By Matt Wirz
This article is being republished as part of our daily
reproduction of WSJ.com articles that also appeared in the U.S.
print edition of The Wall Street Journal (November 15, 2018).
Wall Street has a GE problem.
General Electric Co. 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)
Write to Matt Wirz at matthieu.wirz@wsj.com
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