What's Behind the Curtain at GE?

The market is bouncing nicely on this Friday the 13th, after weeks of disappointing news.  Shareholders of GE, however, are wondering why their stock isn't joining the party.  Investors' concerns may be exacerbated by the fact that financials are experiencing a fairly decent uptick after weeks of bloodletting.  As I mentioned before in previous posts about GE, the supposed bellweather of the economy is actually a financial firm masquerading as a industrial conglomerate.  How do I dare to say such blasphemy?  As evidence, I offer up GE's balance sheet:  $683 billion out of $838 billion in GE's total assets reside in GE Capital.

The recent volatility in GE's shares has been attributed to rumors about GE Capital needing to secure external funding in order to maintain its AAA rating, a possibility that Immelt adamantly denied.

Is it conceivable that weakness at GE Capital could potentially force GE to seek external funding? If you consider GE to be a financial firm, and take a look at the capital raising frenzy among other financials, it's hard to ignore the question.  I have mentioned in the past that I was concerned about the lack of transparency offered in GE's financials, specifically related to assets on the balance sheet labeled as "other" without any further description.  GE Capital's most recent 10-Q provides virtually no transparency into the details of its investment holdings.  It only clearly states that GE Capital holds $683 billion in assets and $624 billion in liabilities, $198 billion of which is short term financing.  Could GE potentially have a funding issue?  Sure, if investors started to question the financial performance of GE Capital's underlying assets.  Let's take a quick look at those assets.

According to GE Capital's 10-Q for the March 31,2008 quarter, the bulk of GE Capital's assets were $417 billion in loans.  The only detail GE provides about its loan portfolio is delinquency rates (all of which were materially higher) and that $9.3 billion of the loans were "related to consolidated, liquidating securitization entities."  Anyone out there who knows what that actually means gets a gold star.  GE Capital also had $84 billion in "other" assets, with no accompanying detail.  For further information about GE's loan holdings and "other" assets, one must go to the year-end 10-K, which is outdated information, but offers a few clues as to the composition of assets.  Rather than provide an entire itemized list, I will highlight the parts that would concern me if I were to consider an investment in the company.

From GE Capital's 2007 10-K, some areas of concern about the then-$385 billion loan portfolio:

• $73.7 billion of the loan portfolio were Non-US residential mortgages, 26% of which were IO's with teaser interest rates on high LTV loans (at inception).  
• $27.3 billion were non-US auto loans.
• $22 Billion in infrastructure loans and leases, $11.6 billion of it tied to commercial aircraft leases. 
• $39.8 billion in real estate.
• $10.2 billion in "other."  No detail.
• $19.7 billion in total leveraged leases.  GE states that it is allowed to deduct the interest expense accruing on nonrecourse financing related to leveraged leases.  Just ask KeyCorp how well that worked out for them.  I'm not saying they did not account for it correctly, but I'd ask a few questions.

From GE Capital's 10-K, some highlights from the $83 billion in "other assets":

• $40 billion in "investments".  No detail.
• $17 billion in real estate, mostly commercial properties.
• $1 billion in "Other."
• $4.8 billion in "Other".  Not sure why this "other" was different from the other "other," but in my opinion you can't create a subcategory called "other" when you are attempting to describe "other" assets.

The highlights are screaming "mortgages! autos! aircrafts! other! other! other!"  I don't profess to have spent days analyzing the information, just a few hours.  Maybe someone with the time and patience to do a more thorough analysis can offer some further insight?  But if you still want to buy the stock without a more thorough analysis, despite the opacity of the balance sheet, be my guest.  We'll get together and discuss it after GE's next earnings report, or pre-announcement, which ever comes first.