Fitch Affirms GE and GE Capital at 'AA-/F1+' on Announcement of Baker Hughes Transaction

CHICAGO--(BUSINESS WIRE)--

Fitch Ratings has affirmed the 'AA-/F1+' Long- and Short-Term Issuer Default Ratings (IDRs) for General Electric Company (GE) and GE Capital Global Holdings, LLC (GE Capital) following the announcement earlier today of its agreement to combine GE Oil & Gas (O&G) with Baker Hughes, Incorporated (BHI). The Rating Outlook is Stable.

A full rating list appears at the end of this release.

The combination of (O&G) with BHI is within Fitch's expectation that GE could deploy substantial capital for acquisitions over the next several years, much of which could be funded with debt. The transaction will create the second largest global oilfield services business. GE will have a 62% interest in the combined business ('New' Baker Hughes), which is being structured as a tax-advantaged partnership between GE and the existing shareholders of BHI.

The combined business should compete more effectively and offer a path toward improved efficiency for customers. GE will pay $7.4 billion of cash to BHI which will be used to fund a dividend to BHI shareholders. The transaction is expected to close in mid-2017. Fitch estimates the enterprise value of the combined business at approximately $50 billion.

BHI is more cyclical than GE O&G, but both parts of the combined business will benefit from increased diversification and a larger customer base. BHI will have access to GE's research and development resources (GE Store) and GE's digital technology which could improve BHI's long-term competitiveness. Fitch expects global exploration and production spending and activity to increase moderately in 2017 with a more robust growth profile in 2018. These considerations should support 'New' Baker Hughes' operational and financial results, particularly given BHI's strong drilling & completions businesses with a focus on the North American (N.A.) market. Annual synergies by 2020 are projected by GE to reach $1.2 billion, primarily from costs.

Fitch expects GE's leverage metrics will rise modestly when considering the BHI transaction and possible future acquisitions. GE's capacity for incremental debt is supported by the recent reduction in absolute risk related to the GE Capital exit, expected growth in earnings and cash flow over the next several years, and additional earnings and cash flow from acquisitions. The impact of the transaction on GE's financial results and credit metrics should not exceed Fitch's negative rating sensitivities but does leave the company with less financial flexibility. However, Fitch expects credit metrics such as leverage will remain appropriate for GE's overall enterprise risk level, which Fitch considers to be relatively low as a result of GE's diversification, strong market positions, strong services earnings, scale, and technology portfolio.

Risks related to the agreement with BHI include integration risk, the realization of anticipated synergies, higher debt at GE's industrial business following completion of the transaction, the negative cash impact from any breakup fee if the transaction is not completed, and the risk that the oil and gas industry remains weak for an extended period.

KEY RATING DRIVERS - GE Industrial

Fitch's ratings and financial measures for GE's industrial businesses (GE Industrial) consider GE Capital on an equity basis, including approximately $60 billion of GE Capital debt as of Sept. 30, 2016 maintained as intercompany debt with GE. The ratings for GE Capital incorporate support from GE.

The ratings for GE incorporate the company's global presence, broad product portfolio, large market shares in its core infrastructure and healthcare markets, and strong technological capabilities. Substantial services revenue generates more than 80% of GE's industrial operating profit and dampens the impact on financial results from volatility in the company's energy and capital goods end-markets. Some credit protection measures are weak for the rating, but Fitch believes GE's strong operating profile and financial resources give it a low overall enterprise risk.

GE's large scale and market position give it a broad perspective on industry developments, the capacity to invest in new technologies, and adjust market trends. When the divestiture of GE Capital's non-core businesses is completed GE's industrial businesses will represent at least 90% of consolidated earnings compared with less than 50% several years ago when GE Capital was larger.

Fitch expects GE will maintain a strong balance sheet and that the company's priority for cash deployment will be acquisitions. A smaller GE Capital provides GE with incremental financial flexibility to leverage its balance sheet over the next several years, but Fitch expects GE will maintain a disciplined financial strategy that supports its ability to invest in its long-cycle power and aviation businesses, focus on markets with high technology content, and maintain strong competitive positions.

