First it was the investment banks, then the Main Street banks, then the insurance companies.
Now the financial crisis is set to topple U.S. manufacturing stalwarts, the companies that actually build things in this country, from airplane engines to medical equipment, high-end motorcycles to military aircraft.
Iconic U.S. companies such as General Electric (GE, news, msgs), Harley-Davidson (HOG, news, msgs) and Cessna aircraft manufacturer Textron (TXT, news, msgs) have seen their share prices decline by 70% or more. Normally, that would signal to smart investors that it was time to buy surefire values. But this is no normal downturn, and these companies are particularly vulnerable to the credit crisis because of their once-profitable finance arms.
A bank by any other name . . .
Involvement in the credit mayhem began innocently enough for General Electric, Harley-Davidson and Textron, evolving gradually, says Kent Mortensen, an analyst with Thrivent Financial for Lutherans:- Years ago they set up finance divisions that lent money to customers to boost sales.
- After finding how easy it was to make money by acting like a bank, they branched into lending that had nothing to do with their core businesses, making loans that in many cases are now going bad. GE now funds things as varied as commercial-real-estate ventures, subprime loans, emerging market debt and credit card lending. Besides making aircraft, Textron funds golf courses, vacation resorts and recreational vehicle sales. Harley-Davidson, at least, stuck to motorcycles. But it became a big player in the asset-backed-securities market, repackaging its bike loans into debt instruments and selling them at a profit to investors. That market has vanished.
- In the final stages, just like the failed investment banks and reckless homebuyers, GE and Textron got seduced by low interest rates. They borrowed more money than was good for them.
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All of this worked well until the economic downturn and credit crunch came along. Now, because of their forays into lending, these companies are getting hit from several sides at once:
- The recession is hurting their core businesses of selling airplane engines, locomotives, aircraft and motorcycles, and GE and Textron are losing money on investments made by their financing arms.
- Because the credit markets are frozen, GE and Textron may have trouble refinancing the short-term debt taken out to fund their long-term investments. That could leave them strapped or, in the worst-case scenario, forced to sell off assets or divert cash from their core businesses.
- Once an economic recovery occurs, all three will no longer have financial divisions as big as they were a few years ago, if at all. So these companies won't be seeing the same profit growth or support in the way of customer financing that they got before.
All of this means that unless we see a quick -- and unexpected -- rebound in the economy, problems at these companies will drag on for some time or get worse.
"We got here because companies that had previously used low amounts of leverage decided they could make more money by becoming the bank," says Gary Jenkins, the head of fixed-income research at Evolution Securities, an investment bank and brokerage in London. "Leverage became the new black. But when you get to the end of the cycle, these things end up losing all the money they made over the previous years."
- Talk back: Do you think the economy can recover?
To be sure, none of these companies will disappear. The federal government will see to that. Washington, D.C., is already helping General Electric by promising to guarantee new debt, which will make it easier for the company to raise money.
Harley-Davidson also hopes to get some form of government assistance. But that doesn't mean these companies will sort through their lending problems quickly or easily.
GE: Bad things come to light
Here's a simple comparison that shows how far General Electric has strayed into lending from its core businesses: In the late 1980s, its financial division, called GE Capital, accounted for about 20% of overall earnings. By 2007 that had grown to 55%.GE didn't make the transition by lending more money to customers buying wind turbines or medical imaging equipment.
Its lending division now has $660 billion in assets that include loans to developers of shopping malls and office space, subprime loans to United Kingdom homebuyers, credit cards loans, and loans to businesses and consumers in emerging market countries such as Poland, Turkey and the Baltic states.
As the economy worsens and unemployment rises, more of these loans are bound to go bad. This could be a big challenge for General Electric because it is company with a huge chunk of assets -- that $660 billion loan book.
Loan losses of 10% to 15% would force GE to take write-downs and see its capital base shrink by an amount that would alarm investors, believes Fariborz Ghadar, a professor at Pennsylvania State University's Smeal College of Business and the director of the university's Center for Global Business Studies. "If we don't pull out of the credit crisis, then GE is going to be in trouble again in a year."
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