Big real estate writedown potential overhangs GE
NEW YORK |
NEW YORK (Reuters) - The potential for multibillion-dollar writedowns in General Electric Co's $84 billion real estate portfolio is emerging as one of the key questions about the future of its GE Capital unit.
Deepening concerns about global liquidity -- given a prolonged U.S. recession, tight credit around the world and the rapidly declining value of U.S. commercial real estate -- have led GE investors to question the company's method of valuing its real estate holdings, an issue some say speaks to an overall lack of transparency at GE.
"What GE is doing is not recognizing any impairment of any significance on this stuff," said Jack De Gan, chief investment officer with Harbor Advisory Corp, which owns GE shares.
"(GE is) hoping they can ride through this recession using held-to-maturity type accounting on everything, not mark it down, and wait for the market to recover under it so they don't have to charge earnings."
The financing needed to roll over a lot of the commercial debt coming due in the next few years is not available. Much of the company's commercial real estate equity is not worth what GE paid for it -- especially assets bought near the market peak in 2006 and 2007.
De Gan said GE should recognize the deterioration in commercial real estate markets and mark down its $84 billion portfolio by 2 to 5 percent. That would add up to "an awfully big potential charge that's being kicked down the road," he said.
He contrasted GE with Goldman Sachs Group Inc, which marks its assets to market in every accounting period, and which he said provided a high level of transparency this week at a time when investors are deeply concerned about liquidity.
"Substantial unrealized losses related to GE Capital's real estate investments could ultimately result in material impairment charges," Standard & Poor's said Friday.
GE Real Estate, part of the vast conglomerate's GE Capital division, posted a loss of $237 million for the latest quarter.
Its assets represent about 15 percent of GE Capital's overall assets. Overall, GE's quarterly second-quarter profits topped expectations but sales fell short of forecasts.
"We continue to see pressure in the commercial real estate book," Chief Financial Officer Keith Sherin told investors Friday.
In an interview with Reuters, Sherin said GE evaluates whether properties are impaired on a quarterly basis, and took $100 million in real estate impairments in the latest quarter.
In April, the company said it did not have adequate visibility to predict the degree of losses in its commercial loan portfolio, but noted it expected a tough commercial real estate cycle given continued job losses.
To be sure, GE has said it plans to hold on to its portfolio and therefore does not need to mark it down under accounting rules. Valuing assets is hard when transaction volumes are down dramatically.
Also, GE says many of its loans were underwritten at conservative loan-to-value ratios, while its real estate equity holdings are well diversified in markets that GE says it understands. Occupancy is "good," it says, and GE is aggressive about renewing leases at the best possible terms.
GE said $6.1 billion of its real estate debt portfolio matures this year, of which $1.6 billion has a loan-to-value ratio above 85 percent. Should prices be down 15 percent or more, such loans would be underwater.
GE has also argued that almost half its debt portfolio is secured by multiple properties in multiple locations, reducing risk. It has far less exposure to construction and development loans than large money-center banks and avoids riskier areas like mezzanine loans, shopping malls and resorts. As a result, GE's delinquencies and default rates are far below those of banks.
But they're rising. GE's real estate delinquencies -- warning signs that precede defaults -- almost doubled in the second quarter to 4 percent, from 2.2 percent in the first.
"We actually play in one of the safest parts of the debt industry for commercial real estate," Ron Pressman, chief executive officer of GE Real Estate, said at a March presentation aimed at easing investors' worries about GE Capital. "We think losses from the commercial real estate portfolio will in fact be manageable."
Another "deep dive" into GE Capital's operations is set for July 28.
While the U.S, housing market has stabilized somewhat after a protracted downturn, the commercial real estate market still faces expected declines in property prices and defaults.
There is also the question of overall U.S. employment. Demand for commercial real estate lags employment, which itself is a lagging economic indicator, suggesting this could be a long downturn.
The 9.5 percent U.S. unemployment rate is already higher than the adverse case for the economy GE cited in March and is expected to keep rising. As employment drives demand for office buildings, retail and other commercial real estate, a poor jobs picture will remain a factor for several quarters.
"With expectations of rising unemployment and higher delinquencies and losses in the quarters ahead, we believe profits at GE Capital will remain under pressure," analysts at William Blair & Co said in a research note.
GE's core real estate business finances the purchase of property by other parties and holds a debt portfolio of about $48 billion.
A second part of its business invests in some 3,200 office and apartment building and other assets, worth about $33 billion, while another operation provides financing to owner-occupied commercial real estate for small to medium-sized businesses -- an area where struggling lender CIT Inc is a major player, whose real estate exposure has helped push it to the verge of bankruptcy.
While a core part of GE Capital supports the parent company's sales of wind turbines, locomotives, medical imaging machines and other expensive equipment, GE Capital has also expanded over the years into tangential areas like insurance and real estate.
(Additional reporting by Scott Malone and Ilaina Jonas; editing by Patrick Fitzgibbons and Gerald E. McCormick)
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