but there is relatively little change in net debt. Commercial paper totaled $2 billion at Sept. 30, 2017. Liquidity also included $20 billion of credit lines exceeding one year. In addition, GE has approximately $5 billion of committed operating lines. GE Capital has indirect access to the lines through intercompany loans from GE Industrial. GE Industrial's long-term debt and short-term borrowings were approximately $52 billion at Sept. 30, 2017 including $3.1 billion at BHGE and adjustments made by Fitch to GE's reported debt. Fitch excludes debt that GE assumed from GE Capital as part the exit plan which is offset by an intercompany receivable from GE Capital for the same amount. GE guarantees debt at GE Capital's international operations, but the debt continues to be reported at GE Capital. Fitch adds customer receivables factored through GE Capital ($11.2 billion as of Sept. 30, 2017) to reflect the potential need to replace the factoring facility in the event it is no longer available. Although the adjustment has a material negative impact on GE's debt and leverage, the overall impact on GE's credit profile is mitigated by other considerations, including the flexibility of the factoring facility as an intercompany transaction, GE's solid access to capital markets and the company's operating and financial flexibility. The rating for GE's guaranteed subordinated debt, which was assumed from GE Capital in 2015, is equalized with GE's senior unsecured debt as the guarantee ranks equally and ratably with GE's unsecured and unsubordinated obligations. The rating for GE's junior subordinated debt is the same as other unguaranteed subordinated debt as Fitch believes expected recoveries in a distress scenario would be similar, partly reflecting the limited amount of GE's total subordinated debt. GE Capital GE Capital has strong liquidity and financial flexibility. GE Capital had approximately $32.5 billion of liquidity as of Sept. 30, 2017 and its liquidity sources (cash, bank line availability and readily available investment securities) divided by short-term debt maturities was 1.5x as of the same date, excluding $20 billion of committed credit lines and $5 billion of committed operating lines at GE. Additionally, 97.6% of GE Capital's debt funding was unsecured as of Sept. 30, 2017. GE Capital's commercial paper outstanding as of Sept. 30, 2017 was relatively modest, totaling $5 billion or 5.1% of total funding. FULL LIST OF RATING ACTIONS Fitch has downgraded the following ratings: General Electric Company --Long-Term IDR to 'A+' from 'AA-'; --Senior secured debt to 'A+' from 'AA-' --Senior unsecured debt to 'A+' from 'AA-'; --Senior unsecured bank credit facilities to 'A+' from 'AA-'; --Subordinated guaranteed debt to 'A+' from 'AA-'; --Subordinated debt to 'A' from 'A+'; --Junior subordinated debt to 'A' from 'A+'; --Preferred stock to 'A-' from 'A'; --Short-Term IDR to 'F1' from 'F1+'; --Commercial paper to 'F1' from 'F1+'. GE Capital Global Holdings, LLC --Long-term IDR to 'A+' from 'AA-'; --Short-term IDR to 'F1' from 'F1+'. GE Capital International Funding Co. --Long-term IDR to 'A+' from 'AA-'; --Senior unsecured debt to 'A+' from 'AA-'. GE Capital International Holdings Ltd. --Long-term IDR to 'A+' from 'AA-'. GE Capital US Holdings, Inc. --Long-term IDR to 'A+' from 'AA-'. GE Capital EFS Financing Inc. --Long-term IDR to 'A+' from 'AA-'. GE Capital Treasury Services LLC --Short-term IDR to 'F1' from 'F1+'; --Commercial paper to 'F1' from 'F1+'. GE Capital Australia Funding Pty. Ltd --Senior unsecured debt to 'A+' from 'AA-'; GE Capital Canada Funding Company --Senior unsecured debt to 'A+' from 'AA-'; GE Capital European Funding --Senior unsecured debt to 'A+' from 'AA-'; GE Capital UK Funding --Senior unsecured debt to 'A+' from 'AA-'; SUSA Partnership, L.P. --Senior unsecured debt to 'A+' from 'AA-'; Security Capital Group Inc. --Senior unsecured debt to 'A+' from 'AA-'. The Rating Outlook is Negative. Contact: GE Industrial Primary Analyst Eric Ause, CFA Senior Director +1-312-606-2302 Fitch Ratings, Inc. 70 Madison Street Chicago, IL 60602 Secondary Analyst Craig Fraser Managing Director +1-212-908-0310 Committee Chairperson Philip Zahn Senior Director +1-312-606-2336 GE Capital Sean Pattap Senior Director +1-212-908-0642 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Johann Juan Director +1-312-368-3339 Committee Chairperson Doriana Gamboa Senior Director +1-212-908-0865 Summary of Financial Statement Adjustments - Fitch adjusts GE Industrial's debt and assets to include approximately $11.2 billion of off-balance sheet customer receivables factored through GE Capital as of Sept. 30, 2017. Changes in receivables sold by GE to GE Capital are classified by Fitch as a financing cash flow item rather than as an operating cash flow as reported. 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