Yesterday we asked if, as a result of its ongoing operational troubles and recent downgrade by S&P, GE was facing another Commercial Paper "moment", with a Moody's downgrade now imminent. The reason is that GE has traditionally been one of the biggest issuers of Commercial Paper to fund daily operations, and used to be one of the biggest issuers of the debt: veteran readers may recall that during the financial crisis, GE's loss of access to the frozen CP/Money Market nearly resulting in a terminal liquidity crisis at the industrial conglomerate.
Since then, GE's reliance on commercial paper was material, and in the second quarter, GE had on average around $16.6 billion of the debt outstanding - a sizable portion of its total $116 billion in debt.
A warning shot came in early October, when S&P cut GE’s short-term grade to A-2, a level below the top tier. That’s a rating of commercial paper that some classic prime money market funds are reluctant to buy. In fact, prime money market funds historically had to have at least 97% of their securities rated at least A-1 from S&P and P-1 from Moody’s, but those rules were loosened amid this decade’s money market reform. Even so, as Bloomberg noted, many funds would be far less willing to buy securities with a split rating, i.e., where at least one rating is below A-1 or P-1.
And with fewer funds interested in buying GE paper, the company would be forced to pay higher rates to sell its commercial paper, according to Peter Crane, president of Crane Data, which tracks money market funds. “They’ll still be able to find buyers, but at a cost of course," Crane said. It cost 2.34% for a top-tier corporation to borrow for 90 days, according to U.S. Federal Reserve data. Companies the next tier down, where one ratings firm has GE, paid 2.71%.
Fast forward to today when moments ago GE found itself completely shut out of the Commercial Paper market, when Moody's downgraded its senior unsecured rating to Baa1, from A2, and downgraded the short-term rating to P-2, from P-1, making future sales of CP impossible.
The silver lining is that GE had a pretty good hint that the downgrade was coming, and in the quarter ended Sept. 30, it brought its total Commercial Paper outstanding to just $3 billion, while noting that GE Capital will exit that market entirely by the end of this year.
In lieu of CP access, on its earnings call GE said it would replace that funding with a net $40.8 billion of available credit facilities committed from banks. In other words, GE will now use its revolver, which carries a higher interest rate, to fund what it previously achieved using CP. At the same time, GE said it had been working to reduce its reliance on short-term financing: Rising U.S. rates have increased the cost of borrowing short term, and regulatory changes have effectively penalized the use of commercial paper relative to other financing methods. Needless to say, GE can well do that, but it would cost it higher interest costs, and considering the adverse impact rising CP rates had on GE stock...
... one wonder a) how much faster the company's decline will be going forward and b) how long until GE loses access to its revolver as well.
The full Moody's downgrade is below:
Moody's Investors Service ("Moody's") downgraded the long-term ratings of General Electric Company ("GE"), GE Capital Global Holdings, LLC ("GE Capital") and its subsidiaries, including the senior unsecured rating to Baa1, from A2, and downgraded the short-term rating to P-2, from P-1. The ratings outlook is stable.
This concludes the review for downgrade that was initiated on October 2, 2018.
The downgrade reflects Moody's view that the adverse impact on GE's cash flows from the deteriorating performance of the Power business will be considerable and could last some time. The weaker than expected performance at Power is not only attributable to a considerable drop in market demand and ensuing heightened competition, but also to GE's misjudgment of financial prospects and operational missteps. In addition to weaker earnings, cash flows in the Power segment are diminishing swiftly due to a decrease in progress collections following a steep decline in equipment orders. As a result, GE's free cash flow (after dividends) will likely be very weak in 2018, even with good performance at GE Aviation and GE Healthcare. Moody's anticipates that a decline in progress collections will continue to hamper cash flows in 2019, as demand for gas turbines will remain soft and GE's market share has recently come under pressure.
The Baa1 senior unsecured rating balances the challenges posed by GE'sPower business with the prospects for earnings and strong cash flows at GE Aviation that are underpinned by a good pace of commercial aircraft deliveries and significant OEM backlogs. GE has significant resources at its disposal and maintains a competitive presence in critical industries derived from technological leadership. The rating also incorporates Moody's expectation that GE will be able to increase EBITA margins to the mid-teens level, increase FCF/debt to high single digits and reduce leverage to less than 3 times by 2020, assuming completion of the planned spin-off of GE'sHealthcare business.
GE's liquidity is adequate, but intra-quarter borrowing needs are well in excess of $10 billion and necessitate the company to draw on its revolving credit facilities that have an aggregate committed amount of approximately $40 billion. Moody's expects liquidity to improve gradually following the decision to eliminate substantially all of GE's dividend and as the company progresses with asset divestitures.
GE's strong implicit and explicit support of GE Capital, including through debt guarantees and provision of borrowing capacity on an unconditional and irrevocable basis, results in Moody's equalization of GE Capital's senior unsecured rating with the senior unsecured rating of GE.
The stable ratings outlook is predicated on Moody's expectation that GE will be able to contend with the challenges posed by its Power business, considerable intra-quarter borrowing needs and high debt balance, as restructuring efforts accelerate, its cash balance increases to around $15 billion and previously announced asset divestitures are completed. The availability of other assets that GE could monetize, including its 62.5% ownership interest in Baker Hughes, a GE Company, LLC, helps to mitigate the risks associated with an array of contingent liabilities and offers the possibility for additional debt repayments.
The ratings could be upgraded if growth in Power resumes and operating margins in the Power business recover to more than 10%, while consolidated EBITA margins are sustained at around 15%. FCF/debt of more than 10% and debt/EBITDA of less than 2.5 times would also be supportive of a ratings upgrade.
The ratings could be downgraded if Moody's expects that GE is unable to halt the decline in Power revenues, to restore operating margins in Power to at least the mid-single digit range, or to successfully fix the turbine blade issue of its HA-class heavy duty gas turbines. The ratings could also be downgraded if GE is unable to sustain FCF/debt at around 7%, in the absence of a steady decline in debt/EBITDA towards less than 3 times, or if GE does not utilize the proceeds from asset divestitures primarily to increase its cash balance, mitigate the risks that arise from contingent liabilities and repay debt.
GE Capital's ratings could be upgraded if GE's ratings are upgraded and if GE's support of GE Capital, including of future debt issuance, remains strong. A downgrade of GE Capital's ratings could result from a weakening of GE's support or weaker than anticipated support of future debt issuance. GE Capital's standalone credit profile could improve if the company strengthens its ratio of tangible common equity to tangible managed assets towards levels comparable to those of finance and leasing company peers and meaningfully reduces its insurance exposures. Conversely, GE Capital's standalone credit profile could be lowered if liquidity or the operating performance of GE Capital's aircraft leasing business weakens materially, or if other events meaningfully reduce the firm's capital position.
GE's bonds were not happy.