Once Bond-Market Royalty, GE Risks Average Joe Issuer Status

(Bloomberg) -- General Electric Co. once prided itself on its gilt-edged credit rating. Then came the global financial crisis, which tarnished the industrial giant’s standing.

Now, as the company faces one of the deepest slumps in its 125-year history, its grade is on the verge of falling again.

S&P Global Ratings put GE on notice that it might lower its grade after the company acknowledged a raft of challenges: cash-flow shortfalls, falling earnings and weak power markets that have undercut its biggest business. With a new chief executive officer and an activist investor sitting on the company’s board, S&P is examining how the company will spend its money as it looks to shore up its beaten-down stock price.

If GE gets downgraded again, it would join a growing list of companies that let their stellar credit grades slide to please shareholders. A decade of cheap borrowing costs have made it an easy decision. Bond markets have been willing to lend to average-Joe borrowers for just a few basis points more than what companies with top-notch grades can command. When there’s little reward for being among the most financially prudent companies, few will embrace it. There are only two companies -- Microsoft Corp. and Johnson & Johnson -- with top AAA ratings. In 1980, there were 32.

“There’s really no value for a company to have the highest ratings,” said Jesse Fogarty, a senior portfolio manager at Insight Investment, which oversees more than $727 billion globally. “It’s more of a status symbol than anything else.”

GE has ramped its borrowings before. In 2015, then-CEO Jeffrey Immelt said he was willing to add as much as $20 billion of additional debt to support expansion efforts, even if it meant lower bond grades. The company was shrinking its finance unit, a key beneficiary of higher credit scores. At the time, GE was rated AA+, the second highest level.

Currently S&P has GE at AA-, its fourth-highest level. The company, which had $136.4 billion of debt as of the end of September, lost its AAA ratings in March 2009.

A representative for GE declined to comment.

More Pain

Now new CEO John Flannery faces extra pressure. Power-generation markets are slumping, and demand for oilfield equipment and locomotives is weak. The company last week slashed its expected adjusted earnings for the year to $1.05 to a $1.10 a share, from a previous range of $1.60 to $1.70 a share. With that reduction, several analysts said GE may have to cut its dividend, a step the company has only taken one other time since 1938 -- in 2009 amid the financial crisis. GE paid about $8.5 billion in dividends in 2016, and bought back $22 billion of shares.

Money managers are concerned about the progress of the company whose shares have been by far the worst performer in the Dow Jones Industrial Average this year. GE agreed earlier this year to cut costs through 2018 after discussions with activist shareholder Trian Fund Management, the firm co-founded by Nelson Peltz. GE’s directors named a Trian representative to its board this month, a step that S&P said could “introduce some uncertainty around the company’s credit quality.”

‘Completely Unacceptable’

Flannery is weighing potentially dramatic changes to GE’s strategy and structure. He is due to detail more of his plans at an investor meeting Nov. 13. Last week he pledged to unload $20 billion of GE’s businesses, and called the company’s quarterly earnings “completely unacceptable.”

While he hasn’t specified everything he plans to do to turn around the business, he has said “everything is on the table.” If that includes a more dramatic step such as a breakup into multiple units, those could each be assigned their own credit ratings -- a risk that bondholders are not currently being paid to take, said Bloomberg Intelligence analyst Joel Levington.

Also among Flannery’s options is to spend money for share buybacks and investments that might leave less cash flow for debtholders. Even if the company is downgraded as a result, lower ratings will have little cost for the company, at least in the near term. A corporation with a grade in the AA range paid an average yield of around 2.74 percent on Thursday, according to Bloomberg Barclays index data. A borrower in the A range paid around 2.99 percent.

That difference is relatively minor. For every $1 billion of bonds a company sells, paying 25 extra basis points would amount to $2.5 million of more interest expense a year, a rounding error for a big corporation. For all its troubles GE, for example, earned $8.8 billion last year. 

That may be why so many companies have accepted lower ratings. In 2013, JPMorgan Chase & Co. analysts found that less than 10 percent of companies were rated at least AA, down from 25 percent in 1993. In 2013, 43 percent of companies were rated BBB, up from 21 percent in 1993. The bank looked at 169 borrowers in the S&P 500 Index.

Investors are expecting GE’s credit quality to deteriorate, so ratings downgrades will probably not have much impact on the company’s borrowing costs, said Kent White, a money manager and director of investment-grade research at Thrivent Financial, which owns GE’s debt. Moody’s Investors Service rates GE at A1, one step below S&P.

“Even if S&P downgraded GE three notches, they would still be OK,” White said, as GE would continue to have an investment grade rating and access to capital markets. “I don’t think the AA- rating is really that important at the end of the day for them.”

--With assistance from Claire Boston

To contact the reporters on this story: Molly Smith in New York at msmith604@bloomberg.net, Richard Clough in New York at rclough9@bloomberg.net.

To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net, Brendan Case at bcase4@bloomberg.net, Dan Wilchins

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