Tuesday, January 27, 2009

GE Rated Aaa = Aaa Joke

In my post regarding the shift in the composition of the Barclays Capital Investment Grade Index, I was asked:

Any idea why most recent data points show Aaa at higher yields than Aa??
In fact, I do... the Aaa (FYI- Barclays Capital refers to this ratings 'tranche' as Aaa, not AAA) is made up predominantly by GE Capital (predominantly is an understatement).



And since mid-2007, spreads on GE Capital bonds have blown out, especially after the Lehman failure in mid-September 2008.



A 450+ bp spread for the CDS (as wide as 600 bp) on a Aaa rated security? As a refresher, an S&P triple A rating is saved for:
The best quality borrowers, reliable and stable (many of them governments)
So why are spreads so wide? According to Morgan Stanley (in reference to GE):
“Investors do not want to own a stock with dividend cut risk. Investors do not want to own a stock with rating agency risk. Investors do not want to own a stock where substantial earnings tailwinds come from past tax reversals. And lastly, investors do not want to own a stock with a financial sub, particularly one which is substantially under-reserved.”
This doesn't sound like a "best quality" "reliable" "stable" or "government-like" entity. Surely the ratings agencies must think differently. Lets get the opinion of S&P analyst Robert Schulz:
The quarterly results show that 2009 may be more difficult than expected for GE Capital. The financial arm makes loans for everything from consumer credit cards to big commercial energy projects.
How difficult? According to Schulz:
Credit losses are now expected to be $10 billion, $1 billion more than GE forecast in December. Losses in the company's real estate portfolio are also expected to reach $4 billion, compared with a $2 billion gain.
So, in the worst financial crisis since the Great Depression, S&P's own analyst declared that after GE needed a $139 billion in FDIC backed debt just two months ago, was put on negative outlook in December, and has its hands in everything from consumer credit cards to big commercial energy projects (again, in the worst financial crisis since the Great Depression) they still deserve a triple A rating.

And this is why the most recent data points show Aaa at higher yields than Aa.