GE GE Aerospace

By Ryan Tracy and Ted Mann 

WASHINGTON -- General Electric Co.'s lending arm became the first big financial institution to escape stricter post-crisis rules by sharply shrinking, in what could be a sign of things to come for other titans of finance.

The U.S. Financial Stability Oversight Council said Wednesday that it voted this week to remove its label on GE Capital as "systemically important financial institution," which carries more stringent oversight. Treasury Secretary Jacob Lew, who chairs the council, said the change shows that designation is a "two-way process" -- a rebuttal to critics who have said its process for branding "systemic" firms is opaque and doesn't give firms a clear road map on how to reduce risk.

GE said about a year ago, in April 2015, that it would seek to have its status changed, as it decided to pivot away from financial services and sell off most of GE Capital, what was then its $500 billion lending business and one of the largest banking businesses in the U.S.

GE Chief Executive Jeff Immelt said changed market conditions and new regulations had caused GE Capital's returns to fall below its cost of capital. And investors had long urged Mr. Immelt to get out of the lending business, which nearly sunk the entire company during the financial crisis.

Since deciding to wind down the finance arm, GE Capital has signed agreements for the sale of about $180 billion of businesses and has closed about $156 billion of those transactions. The head of GE Capital, Keith Sherin, said the decision by regulators is a result of the transformation of GE Capital into a "smaller, safer financial services company."

GE shares rose 1.7% to $30.46 in afternoon trading.

While the move is a big win for GE, it's also a victory the Obama administration and its vision for how finance should be overseen. While resisting populist political pressure to simply break up big financial institutions, regulators have used various powers and pressures to encourage firms to shrink themselves and reduce their complexity and risk-taking. In addition to using the "systemically important" label to do so, regulators have required big banks to hold more capital on their books, and have continued to add "surcharges" for the very biggest banks, essentially imposing a tax on size.

The GE case marks the first time the oversight council has removed the "systemically important financial institution," or SIFI, tag since it was created under the 2010 Dodd-Frank financial overhaul law. "The Council follows the facts: When it identifies a company that could threaten financial stability, it acts; when those risks change, the Council also acts," Mr. Lew said. He said the council conducted a "methodological analysis" of GE Capital and determined it is "significantly smaller and safer, with more stable funding."

The decision comes as FSOC -- a committee made up of senior U.S. regulators and officials including heads of the Federal Reserve and the Securities and Exchange Commission -- is caught in the middle of both legal and political battles challenging its authority. It was designed to give regulators new powers to impose bank-like supervision and safeguards on the types of nonbank firms, such as American International Group Inc., that helped fuel the global market meltdown.

On the legal front, FSOC is appealing a March federal judge ruling nullifying its authority to impose the "systemically important" label on insurance giant MetLife Inc. The stakes are seen as so high that the government case has drawn supporting briefs from an all-star cast of financial crisis-era policy makers, including former Federal Reserve Chairs Ben Bernanke and Paul Volcker, and former lawmakers Chris Dodd and Barney Frank, the co-authors of the 2010 Dodd-Frank Act that created FSOC.

Meantime, Republicans in Congress are moving legislation that would replace Dodd-Frank, including provisions that would scale back FSOC's authority to designate firms as SIFIs.

Wednesday's announcement leaves two nonbank firms with the systemically important label, as opposed to four just a few months ago. Huge insurers Prudential Financial Inc. and American International Group Inc. also received the label in 2013 are still considered systemically important, meaning they are overseen by the Fed and face stricter rules than their peers.

MetLife was designated in late 2014, but its court victory nullified that status, pending the government's appeal.

GE Capital's success at rescinding the label by appealing directly to the oversight council could lead Prudential or AIG to follow a similar path. The council is required to review the labels annually under Dodd-Frank.

Separately, some investors are pressuring some of the SIFIs--both banks and nonbanks--to follow GE's strategy of shedding assets and shrinking to persuade they government they don't pose a threat to financial system.

While GE Capital has shown it is possible to convince regulators to rescind the SIFI label, the specifics of its case don't necessarily apply to other firms.

In an explanation of its decision, the oversight council noted that GE Capital had divested about $272 billion of assets since 2012, cut its use of short-term funding sources by 86% and reorganized its legal structure in a way that would make its failure more orderly. Regulators also liked the fact that GE decided to guarantee GE Capital's debt, making it less likely that lenders to the latter firm would come under duress.

Other firms don't have a parent like GE, or might not be able to restructure on such an immense scale.

Over the past year, GE has narrowed its focus to high-tech industrial products like jet engines, power turbines, locomotives and medical scanners and, since announcing its plan to exit financial services last April, has sold off GE Capital in chunks, dispersing its operations sector by sector, often to some of its chief competitors.

GE unloaded more than $30 billion in real estate and also sold its North American commercial lending business, which had about $30 billion in assets, to Wells Fargo last fall, among other operations

GE formally asked for the label to be removed in March, and met with the council staff during April and May, the Treasury Department said.

Still, major financial services operations will remain at GE. The company is holding onto its profitable business that leases aircraft and finances jet engine purchases. It is also retaining its energy industry finance unit and a rechristened industrial finance unit that will handle capital needs for the company's manufacturing businesses as well as its health-care financing. In all, the reconfigured GE finance operation will have about $80 billion in assets, Mr. Sherin said in an interview. Overall, the share of GE's profits from lending will drop substantially, however, from about half in the middle of the last decade, to less than 10% of total earnings by 2017, the company says.

Shedding the SIFI tag means GE can fully wind down the regulatory infrastructure that it built up in the years after it was first put under supervision by the Fed.

It can also reduce its capital ratio below the 14% it had agreed on with the Fed at the outset of the wind-down plan--a step that will enable GE Capital to meet its goal of sending $18 billion in capital back up to the parent company.

"Now that we have exited Fed supervision, we are going to re-evaluate that level and I'm sure it's going to be lower than that," Mr. Sherin said.

GE may also be able to add more debt to its balance sheet as Nelson Peltz's Trian Fund called for when the activist investor took a $2.5 billion stake in the conglomerate last year. Executives have been waiting to get out from under Fed oversight to explore such moves.

Write to Ryan Tracy at ryan.tracy@wsj.com and Ted Mann at ted.mann@wsj.com

(END) Dow Jones Newswires

June 29, 2016 13:25 ET (17:25 GMT)

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