GE Capital has ‘zero equity value’

General Electric’s finance business has “zero equity value,” Bank of America Merrill Lynch analysts wrote in a note Thursday.

The GE Capital portfolio is under scrutiny after ending last year with $95 billion in debt outstanding, combined with two investigations into the business. The firm’s analysis comes as The Wall Street Journal reported the embattled industrial conglomerate may sell the full GE Capital portfolio, potentially at a loss, citing sources familiar with the situation.

GE Capital is believed by some on Wall Street as adding no value to GE’s stock, the Journal reported. Bank of America fits squarely in this camp, with its latest report reaching that conclusion after walking through the risks facing General Electric if it retains GE Capital – and the crown jewel of aviation services buried within it.

Bank of America finds that GE Capital Aviation Services is the largest in the portfolio’s assets, accounting for 35 percent (or $40 billion). The firm said it expects the business to “remain solid” if today’s steady “aerospace cycle holds.” That cycle has remained strong over the past 40 years, seen in the chart, with Boeing, Airbus, Bombardier and Embraer consistently adding to the number of aircraft in service around the world.

With nearly 60 percent of the aviation division’s revenue “coming from high-growth regions outside the U.S. and Europe,” Bank of America said GE Capital Aviation Services “has a solid profitability outlook.”

GE has established bank lines worth $40 billion to stop gap GE Capital in the event of a credit rating downgrade, which Bank of America estimates will sustain the business through 2020.

“[But] there is little room for error from the execution standpoint or [for] another sizable charge at GE Capital,” Bank of America wrote.

The Securities and Exchange Commission opened an investigation into General Electric’s accounting practices in the wake of the conglomerate’s review of its insurance business. On Jan. 16, GE revealed it had conducted a review of its GE Capital insurance portfolio and decided to take a $6.2 billion after-tax charge in the fourth quarter of 2017, and contribute $15 billion over the next seven years to shore up the portfolio’s reserves. The SEC is investigating both the process that led to the insurance reserve increase and the fourth-quarter charge, GE Chief Financial Officer Jamie Miller said at the time.

In addition, the U.S. Justice Department has opened an investigation in connection with alleged subprime mortgage violations. GE said in a regulatory filing Feb. 23 that the company faces allegations that GE Capital, and its now defunct WMC Mortgage business, violated U.S. law in connection with subprime mortgages.

The Justice Department “is likely to assert” violation of financial regulatory law, GE said in the filing, due to “WMC’s origination and sale of subprime mortgage loans in 2006 and 2007.” The company, which sold WMC in 2007, said the warning about potential Justice action includes the outcomes from investigations of other financial firms.

“These outstanding legal matters or investigations amount to up to $10 billion in incremental liability in GE Capital,” Bank of America said, while noting that it sees this total charge as “the worst case scenario.”

The analysts note GE has already set aside to pay “some of the potential liabilities” – reserves of which are now $426 million, according to Deutsche Bank’s estimates. But Bank of America said its model assumes about “$1 billion of cash outflow to settle” the WMC claims.

The expected sale of $20 billion in General Electric assets is why Bank of America believes GE Capital will have “sufficient liquidity through” 2020. In the best case scenario, GE Capital has an equity value of $7 billion, making a sale of the portfolio a more palatable undertaking for a buyer. Yet Bank of America’s worst case scenario puts GE Capital as a $4 billion loss, or minus 50 cents per share. At that point, offloading GE Capital would require the conglomerate to pay an entity to acquire the portfolio.

General Electric is expected to report its first-quarter earnings on April 20. Chief Executive John Flannery said Wednesday at CNBC’s Net/Net event that this will be GE’s “first report card” toward proving the company’s restructuring is helping to “run the company better.”

“We know we have great franchises; we know we can run them better,” Flannery said. “There’s a nucleus of strength and improvement in that we see right in front of us.”

GE stock’s was near $13 per share on Thursday, having dropped more than 56 percent over the last 12 months.