GE 2011 Annual Report Download - page 62

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60 GE 2011 ANNUAL REPORT
Preferred Share Redemption
On October 16, 2008, we issued 30,000 shares of 10% cumulative
perpetual preferred stock (par value $1.00 per share) having an
aggregate liquidation value of $3.0 billion, and warrants to pur-
chase 134,831,460 shares of common stock (par value $0.06 per
share) to Berkshire Hathaway Inc. (Berkshire Hathaway) for net
proceeds of $3.0 billion in cash. The proceeds were allocated to
the preferred shares ($2.5 billion) and the warrants ($0.5 billion) on
a relative fair value basis and recorded in other capital. The war-
rants are exercisable for fi ve years at an exercise price of $22.25
per share of common stock and settled through physical
share issuance.
The preferred stock was redeemable at our option three
years after issuance at a price of 110% of liquidation value plus
accrued and unpaid dividends. On September 13, 2011, we
provided notice to Berkshire Hathaway that we would redeem
the shares for the stated redemption price of $3.3 billion, plus
accrued and unpaid dividends. In connection with this notice,
we recognized a preferred dividend of $0.8 billion (calculated as
the difference between the carrying value and redemption value
of the preferred stock), which was recorded as a reduction to
our third quarter earnings attributable to common shareown-
ers and common shareowners’ equity and a related EPS charge
of $0.08. As a result and beginning in the fourth quarter of 2011,
we are no longer required to pay the preferred share dividends
of $0.3 billion annually. The preferred shares were redeemed on
October 17, 2011.
EXCHANGE RATE AND INTEREST RATE RISKS are managed with a
variety of techniques, including match funding and selective use
of derivatives. We use derivatives to mitigate or eliminate certain
fi nancial and market risks because we conduct business in
diverse markets around the world and local funding is not always
effi cient. In addition, we use derivatives to adjust the debt we are
issuing to match the fi xed or fl oating nature of the assets we are
originating. We apply strict policies to manage each of these risks,
including prohibitions on speculative activities. Following is an
analysis of the potential effects of changes in interest rates and
currency exchange rates using so-called “shock” tests that seek
to model the effects of shifts in rates. Such tests are inherently
limited based on the assumptions used (described further below)
and should not be viewed as a forecast; actual effects would
depend on many variables, including market factors and the
composition of the Company’s assets and liability portfolio at
that time.
• It is our policy to minimize exposure to interest rate changes.
We fund our fi nancial investments using debt or a combina-
tion of debt and hedging instruments so that the interest rates
of our borrowings match the expected interest rate profi le on
our assets. To test the effectiveness of our fi xed rate positions,
we assumed that, on January 1, 2012, interest rates increased
by 100 basis points across the yield curve (a “parallel shift” in
that curve) and further assumed that the increase remained
in place for 2012. We estimated, based on the year-end 2011
portfolio and holding all other assumptions constant, that our
2012 consolidated net earnings would decline by less than
$0.1 billion as a result of this parallel shift in the yield curve.
• It is our policy to minimize currency exposures and to con-
duct operations either within functional currencies or using
the protection of hedge strategies. We analyzed year-end
2011 consolidated currency exposures, including derivatives
designated and effective as hedges, to identify assets and
liabilities denominated in other than their relevant functional
currencies. For such assets and liabilities, we then evaluated
the effects of a 10% shift in exchange rates between those
currencies and the U.S. dollar, holding all other assumptions
constant. This analysis indicated that our 2012 consolidated
net earnings would decline by less than $0.1 billion as a result
of such a shift in exchange rates.
Debt and Derivative Instruments, Guarantees and Covenants
PRINCIPAL DEBT AND DERIVATIVE CONDITIONS are described below.
Certain of our derivative instruments can be terminated if speci-
fi ed credit ratings are not maintained and certain debt and
derivatives agreements of other consolidated entities have provi-
sions that are affected by these credit ratings. As of December 31,
2011, GE and GECC’s long-term unsecured debt credit rating from
Standard and Poor’s Ratings Service (S&P) was “AA+” with a stable
outlook and from Moody’s Investors Service (“Moody’s”) was “Aa2”
with a stable outlook. As of December 31, 2011, GE, GECS and
GECC’s short-term credit rating from S&P was “A-1+” and from
Moody’s was “P-1”. We are disclosing these ratings to enhance
understanding of our sources of liquidity and the effects of our
ratings on our costs of funds. Although we currently do not
expect a downgrade in the credit ratings, our ratings may be
subject to revision or withdrawal at any time by the assigning
rating organization, and each rating should be evaluated indepen-
dently of any other rating.
Fair values of our derivatives can change signifi cantly from
period to period based on, among other factors, market move-
ments and changes in our positions. We manage counterparty
credit risk (the risk that counterparties will default and not make
payments to us according to the terms of our standard master
agreements) on an individual counterparty basis. Where we have
agreed to netting of derivative exposures with a counterparty,
we offset our exposures with that counterparty and apply the
value of collateral posted to us to determine the net exposure.
Accordingly, we actively monitor these net exposures against
defi ned limits and take appropriate actions in response, including
requiring additional collateral.
Swap, forward and option contracts are executed under stan-
dard master agreements that typically contain mutual downgrade
provisions that provide the ability of the counterparty to require
termination if the long-term credit rating of the applicable GE
entity were to fall below A-/A3. In certain of these master agree-
ments, the counterparty also has the ability to require termination
if the short-term rating of the applicable GE entity were to fall
below A-1/P-1. The net derivative liability after consideration
of netting arrangements, outstanding interest payments and