GE Capital Was a Bank Attached to an Industrial Company
General Electric's finance arm generated a large share of group profits for years. It also carried risks the industrial business was not built to absorb, and 2008 exposed them.
What It Became
General Electric built a finance business that grew far beyond supporting sales of its own equipment. GE Capital engaged in commercial lending, leasing, consumer finance, insurance, and real estate.
At its peak it contributed a substantial share of group profits, and the market largely valued the whole company on the multiple appropriate to a high quality industrial manufacturer.
The Valuation Arbitrage
That last point is the analytically interesting part. Banks trade at lower multiples than quality industrials, because their earnings are more cyclical, more leveraged, and less predictable.
By housing a large financial business inside an industrial group with an exceptional reputation, GE effectively obtained an industrial multiple on financial earnings. The market was not pricing the finance arm as a bank, and the finance arm was a bank in economic substance.
The same earnings are worth less when they come from a leveraged lender than from a manufacturer. The structure obscured which kind of earnings these were.
The Funding Model
GE Capital funded itself heavily in commercial paper markets, borrowing short term at low rates supported by the group's top tier credit rating, and lending or leasing over longer terms.
That is the classic maturity transformation performed by banks. Banks conduct it with deposit insurance, central bank access, and capital requirements. GE Capital had none of those, and relied instead on the parent's credit rating maintaining access to short term funding.
What Happened in 2008
When commercial paper markets seized, the model came under severe pressure. The company obtained access to government guarantee programmes supporting debt issuance, and separately raised capital including a high profile investment from Berkshire Hathaway on expensive terms.
An industrial manufacturer required emergency support of a kind associated with banks, because it had been operating a bank.
The Long Unwind
Following the crisis and subsequent regulatory designation as systemically important, the company decided to substantially exit financial services, disposing of the majority of GE Capital over subsequent years.
The industrial business faced its own difficulties afterward, including problems in power generation and legacy insurance obligations that required substantial reserve increases years after the businesses were written.
That last item is worth noting separately. Long tail insurance liabilities can produce losses decades after the policies were sold, which is a specific hazard of insurance businesses acquired for diversification.
The Analytical Habit
The practical lesson is to identify where earnings actually come from and value each component appropriately. A conglomerate's consolidated multiple can obscure that one segment is a leveraged lender deserving a different valuation entirely.
Sum of the parts analysis exists for this reason, and the discipline is to apply the multiple each business deserves rather than the multiple the group reputation attracts.
The Bottom Line
GE Capital ran a bank's balance sheet without a bank's protections, valued at an industrial multiple. Work out what each segment actually is before accepting what the group is worth.