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GE's Immelt shows how to break up a big bank

General Electric Co. just became a much safer stock for long-term investors, as CEO Jeff Immelt has finally delivered on his promise of turning the company back into an industrial powerhouse.

General Electric Co. GE, +7.50% said on Friday that it would sell most of the assets of GE Capital Real Estate for roughly $ 26.5 billion to investment funds managed by Blackstone Group LP BX, +1.94% with a portion of the loans going to Wells Fargo & Co. WFC, +0.26%

The asset sale will result in $ 16 billion in first-quarter after-tax charges, of which $ 12 billion will be noncash charges.

This move follows the initial public offering of Synchrony Financial SYF, +0.70% GE Capital’s consumer finance unit, in August. GE holds 85% of Synchrony’s stock, but plans to complete its full exit from the business through a tax-free spinoff by the end of 2015.

GE Capital had $ 494 billion in total assets as of Dec. 31. Excluding liquidity, the financial arm’s “net ending investment,” or ENI, was $ 363 billion. as of Dec. 31, down from $ 538 billion at the end of 2008. Following the completion of the sale of the real-estate assets and the spinoff of Synchrony Financial, the company expects GE Capital’s remaining ENI to total about $ 90 billion.

GE Capital’s remaining activity will be limited to providing financing for the parent company’s industrial customers, as GE made plain in this chart, sent out by Immelt via Twitter early Friday:

General Electric Co.

GE CEO Jeff Immelt sent out this chart early on Friday to emphasize GE’s focus on its industrial businesses, with a much smaller GE Capital dedicated to providing financing for the parent company’s industrial customers.

The importance of lowering liquidity risk

GE’s news release announcing its latest and greatest reduction of GE Capital summed up the move beautifully, saying “the business model for large wholesale-funded financial companies has changed, making it increasingly difficult to generate acceptable returns going forward.”

“Wholesale-funded” refers to GE Capital’s traditional reliance on the commercial paper market for liquidity. The problem with this short-term funding model for a balance sheet with long-term assets is that during a financial crisis, overnight liquidity tends to dry up as it did for GE late in 2008. When the company had difficulty finding buyers for its paper, the Federal Deposit Insurance Corp. stepped in and through its Temporary Liquidity Guarantee Program (TLGP) was covering $ 21.8 billion of GE commercial paper. GE Capital registered for up to $ 126 billion in commercial-paper guarantees under the TLGP.

General Electric obviously wishes to avoid ever needing another government bailout. When GE Capital’s ending net investment declines to roughly $ 90 billion at the end of 2015, the company estimates needing just $ 40 billion in funding, which is a relatively small amount. GE Capital will also “work with regulators” to end the unit’s designation by the Financial Stability Oversight Council as a “systemically important financial institution.” This means it will no longer be subject to the Federal Reserve’s annual stress tests or the regulator’s heightened level of scrutiny for major lenders.

Capital return is icing on the cake

GE’s stock was up 8% in the premarket, which isn’t a surprise, considering that the company is making such a big move to end its liquidity problem. The company also said it was expecting “approximately $ 35 billion in dividends from GE Capital under this plan,” and that the windfall would be used to fund most of a new stock buyback program totaling up to $ 50 billion through 2018.

It can be a bad sign for a company to make such huge buybacks, possibly implying that it doesn’t have better use for the cash. But GE already had $ 16 billion in cash and equivalents (excluding GE Capital’s $ 122.1 billion in cash and equivalents) as of Dec. 31. The company has plenty of cash and made it clear that its capital deployment plan would still “allow room for opportunistic ‘bolt-on acquisitions in GE’s core markets.”

The company also said it expect to maintain its current dividend through 2016, “and grow it thereafter.” GE pays a quarterly dividend of 23 cents, for an attractive yield of 3.58%, based on Thursday’s closing price of $ 25.73.

The combination of the vast liquidity improvement, the dividend and the share-count reduction and boost to earnings-per-share from the buybacks, should place a floor under the shares, cementing GE’s stock as a core conservative portfolio holding.

Back in January, after the company reported a 10% increase in annual profit from its industrial businesses, Jeff Reeves called GE “a boring stock everyone should own.”

Well, the stock just got a bit more boring, but boring is a very good thing, when it means lower risk, reducing the regulatory burden, lowering the share count and boosting earnings per share.

The breakup of GE’s “big bank,” could also help increase its price-to-earnings multiple. The stock at Thursday’s close was trading for 14.9 times the consensus 2015 earnings estimate, among analysts polled by FactSet. This compared with a forward P/E multiple of 17.5 for the S&P 500 index. SPX, +0.47% Large banks tend to trade for significant discounts to the S&P 500, and it is quite possible that investors who shied away from GE because of its status as a systemically important financial institution, will now look more favorably at the stock.

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