A key rating consideration is the 'GE Capital Exit Plan,' launched in 2015 and expected to be largely completed by the end of 2016. After its non-core businesses have been divested, GE Capital will be concentrated in its vertical businesses that serve the aviation, energy and industrial (working capital solutions, healthcare equipment finance, and trade payables services) markets. GE Capital's smaller size reduces the company's exposure to funding, credit quality, regulatory and other risks inherent to finance companies.

Rating concerns include potential support required for GE Capital albeit much lower than in the past, large net pension liabilities, the risk that future larger-than-expected share repurchases or acquisitions could weaken GE's currently strong financial profile, and cyclicality in GE's infrastructure markets. However, Fitch believes future acquisitions will be targeted toward adjacent industrial markets, of which the pending 'New' Baker Hughes partnership is an example, and that GE will be disciplined in its cash deployment for acquisitions or share repurchases.

Other concerns include the typical large intra-quarter use of commercial paper and the high dividend payout which affects free cash flow as defined by Fitch. Rating concerns are offset by GE's diversification, significant financial resources, and steady operating performance through business cycles compared to its industrial peers.

GE's financial leverage included total adjusted debt/EBITDAR of 2.7x at Sept. 30, 2016 on a preliminary basis as estimated by Fitch, defined to include customer receivables factored through GE Capital that totaled $13 billion at Dec. 31, 2015. Fitch's calculation of leverage would be lower when including earnings from GE Capital which Fitch excludes from EBITDA in order to focus on industrial credit metrics.

Leverage would be higher if GE's intra-quarter use of commercial paper were included. The company repays most commercial paper at quarter-ends as part of its working capital management. A portion of the repayment is funded temporarily from cash located outside the U.S., which Fitch does not typically include as available cash due to tax liabilities that could be incurred if the cash is repatriated. GE's industrial business maintained total cash balances of $10.4 billion at the end of 2015 compared to $500 million of commercial paper balances.

GE typically generates strong cash flow from operations. Fitch estimates operating cash flow in 2016 could be approximately $12 billion-$13 billion, excluding dividends from GE Capital, compared to more than $10 billion in 2015 which included nearly $2 billion usage for working capital. Fitch estimates FCF after dividends in 2016 could be slightly positive. Fitch's calculation of FCF is after pension contributions and excludes dividends from GE Capital. It also excludes changes in receivables sold to GE Capital. Corporate dividends to shareholders represent a large use of operating cash flow and contribute to GE's low FCF compared to some other large industrial companies.

Fitch also considers GE's cash flow metrics adjusted to include dividends from GE Capital as GE Capital is a significant contributor to GE's consolidated financial results and valuation. Fitch estimates these dividends, excluding one-time large dividends in the near term, could be approximately $1 billion annually after the GE Capital exit is completed.

Under Fitch's criteria for rating non-financial corporates, Fitch calculates an appropriate debt/equity ratio of 6x at Financial Services based on solid asset quality, sufficient liquidity and strong funding profile. As actual debt/equity as measured by Fitch was below this level, there would be no need to make an equity injection to maintain leverage at or below the 6x level.

KEY RATING DRIVERS - GE Capital

The IDRs for GE Capital and its rated subsidiaries are linked to and equalized with those of GE, reflecting Fitch's view that GE Capital is a core subsidiary of GE, as defined under Fitch's 'Global Non-Bank Financial Institutions Rating Criteria.'

This view is supported by the fact that GE Capital remains a key and integral part of certain of GE's industry verticals, shares its branding with the broader GE organization and benefits from explicit guarantees of its existing financial obligations. GE has made strong legal commitments to support GE Capital under the second global supplemental bond indenture dated Dec. 2, 2015, under which GE Capital's existing obligations are fully, irrevocably and unconditionally guaranteed by GE. In addition, GE Capital operates in the same jurisdictions as GE and is a wholly-owned subsidiary of GE. Lastly, the reduced size of GE Capital's assets to $202.7 billion as of Sept. 30, 2016 from $500.6 billion as of Dec. 31, 2014, increases GE's financial ability to support GE Capital.

