UPDATE: Since we published this post, GE’s stock has dropped to $10. So this question seems more relevant than ever. The numbers below are for Q3. We’ll update soon with Q4.
EARLIER: GE’s stock (GE) continues to dive, recently hitting $16 (mid-1990s levels). In this economy, anything is possible. So could it go to zero?
If GE were still primarily an industrial company, this possibility would be so remote as to be barely worth considering (assuming GE’s current cash flows and cash cushion). Now that GE has such a huge finance division, the odds are higher, but still remote.
As Warren Buffett pithily explained, anything multiplied by zero is zero, so if GE Finance suddenly has a run on the bank, the rest of the company could go down with it. That said, GE Finance is insulated from the credit crisis by carrying far less leverage (debt) than its Wall Street competitors and also by not marking its entire book of assets to market. If it had to do the latter, GE Finance’s writedowns thus far would likely have been far greater than they have been. By holding loans to maturity instead of in a trading book, however, GE Finance can wait to take losses until loans actually stop performing. This eases the pressure on near-term funding requirements and reduces the likelihood of a run on the bank.
GE is also rushing to diversify its sources of short-term financing by building a consumer bank, which has gathered $43 billion in deposits thus far (up from $20 billion last year). (See graphic at left). These deposits can be used to reduce GE’s dependence on commercial paper, which has previously funded much of GE Finance’s short-term cash needs. Lastly, the government is now buying GE’s commercial paper, which eliminates the need to worry about private investors suddenly getting scared and cutting off the company’s oxygen supply.
For GE Finance to go to zero, the company’s short-term financing would have to dry up suddenly, the way Lehman Brothers’, Bear Stearns, and AIG’s did. Now that the government is buying GE paper, this seems highly unlikely. Also, because the company isn’t marking its whole book to market, it’s unlikely that it will have to take devastating losses each quarter that would suddenly make its leverage ratio fly through the roof (and blow its credit rating), as happened at its erstwhile Wall Street competitors.
More likely, GE Finance will just continue to have crappy profits until the credit crisis ends. This could still hammer the stock, as GE Finance’s profits still account for more than a third of GE’s profits. In a really bad scenario, if GE’s $600 billion of loans started to default en masse, this might force GE to raise more equity capital or sell off other divisions at fire sale prices just to cover the Finance losses. But even this still wouldn’t be likely kill the whole company.
So we’ve got that going for us.
More from GE’s Q3 investor presentation below:
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