Standard & Poor's Ratings Services today said it has revised its outlook on General Electric Co. (NYSE:GE) and units, including General Electric Capital Corp. (GECC) to negative from stable and affirmed its 'AAA' long-term and 'A-1+' short-term credit ratings. The rating outlook revision reflects, in part, concerns relating to GECC. (Please see the related release on GECC, to be published shortly after this release.)

"The negative outlook is based partly on the concerns regarding GECC's future performance and funding," said Standard & Poor's credit analyst Robert Schulz. "In addition, fundamentals-based earnings and cash flow could decline sufficiently during the next two years to warrant a downgrade. We will continue to monitor GECC's success in executing on its funding and liquidity plans in light of capital market turmoil," he continued.

The rating affirmation is based on GE's massive scale, diversity, and track record of managing its businesses (including its financial services unit GECC) in a variety of difficult markets, and on the demonstrated ability of these businesses to earn solid profits and generate substantial cash, even in very tough economic conditions. GE has not remained static in the face of negative economic and capital market conditions that will persist in 2009. Its recent financial policy actions have been consistent with what we would expect of a company with the highest credit quality: raising equity and eliminating shareholder-friendly uses of cash (share repurchases, dividend increases, and major acquisitions). The downsizing of GECC and the increase in liquidity resources available to GECC are other important factors in the affirmation. GECC will account for about a third of GE's earnings in 2009--or less if worse-than-expected credit losses further reduce GECC's earnings. Even with its current standalone credit profile of 'A+', GECC remains one of the world's most profitable and highly rated financial institutions.

The ratings on GE reflect its excellent business risk profile, the minimally leveraged balance sheet for its industrial operations, its significant cash flow and liquidity, its strong corporate governance, and management's commitment to maintaining the highest credit quality. Recent actions announced regarding GECC, including the raising of $15 billion of common and preferred equity, are considered evidence of GE's commitment to this level of credit quality. GECC is a core entity within GE, and financial services have historically contributed a substantial amount of consolidated earnings. In light of the turmoil sweeping the global financial services sector, we will continue to monitor closely any effect on GECC's funding. With its lower originations and earnings than in previous years, we expect GECC to lessen somewhat in importance to consolidated earnings and cash flow generation capabilities. Still, GECC needs to return its dividend payout to GE to higher levels after 2009. As always, we will continue to monitor the balance between liquidity and capital resources at GECC and at the parent.

Despite current U.S. and developing international economic weakness, we expect GE's broad business and geographic diversity to allow for continued generous cash flow alongside a strong financial risk profile and maintenance of adequate capital at GECC. We believe GE has about $10 billion of cash that could be infused into GECC, beyond the $5 billion already contributed in December 2008, and this additional contribution would represent a significant further increase in GECC's equity.

GE has strong leadership positions across its global business platforms. Its diversity is unparalleled, customer concentration is negligible, sales are geographically dispersed, and its end markets run the gamut of economic activity. Still, its operations are exposed to varying degrees of cyclicality and price pressures, which has been clearly evident in 2008 and will remain so in 2009. Certain segments--notably portions of GECC and Consumer and Industrial products (appliances and lighting)—are suffering because of the weak U.S. economy and softening in real estate markets. Some key segments, such as the energy business, are benefiting from underlying global economic fundamentals and are increasing earnings in 2008. We believe the company is well-positioned against the broader global slowdown--the backlog is diverse, and advance payments of 70% or more are collected on large equipment orders.

The large amount of high-margin service and aftermarket sales provides significant earnings support throughout the business cycle. The very profitable customer service agreement backlog is expected to be about $120 billion at the end of 2008. This backlog will generate about $38 billion of revenue--at 30% margins--in 2009. GE's operating culture emphasizes Six Sigma principles, low-cost manufacturing, good working-capital management, superior product quality, and customer satisfaction, and is a competitive strength that enables the company to consistently generate an operating margin comparable to that of strong industrial companies such as Illinois Tool Works Inc., Emerson Electric Co., and United Technologies Corp.