Credit strengths of GE Capital on a standalone basis include its strong franchise and global brand, market leading position in aircraft lending and leasing, established positions in energy finance and industrial finance, strong and experienced management team, adequate liquidity, reduced commercial paper utilization, and high unsecured debt levels.

Credit constraints on a standalone basis include reliance on wholesale funding sources, cyclicality and residual value risk inherent in certain of GE Capital's activities, particularly aircraft leasing, and less current and expected regulatory oversight of GE Capital.

Fitch views GE Capital's execution on the exit plan as strong, with signed agreements with buyers for $193 billion of ending net investment (ENI) excluding liquidity, of which $170 billion was completed as of Sept. 30, 2016. In 2015, GE Capital also finalized the split-off of Synchrony Financial, merged legacy General Electric Capital Corporation into GE, and exchanged $36 billion of legacy General Electric Capital Corporation debt for new GE guaranteed notes, each of which skewed interim financial performance but support an improved risk profile.

GE Capital has strong underwriting standards and risk controls. Since 2012, GE Capital has enhanced its economic capital (E-Cap) framework based on regulatory guidance and industry practice. The E-Cap model utilizes various tools that are driven by simulations and value-at-risk across various asset classes. These include aircraft operating leases and aircraft loans in GE Capital Aviation Services (GECAS), debt, tax equity and equity investments in structured and project finance in GE Energy Financial Services (EFS), and working capital solutions and trade payables services in GE Industrial Finance (IF). The company also performs ongoing stress testing. GE Capital's overall control framework consists of limits, product standards, monitoring and reporting to governing bodies including the Enterprise Risk Management Committee and GE Board of Directors, which ensures compliance and regular monitoring.

Asset quality metrics have been largely stable despite the shift in portfolio mix as a result of the exit plan that has weakened overall lessee and borrower credit quality. GE Capital's main industry verticals (GECAS, EFS, IF and other) funded $2.8 billion of investments and enabled $4.2 billion of GE Industrial orders in 3Q'16, while incurring lower impairments in EFS when compared to 3Q'15.

GE Capital's leverage ratio, defined by Fitch as gross debt to tangible equity (total shareowners' equity including preferred equity less goodwill and other intangible assets) was 5.0x as of Sept. 30, 2016, compared to 5.2x as of Dec. 31, 2015 and 4.1x as of Dec. 31, 2014. Company-reported gross debt to equity was 4.6x as of Sept. 30, 2016, compared to 4.6x as of Dec. 31, 2015 and 4.0x as of Dec. 31, 2014. Fitch expects this leverage ratio to remain within the 4.5x-5.0x range over the next two years, now that the D-SIFI designation has been rescinded. Fitch tends to focus on gross debt leverage ratios; however, company-reported net debt to equity was 2.6x as of Sept. 30, 2016, compared to 2.6x as of Dec. 31, 2015 and 3.1x as of Dec. 31, 2014.

While current and future leverage ratios are viewed as higher than Fitch's quantitative benchmarks for a standalone finance and leasing company rated 'AA-', the GE guarantee on GE Capital's debt and GE's ability to provide support to GE Capital offset the standalone leverage ratio.

GE Capital's earnings and profitability ratios in 2015 and the year-to-date period ended Sept. 30, 2016 were negatively impacted by one-time financial charges associated with the GE Capital exit plan, as well as losses from discontinued operations. Net loss from GE Capital attributable to GE common shareowners was $2.4 billion for the year-to-date period ended Sept. 30, 2016 and a $15.8 billion net loss in 2015, compared to net earnings of $6.9 billion in 2014. Fitch expects financial charges and earnings from discontinued operations to become less meaningful as the company completes the GE Capital Exit Plan throughout the remainder of 2016.

