House Of Cards.

     ‘Too Big To Fail’. 

     The notion that a financial institution or an organization has assumed a role that is so vital to the health and survival of the economy of a country that its government would go all out to prevent its cessation of business or bankruptcy in order to avoid the resultant aftershocks that would bring the economy to its knees.

     In the aftermath of the financial chaos that 2008 unleashed upon the global economy, TBTF was an unflattering, almost loathed title that was slapped onto institutions that governments across the world couldn’t let sink into oblivion, lest the contagion that would result. With economies across the world tumbling, governments had to step in to infuse some confidence into the system and prevent banks from going bust. And it was primarily the banks and financial institutions that were propped up with billions of dollars’ worth of bailouts, even as they attracted widespread criticism for having sparked the blaze in the first place, a blaze that was now threatening to engulf them and bring them crashing to the ground.

     Yet, in the midst of the crisis, an unlikely name was also handed the TBTF tag. It was a global giant that wouldn’t, in the normal scheme of things, be classified as a bank or even a financial institution, for that matter. This behemoth had long featured in the list of America’s most consecrated corporations and it had established a presence in almost every business segment and multiple countries across the globe. This is the tale of how one particular division of that same corporation ran wild and almost succeeded in dragging the entire conglomerate down into a bottomless pit of doom. This is the story of General Electric’s star – crossed subsidiary, GE Capital.

     With its roots tracing all the way back to the era of Thomas Edison in the 1890s, General Electric (GE) is one of the largest conglomerates in the USA and features in the league of stalwart multinational corporations that have made a distinct mark in their industries. A Fortune 500 corporation, General Electric was one of the twelve companies that first listed on the Dow Jones Industrial Average index and today, it is the sole survivor. GE, commanding a market capitalization of around $250 billion, with a $150 billion topline and a $13bn bottomline, has a leading presence in sectors such as energy, aviation, electrical distribution, gas, healthcare, lighting, oil, software, defence, alternate energy and financials. And in the midst of the financial crisis that 2008 brought around, the entity was brought to the brink by its own arm.

     With its origins in the Great Depression of the 1930s, GE Capital was conceived as a division to fund customer purchases from its parent and in turn, drive GE’s business. All along, over the course of five decades, GE Capital remained an underling but all that changed in the 1980s, with the advent of the Jack Welch era. In 1981, Jack Welch took over as GE’s CEO and it was under his reign that GE Capital began to grow in size and stature. In a bid to increase GE’s core business performance, GE Capital began to aggressively offer credit at rock – bottom interest rates with prolonged repayment periods. While GE’s bread – and – butter businesses were witnessing slackening growth, GE Capital was growing twice as fast, while making inroads into consumer lending, credit cards, auto loans, equipment leasing, mortgages and real estate. Housing finance and mortgages was a key focus area for the company. Aviation finance was another area into which GE Capital expanded aggressively by leveraging on GE’s stronghold on both aircraft manufacturers and airlines alike. It offered aircraft leases, engine financing, structured loans and engine exchange options. All these, in turn, helped GE grow its aviation – focussed business further. By the time the new millennium rolled around, GE Capital had already grown to a formidable size, accounting for almost half of GE’s profits. And that was precisely where GE’s problems stemmed from.

     GE Capital, by borrowing funds from the money markets via the issue of commercial papers and lending funds to the customers of GE, was more or less acting as a bank. Commercial papers are essentially unsecured money market or short – term instruments that credit – worthy companies use to raise working capital at rates of interest that are below prevailing market rates. GE Capital rode on its parent’s AAA credit rating, resulting in it being able to raise funds at a low cost, even under 2 – 3%. It was able to lend these funds at a rate that was far below most banks’ lending rate and the spread between this lending rate and its cost of funds gave it a healthy profit margin. Besides, GE Capital certainly had its benefits. When GE’s core businesses faced intermittent slowdowns, GE Capital would often sell or purchase assets and help make the quarter’s numbers, thus propping up the company’s scrip and in turn, keeping the Street happy. While GE Capital’s business was in line with what a commercial bank does, it faced little or no regulatory supervision from the Federal Reserve, quite unlike what a standard bank would be subject to. GE Capital, in essence, was operating as a shadow bank.