The business strategy includes both bolt-on and strategic acquisitions, as well as divestitures; we expect acquisition activity to be modest for the next year in light of the current economic weakness and uncertainty. We view the substantial shifts in its portfolio of industrial and financial businesses in recent years as having eliminated many risky or vulnerable operations. But GE is not likely to complete certain other divestitures in the near term, such as Consumer and Industrial or private-label credit cards, given their outlook for 2009.

GE expects fourth-quarter industrial earnings (excluding Consumer and Industrial) to be flat to up 5%, and results in Consumer and Industrial and GECC to be down sharply, albeit still profitable. This expectation is consistent with our view of the strength of the industrial businesses, but also of the weak economic outlook. In light of the current market conditions, GECC now expects financial services' net earnings in 2008 of $8 billion, down about 30% from 2007 earnings. GECC's earnings are also expected to drop again in 2009 to about $5 billion. GECC's earnings are negatively affected by higher consumer-related loss provisions, lower gains on asset sales, and certain adverse mark-to-market effects. However, GECC continues to significantly outperform the majority of its large financial institution peers, owing to its broad product and geographic diversity and conservative underwriting standards.

In 2008, industrial cash from operating activities should be at least $15.5 billion, about flat with 2007 levels. We expect GE to use its robust cash flow mainly for supporting the dividend in 2009, leaving industrial debt unchanged and cash balances elevated and available for GECC. GE has stated that it will keep the dividend at 2008 levels in 2009 and 2010, and it has suspended share repurchases. We continue to expect the company to pay careful attention to financial policy. We also expect strong internal cash flow and proceeds from asset sales to keep GE's industrial debt stable. Total funds from operations to adjusted debt has been far greater than 100% recently. We expect this measure to decline in 2009, but to remain above 80%.

GE's past disclosures regarding incorrect but immaterial revenue recognition and subsequent corrective actions do not affect the rating. We believe GE's internal controls are rigorous, but we will continue to monitor any further developments, given that the SEC investigation persists.

GE has substantial liquidity. Cash and equivalents should be about $10 billion at year-end 2008, after contributing $5 billion in equity to GECC. Our expectation is for about $1.5 billion for daily operating needs in the industrial businesses. Free operating cash flow has exceeded $12 billion during the past four years and has run even higher recently. We expect free operating cash flow to remain around these levels, but the large dividend payment will test cash flow after dividends in 2009. GE also has committed bank facilities totaling about $13 billion.

Both GE and GECC have a large number of units they could sell. Market volatility and returns in 2008 are likely to reduce pension overfunding. GE's main pension plan was overfunded by $17 billion at year-end 2007, while the underfunded other postretirement employee benefit obligations totaled $11.2 billion. We do not expect GE to need to make any substantial cash pension contributions in the next few years. GECC is lowering its reliance on commercial paper as a percentage of total debt meaningfully below previous levels. Still, given GECC's still-large balance sheet relative to GE's, there are limits to the financial support GE could provide to GECC, especially in a short period.

The outlook is negative, indicating that we believe there is at least a one-in-three possibility of a downgrade within the next two years. GE's commitment to maintaining the highest credit quality, the still-solid prospects for many of its business segments (even in light of developing economic weakness), and the company's ample financial flexibility should continue to support our ratings. We would re-examine our credit opinions if, for example, GE failed to generate free cash flow (after dividends and assets sales) in 2009 or 2010. This would likely require a combination of events: net earnings below the $14 billion area, which could occur if GECC's earnings are much weaker than the $5 billion that GE expects; a reduction of 25 basis points or more in the industrial gross margin; and GE's being unsuccessful in managing working capital or asset sales in 2009. We could review the rating if GECC fell short of its various earnings and other funding measures in 2009.

We would also review the rating if the company shifted its financial policies or if strategic shifts in GE's portfolio of businesses were to jeopardize the company's excellent business risk profile.

We could revise the outlook to stable if it appears that GE's industrial businesses will perform better in 2009 and 2010 than we expect (including substantial excess cash generation after the dividend) and GECC's earnings will recover significantly in conjunction with demonstrating progress in lowering the risk of its funding and capitalization.