Will GE Be the Biggest Loser of Financial Reform?

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As the Obama administration begins to unveil sweeping reform of financial regulation, financial groups will need to adapt to a new playing field. For the banking industry -- already one of the most highly regulated sectors in the economy -- the change is essentially one of degree. For a few non-bank financials, the change amounts to a wholesale change of regime. The most prominent of these is GE Capital -- the lending arm of General Electric (NYSE: GE).

Look out, parent!
GE Capital was part of the "shadow banking system"; it's quite normal that an institution that poses a systemic risk should face increased scrutiny post-crisis. However, new rules could mean regulatory oversight that encompasses the parent economy, with limits on its non-financial activities.

Although GE Capital hasn't been specifically named as a "systemically important institution," at nearly $613 billion in assets, its balance sheet dwarfs that of all but a handful of U.S. banking groups. Despite what looks like a decent equity cushion (see table below), its size poses an obvious risk.

Bank	Tangible Common Equity to Tangible Assets Ratio
GE Capital	6.5%
Goldman Sachs (NYSE: GS)	4.6%
Morgan Stanley (NYSE: MS)	4.3%
U.S. Bancorp (NYSE: USB)	3.7%
Wells Fargo (NYSE: WFC)	3.3%
Bank of America (NYSE: BAC)	3.1%
Citigroup (NYSE: C)	1.7%

[Note that authorities concluded during the stress tests that four of the six banks in the above table had a capital shortfall: Morgan Stanley, Wells Fargo, B of A and Citi.]

This development creates an additional incentive for GE to spin off its finance arm. Despite this, the company repeated that it is "committed to retaining GE Capital," which implies that management believes there are synergies between its industrial and financing activities. I don't see any evidence of that; in fact, I think there are negative synergies: The whole company trades at a discount due to GE Capital. Increased regulation of non-financial businesses would compound that phenomenon.

Is "no spin-off" just spin?
In truth, this isn't a propitious time to spin off GE Capital as the valuations of financial stocks remain somewhat depressed; perhaps GE is simply biding its time. Furthermore, a spin-off would require the market's stamp of approval that GE Capital is a stable, viable business. A botched operation would undermine investor confidence which was hard earned during this crisis. However, once crisis memories (and valuations) fade away, a breakup makes all the sense in the world.

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