     GE Capital, however, did not confine itself to the USA. It expanded overseas, moving into countries such as Canada, Mexico, India, Japan, Poland and Australia. Under the reign of GE’s CEO, Jeffrey Immelt, GE Capital built up gargantuan portfolios of loans, mortgages and credit card lending, both at home and in its overseas markets. It even went as far as acquiring banks in Poland, Hungary and the Czech Republic. By 2007, GE Capital’s asset book had ballooned to a size of over $600bn. It was already, in fact, America’s seventh largest ‘bank’, in terms of the size of its asset book. While the economy was roaring along on the back of a credit boom, General Electric was expanding as well. It ventured into new lines of financial services, which weren’t strictly within GE’s circle of competence. In those euphoric days of 2007, GE had a Midas touch and anything it expanded into seemed to fuel its explosive growth, including GE Capital’s grandiose forays into housing finance and mortgages, all at the very peak of the American housing market. And grow it did. The only oddity was that GE Capital, with each passing day, was playing an increasingly important role in that growth, more than what GE’s core business could keep up with. Slowly but surely, GE Capital was beginning to eclipse its parent, General Electric.

     In late 2008, when the heady days came to an end and markets around the world began collapsing in what was a domino effect, it was GE Capital that turned out to be the problem child for GE. When the credit markets tightened, the market for commercial papers dried up and raising fresh funds became costlier. While asset prices crashed, debt refinancing too was becoming increasingly difficult. What was worse, on the back of a weakening global economy, the demand for capital goods declined significantly. This subsequently led to a lacklustre performance by GE’s core industrial businesses and its credit rating was downgraded from AAA to AA+, automatically elevating its cost of borrowing. GE Capital now posed a major threat to the consolidated entity, with a $600bn – worth asset book that was now faced with declining asset prices globally and a balance sheet that was choking with debt in the form of commercial papers. General Electric was caught between the devil and the deep sea.

     GE Capital was on the verge of a debilitating crisis. It had billions of dollars in debt that had to be refinanced in the following two years. While many opined that GE’s diversified presence in multiple sectors would help the company overcome the gloom and doom that surrounded it, GE’s over – reliance on its financials arm turned out to be its undoing. GE Capital was turning into a dead weight that GE wouldn’t be able to carry for long. Simply put, GE Capital was slowly turning into a toxic cesspool, with over $600bn – worth of deteriorating assets on its books, on the back of an economy that was all but heading down towards Davy Jones’ locker. 

   

     With General Electric hurtling towards disaster, Jeffrey Immelt decided that the company, already groaning under the strain of GE Capital, couldn’t reverse its fortunes without some outside help. And that was when the Federal Reserve stepped in and slapped a SIFI (Systemically Important Financial Institution) tag on GE, essentially deeming it ‘Too Big To Fail’. The Fed, of course, couldn’t afford to have GE go belly up. For, if it did, the commercial paper markets, in which GE was a major participant, would receive a knockout blow. Moreover, GE itself had lent to hundreds of its clients. With the SIFI tag entailing the Fed’s regulatory oversight, GE was now forced to report all its major transactions to the Fed on a weekly basis. The Fed had to sign off on any major acquisition or deal that GE wanted to pursue. Moreover, GE was mandated to set aside capital, in order to create a reserve against the loans it had lent, akin to a bank’s statutory reserves. While this dealt a massive blow to GE’s return ratios, it also led to a great deal of cumbersome regulatory oversight. The markets, ever since the global economic crisis had set in, had hammered GE’s scrip from levels of over $40, all the way to levels of under $10, resulting in a loss of $280 billion in terms of market capitalization. And all because GE Capital had gone on to assume a more important role to GE than the core business of the company. And now, the SIFI tag had become an albatross around its neck. It was almost as if the inmate had taken over the asylum.

     As each quarter passed by, GE Capital was forced to set aside more and more capital to meet the Fed’s capital adequacy requirements, capital which it couldn’t use to grow and expand its operations, in anticipation of the next uptick in the economy. As a result, with its profits falling and its appetite for capital growing, GE began witnessing dwindling returns on capital employed and increased borrowings, both of which only increased the downward pressure on its stock price.