On a core basis, Fitch views GE Capital's earnings as strong, supported in part by the benefit of lower funding costs relative to most standalone finance and leasing companies. Return on average assets (ROAA), defined as GE Capital's net earnings attributable to GE common shareholders excluding after-tax charges related to the GE Capital Exit Plan divided by average assets, was 1.5% in 2015, and although negative the first half of 2016 due to the timing of charges prior to dispositions, turned slightly positive in 3Q'16. ROAA was 1.4% in 2014.

The 'AA-' IDR for GE Capital EFS Financing Inc. reflects the credit support provided by GE Capital, and thus GE, to GE Capital EFS Financing Inc. The 'F1+' rating for GE Capital Treasury Services LLC reflects that this entity is an issuer of commercial paper, guaranteed by GE, which is used to fund GE Capital's short-Term working capital needs.

The 'AA-' senior secured debt rating of GE Capital and the 'AA-' senior unsecured debt ratings of GE Capital International Funding Co. and other GE Capital subsidiaries are equalized with the IDRs of these entities and reflect Fitch's expectation of average recoveries. The 'A+' subordinated debt rating and the 'A' preferred stock rating reflect incremental risk relative to the IDR; these notches are a function of increased loss severity due to subordination and heightened risk of non-performance relative to senior obligations.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for GE Industrial include:

--Organic revenue grows by low single digits in 2016 as higher sales in the Power, Aviation and Renewables segments more than offsets lower sales of locomotives and a large decline in the oil and gas segment.

--The combination of GE Oil & Gas with BHI is completed in mid- 2017;

--EBITDA margins in 2016 decline due to the negative impact of the Alstom acquisition. Margins improve after 2016 due to benefits from the integration of Alstom, lower restructuring costs, and ongoing cost improvements.

--The GE Capital Exit Plan is completed as planned.

--Large dividends from GE Capital are used to fund share repurchases in the next two to three years as part of the GE Capital Exit Plan.

--Alstom integration contributes to cost synergies, including $1 billion in 2016.

--GE generates positive FCF.

--Cash deployment prioritizes acquisitions over share repurchases.

Fitch's key assumptions within the rating case for GE Capital include:

--GE Capital's outstanding debt will remain explicitly guaranteed by GE.

--GE Capital will pay $20 billion in dividends to GE in 2016.

--GE Capital's gross debt to tangible equity calculated by Fitch and GE Capital's company-reported gross debt to equity will remain around 4.5x-5.0x over the Outlook horizon.

--The company will complete the exit plan by year-end 2016 with ENI remaining around $80 billion.

RATING SENSITIVITIES

GE Industrial

Future developments that may, individually or collectively, lead to a negative rating action include:

--GE directs its operating strategy away from its industrial businesses;

--Market shares decline materially;

--Services generate a consistently lower proportion of revenue and profit;

--EBITDA margins fail to recover following an expected decline in 2016;

--GE Capital's asset quality and liquidity are weaker than expected, resulting in lower dividends to, or requiring support from, GE.

--GE's financial strategy becomes more aggressive than expected, including debt-funded acquisitions or share repurchases that lead to consistently higher leverage, including total adjusted debt/EBITDAR sustained above 2.0x (above 3.0x including Fitch's adjustments for factored receivables), or funds from operations (FFO) adjusted leverage sustained above 2.2x (above 3.2x including Fitch's adjustments for factored receivables).

Future developments that may, individually or collectively, lead to a positive rating action include:

--Segment margins increase toward 20% on a sustained basis.

--FCF and liquidity are sufficient to reduce GE's average commercial paper usage well below $10 billion.

GE Capital

As long as GE Capital's outstanding debt remains explicitly guaranteed by GE, Fitch cannot envision a scenario where GE Capital's ratings would not be equalized with those of GE. If in the future, GE Capital or its subsidiaries were to issue (or signal their intention to issue) debt that did not benefit from an explicit guarantee from GE, Fitch would consider the degree of strategic importance of GE Capital to GE and the willingness and ability of GE to extend financial support to GE Capital in determining the ratings of GE Capital and its debt obligations. Since the ratings of GE Capital and its rated subsidiaries are linked to those of GE, the rating sensitivities for GE Capital are the same as those listed for GE Industrial.

