GE Capital

      This note summarizes some of the salient figures behind the computation of equity available to GE Capital to underwrite risk in their businesses, and in particular their leasing business. Where feasible, information for the Middle Market Financing segment of GE Capital is provided as well, as that business incorporates the bulk of the middle ticket equipment leasing assets owned or managed by GE Capital.

     As a disclaimer, GE Capital has complex financials. This note of necessity summarizes much more detailed computations; and in several cases where no reliable published information is available on the Middle Market Financing segment, the authors relied on other sources, where information from those sources was consistent with available data.

     Primary source materials for the analysis were the GE Capital 2001 10K filing and Q1 2002 10Q filing with the American Securities and Exchange Commission; analyst reports on GE Capital from major securities firms; information provided by GE Capital during proposals and acquisitions; and (for MMF) conversations with knowledgeable industry sources.

     There are four key numbers behind the calculations in the Benchmark Report: assets for which GEC is at some risk; equity to support the assets; reserves against future losses; and net earnings. None of these is straightforward for GEC. Each is discussed in more detail below.

Assets

     GEC shows a nominal $381B USD in assets on the balance sheet as of 31 December 2001. To arrive at the figure used to compute the equity percentage in the report, this figure was adjusted to reflect assets for which GEC is at some risk. Several different approaches were used, all of which resulted in an at risk asset total (both on balance sheet assets and off balance sheet assets in Special Purpose Entities for which GEC retains some liability) of approximately $376B. An example of one method of calculating this total follows:

$190B financing receivables ($14.3B off balance sheet)

27B net operating lease exposure after guarantees

79B in securities not fully hedged

26B other receivables

54B other assets¹

$376B

     MMF assets are $108B, of which $55B are finance and leveraged leases (for leveraged leases, only the portion funded or guaranteed by GEC is included).

Equity

     GEC shows equity of $31.6B on the balance sheet as of 12/31/01. This total, however, includes $14.5B in goodwill, and excludes $9.6B in reserves. After those adjustments, equity available to support risk is $26.7B. This amount includes an equity infusion from the parent of $2.65B in 2001 to support the Heller Financial acquisition. As the Heller portfolio is processed by GEC over the next two years to meet GEC risk standards, the equity required to support that portfolio will likely decline (resulting in increased dividends to the parent).

1.   A guarantee by GE to contribute equity to GEC if certain conditions are met (“If GEC’s ratio of earnings to fixed charges, which was 1.72 to 1 at the end of 2001 deteriorates to 1.10 to 1 or, upon redemption of certain preferred stock, its ratio of debt to equity, which was 7.31 to 1 at the end of 2001 exceeds 8 to 1, GE has committed to contribute capital to GEC.”)

2.   GEC has $8.1B in deferred income taxes that will not come due as long as GEC continues to grow tax advantaged business, which they expect to do indefinitely. These deferred taxes in effect act as additional retained earnings, or implicit equity. This amount is NOT included in our calculations.

Of the$26.7B in equity, $11.7B supports the insurance business. Our estimate of the equity supporting the $108B in MMF assets is $5.3B, after subtracting goodwill of $2.5B assigned to MMF.

Reserves

     It is difficult to determine true reserve levels for GEC: a top down approach suggests $9.1B in reserves against future losses, while a bottom up approach shows $9.6B ($5.3B against the $190B in financing receivables; $4.3B in over reserves in insurance and elsewhere). For our analysis, we used $9.6B. The reserves for on balance sheet non-consumer financing receivables ($125B) are $2.8B, of which about $1.8B appears due to MMF business.

Earnings

     Net earnings after taxes for 2001 were reported as $5.9B, of which $1.28B were from MMF. Taxes were reported as $1.73B, but actual cash taxes were just $269M, resulting in cash earnings of $5.90 + $1.73 - $0.27 = $7.36B. These earnings included a gain on sale of the Americom business ($1.2B gain on sale, of which about $0.4B appeared to have been salted away in reserves, and $0.8B brought down to pre-tax income). For the Benchmark Report, we used the reported net earnings. Using cash earnings, and adjusting out the one time gain on Americom, would have increased ROE by about 4 percentage points.

Summary

     The figures in the benchmark report were developed by adhering as closely as reasonable to the published figures for GEC assets, equity, reserves, and earnings. Most of the adjustments that might reasonably have been made to earnings would increase reported ROE; adjustments that might have been made to equity (considering deferred taxes; including unamoritized goodwill) would have reduced ROE. The only scenario that would increase the GEC ratio of equity to assets to the average risk capital level for the equipment leasing industry would be to include all reserves and all goodwill in the equity figures, while omitting assets for which GEC is not truly at risk.

     MMF in particular appears to operate with a low level of equity, even if goodwill is included (about 7.5% with goodwill). This reflects the very careful and proactive approach to risk management adopted both in the origination processes and in the ongoing portfolio management. Given the general credit profile of MMF customers, which is similar or possibly slightly lower than average for the leasing industry, this suggests the value the rating agencies place on sound risk management and standardized processes.