GE announced this morning that it will take an after-tax charge of $6.2 billion in the 2017 fourth quarter against the value of GE Capital’s run-off insurance portfolio, North American Life & Health (NALH). In addition, GE Capital will make $15 billion of statutory reserve contributions over the next seven years, including $3 billion in February and $2 billion annually from 2019 to 2024.
The charge follows a comprehensive review of NALH’s run-off insurance portfolio, conducted with the aid of two outside actuarial firms and utilizing KPMG’s audit procedures. As a result of this process, GE Capital re-evaluated all of its actuarial assumptions on this portfolio in response to the trend in adverse claim behavior. Most of the charges apply to NALH’s long-term care portfolio covering about 300,000 policies.
The charge will have no impact on GE’s credit ratings or its capital allocation plan. GE Capital will suspend dividends to the parent company for the foreseeable future, in order to build back its reserve base. As a result of the charge, GE Capital’s debt/equity ratio will increase from 4.6 times in the 2017 third quarter to 7.1 times at year-end. However, management expects that the debt/equity ratio will fall back to about 4.5 times by the end of 2019, in large part by retaining dividends and paying off so-called “stranded” debt over the next two years.
Besides the insurance review, GE also announced that it will shrink two of GE Capital’s businesses – Energy Financial Services (EFS) and Industrial Finance. EFS’s assets are expected to fall by more than half from $10 billion at year-end 2017 to less than $5 billion by year-end 2019. Industrial Finance’s assets will decline from $26 billion to about $15 billion over the same period. In total, this will GE Capital’s total assets from $76 billion to about $60 billion in 2019. In conjunction with these moves, GE Capital will book a $1.8 billion goodwill impairment charge related to EFS (and to shortened hold period assumptions) and in the 2017 fourth quarter.
GE management continues to review other GE Capital exposures, including WMC, its discontinued subprime mortgage business, which still face lawsuits arising from the origination and sale of mortgages from 2005 to 2007 and a Dept. of Justice investigation into potential violations of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA). Management also continues to review other trailing liabilities of GE Capital.
Management also announced that it expects to take a charge of $3.4 billion in the fourth quarter related to the implementation of tax reform on overseas earnings and revaluation of deferred taxes. That $3.4 billion includes $1.3 billion related to the insurance charge. It anticipates a long-term tax rate in the low- to mid-20% longer term, but still expects a tax rate in the high teens in 2017 and 2018.
GE now anticipates 2017 non-GAAP industrial operating and verticals EPS at the low end of its $1.05-$1.10 guidance range. That non-GAAP guidance excludes GE Capital insurance-related charges of $6.2 billion, the $3.4 billion of tax reform-related charges and $1.6 billion of after-tax Industrial portfolio-related charges, including charges taken on assets held-for sale. (Presumably, since EFS is a vertical, the $1.6 billion after-tax charge reflects the $1.8 billion of goodwill impairment charges (presumably pre-tax) expected on EFS and shortened hold period assumptions). On a positive note, GE Industrial CFOA will be above management’s previous full-year estimate of $7 billion.
GE CEO John Flannery characterized the insurance-related charges as disappointing and the market agreed, pushing down GE’s stock by $0.67 per share or 3.5% to $18.09 in mid-day trading. I, however, view this as part of the ongoing housecleaning taking place at GE with the goal of minimizing restructuring or repositioning-related charges going forward.
Although the insurance moves are designed to make GE Capital (and GE) smaller and more focused, it is noteworthy, I believe, that GE has not said that it will take the steps to make GE Capital even more focused by selling off its insurance portfolio. Such a move would almost certainly require GE to pay someone to take the portfolio off its hands (presumably as much as the $15 billion in statutory capital that it expects to contribute over the next seven years). GE might therefore balk at the prospect, but if it has truly marked the portfolio to market, it should be able to find a buyer at or around that price and should be happy to exit the business so that it can focus on its continuing businesses.
January 16, 2018
Stephen P. Percoco
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