LIQUIDITY AND DEBT STRUCTURE

GE Industrial's liquidity at Sept. 30, 2016 included cash of $11 billion. Most of GE's cash is held outside the U.S. and is subject to income taxes if repatriated. Average cash and debt balances are higher than reported at quarter-ends due to GE's use of commercial paper. Commercial paper typically is highest during intra-quarter periods and is substantially repaid before quarter-ends using overseas cash. Liquidity also included $20 billion of credit lines exceeding one year. GE Capital has indirect access to the lines through intercompany loans from GE Industrial.

At June 30, 2016, GE Industrial's liquidity was offset by nearly $8.3 billion of debt due within one year, excluding amounts assumed from GE Capital. GE's industrial debt totaled $24.3 billion and included approximately $15 billion of notes due between 2017 and 2044 and a $ 5 billion short-term note payable to GE Capital.

GE Capital has strong liquidity and financial flexibility. This entity had $57 billion of liquidity as of Sept. 30, 2016, comfortably exceeding short-Term borrowings of $24 billion. Additionally, approximately 96.7% of GE Capital's debt funding was unsecured as of Sept. 30, 2016. GE Capital completed approximately $2 billion of asset-liability management actions in 3Q'16 including calling certain hybrid securities and completing make whole calls. Commercial paper outstanding as of Sept. 30, 2016 totaled $5 billion or 3.8% of total funding.

Approximately $162 billion of GE's consolidated debt, including approximately $13 billion of GE receivables factored through GE Capital, is covered by the ratings.

For more details about Fitch's view of GE, see full rating reports published Sept. 19, 2016 for General Electric Company and GE Capital Global Holdings, LLC.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

General Electric Company

--Long-Term IDR at 'AA-';

--Senior unsecured debt at 'AA-';

--Senior unsecured bank credit facilities at 'AA-';

--Subordinated debt at 'A+';

--Preferred stock at 'A';

--Short-Term IDR at 'F1+';

--Commercial paper at 'F1+'.

GE Capital Global Holdings, LLC

--Long-Term IDR at 'AA-';

--Senior secured debt at 'AA-';

--Subordinated debt at 'A+';

--Preferred stock at 'A';

--Short-Term IDR at 'F1+'.

GE Capital EFS Financing Inc.

--Long-Term IDR at 'AA-'.

GE Capital Treasury Services LLC

--Short-Term IDR at 'F1+';

--Commercial paper at 'F1+'.

GE Capital International Holdings Ltd.

--Long-Term IDR at 'AA-'.

GE Capital US Holdings, Inc.

--Long-Term IDR at 'AA-'.

GE Capital International Funding Co.

--Long-Term IDR at 'AA-';

--Senior unsecured debt at 'AA-'.

GE Capital Australia Funding Pty. Ltd

--Senior unsecured debt at 'AA-'.

GE Capital Canada Funding Company

--Senior unsecured debt at 'AA-'.

GE Capital European Funding

--Senior unsecured debt at 'AA-'.

GE Capital UK Funding

--Senior unsecured debt at 'AA-'.

SUSA Partnership, L.P.

--Senior unsecured debt at 'AA-'.

Security Capital Group Inc.

--Senior unsecured debt at 'AA-'.

The Rating Outlook is Stable.

SUMMARY OF FINANCIAL STATEMENT ADJUSTMENTS

Factoring: GE Industrial's debt and assets have been adjusted to include approximately $13 billion of off-balance sheet customer receivables factored through GE Capital as of Dec. 31, 2015.

Additional information is available on www.fitchratings.com

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

Global Non-Bank Financial Institutions Rating Criteria (pub. 15 Jul 2016)

https://www.fitchratings.com/site/re/884128

Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 29 Feb 2016)

https://www.fitchratings.com/site/re/878264

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1014046

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014046

Endorsement Policy

https://www.fitchratings.com/regulatory

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