Real Estate Accounting - “Look Out Below”

Meanwhile, how the company accounts for its real estate holdings has raised eyebrows on Wall Street.  GE values its properties at the price it paid for them, depreciating the values over time, rather than periodically marking them to their current market value - the latter practice known as fair-value accounting, or “marking to market.”

GE Capital “has staunchly defended its long-term hold position for real estate assets, allowing it to carry positions at historical cost (and depreciate those values over time), rather than marking-to-market, which we imagine could turn into a ‘look-out-below’-type exercise in the current climate,” wrote CreditSights Inc. analysts Richard Hoffman in a March 3 note to investors.

“We conservatively believe there could be 5% to 13%, or $4.3 billion to $11.0 billion, of cumulative losses/write-downs in the commercial real estate portfolios,” Nicholas P. Heymann, an analyst at Sterne Agee, a Birmingham, Ala.-based brokerage, and a long-time follower of GE, wrote in a note to investors last week.

“Furthermore, our analysis of the commercial real estate portfolio indicates the company’s holdings are concentrated in markets that are early in the credit deterioration/vacancy cycle,” Heymann wrote.

Credit Rating Under Review

Another question facing GE is what will happen to its current top-notch credit rating.
Many on Wall Street expect Moody’s Investors Service (MCO) and Standard & Poor’s to cut GE’s “triple-A” credit rating to “double-A.” 

Moody’s said Jan. 27 that it’s evaluating whether to lower GE’s rating, which typically takes about 90 days. GE cut its dividend Feb. 27 for the first time since 1938, saving $9 billion a year.

GE would be subject to an $8.2 billion collateral call if its rating was lowered to “A+2?, BernsteinResearch’s Winoker wrote in last week’s client note.  A much deeper cut - to “BBB+” - means GE would be looking at an additional payment of $2.9 billion.

Winoker also noted that, while he thinks GE will need to mark down the value of its financial portfolio over time, a large-and-immediate write-down is unlikely.

“We think such write-downs, if needed, would be spread over several years, which will lessen the need for equity [infusions], but [which] will hurt long-term earnings,” he said.

Inch, of Merrill Lynch, also considers it unlikely GE would have to raise additional capital.  But he warned that if the situation changes, GE could find it difficult to raise much money in the equity markets, due to its low stock price.

If GE Capital did face a funding crisis, Inch believes the U.S. government may bail it out to block a bankruptcy filing or a spin-off, considering the lender’s huge role in the U.S. financial system.

Wrote Inch: “Investors cannot assume that the risks of a future government bailout of GE Capital are zero.”