     The SIFI tag meant that GE Capital was eligible for the Federal Deposit Insurance Corporation’s Temporary Liquidity Guarantee Program (TLGP), which gave it access to around $51 billion worth of loans from the Fed. GE Capital also tapped the Federal Reserve’s Commercial Paper Funding Facility (CPFF) and raised $12 billion. However, in what turned out to be the first bit of good news for the troubled entity, it received a vote of confidence from Berkshire Hathaway in the form of a $3 billion investment via the preference share route and it also raised a further $12 billion from a consortium of investors led by Warren Buffett.

     With the billions in fund that GE had managed to raise, it set out to clean up its books by meeting the Fed’s capital adequacy entirely, selling some of its loans and exiting unprofitable ventures. With GE Capital turning out to be a major overhang for the company, GE decided that enough was enough. It was time to reduce its focus on financials and return to doing what GE was best known for by America Inc. Jeffrey Immelt had decided that the time had come for General Electric to make recourse to its industrial roots. General Electric had decided that its seventy year itch with GE Capital had to come to an end.

     When GE announced its intent to shed its financials arm, which had turned out to be a major liability in terms of the large chunks of capital it needed and the Fed oversight that it brought with it, the company’s creditors, borrowers, customers and suppliers heaved a collective sigh of relief. For years, the markets had felt that GE Capital had outgrown both its capacity and its parent’s ability to keep its own house in order. Besides, GE Capital had succeeded in sapping billions of dollars from GE and had depressed the company’ results for several quarters on the trot, especially following the SIFI declaration. And as far as GE’s management was concerned, in what would’ve surely added a great deal of insult to the injury that GE Capital had already inflicted, the GE scrip jumped close to 15%, from $25 to $29, on the day of the announcement of the company’s intent to walk away from GE Capital.

     Following its game – changing announcement to jettison GE Capital, GE began its spring cleaning operation. It shuttered its Japanese operations after writing off over a billion dollars and it offloaded several European arms. In India, GE Money’s operations were sold to Magma Fincorp and the company beat a hasty retreat. The entity also announced its exit from another joint venture in India, SBI Cards, which is the country’s third largest credit card issuer. Its North American consumer finance arm IPOed as Synchrony Financial and GE shed a 15% stake in the company. In a series of mega – deals exceeding $25 billion, GE sold its property businesses to Blackstone and Wells Fargo. Its private equity arm was sold to France’s Ardian (the erstwhile AXA Private Equity) and its fleet business was acquired by Element Financial Corporation. GE then announced that by 2018, its core aviation and medical equipment businesses would once again contribute 90% of its profits and the only financial businesses that the company would retain would be those that were directly tied in to its core segments. For an American giant that was once flying high, it was indeed nothing short of a major fall from grace.

     While GE never declared a full quarterly loss in those hellacious years, the company was taken close to the brink in terms of its cash flows adequacy. In fact, word on the Street has it that Jeff Immelt personally approached Hank Paulson, the then – Treasury Secretary, with a plea for a bailout as GE was unable to raise further funds via the commercial paper route to sustain its cash guzzling operations. In what was a desperate attempt to allay the Street’s fears, Immelt assured investors that GE’s commercial paper programme was ‘robust’ and the company’s fund – raising capacity was intact. It was on a Monday that GE went to the Fed with a begging bowl. And that was when the Fed intervened with the SIFI collar and the sponsored bailouts, just in the nick of time. America Inc. may have been blissfully unaware, at that point of time when the economy was crashing around it, but one of its most renowned titans had been just days away from filing for Chapter 11.

     General Electric’s move to walk away from the financials business may have been a difficult one to embark upon in the first place but it does ensure that the company would see the light of day for the foreseeable future at least. The move should also help the company’s scrip break out of the $25 – 30 range, which has proven to be a quicksand zone for a number of years. More importantly, GE’s focus on its industrials business should help it reclaim some of the investor community’s trust and the glory and lustre that it commanded in its heyday.

     GE’s CEOs, be it Jack Welch or Jeffrey Immelt have always been held as legends in the world of business. GE, in its own right, has been one of America’s most admired companies and a symbol of America Inc. However, despite its revered and holier – than – thou image, General Electric did mislead its own shareholders and Wall Street by trying to assure them that its house was in order when in reality, it was on the verge of turning into a house of cards.

     If there’s anything that the financial crisis has taught Wall Street and the world, it’s that even the mighty can crumble and giants can fall. And more importantly, nothing lasts forever and nothing is ‘Too Big To Fail’.

     Nothing.

     Not even General Electric.