GE’s Heller Buy Confirms Solo Model’s Deficiencies

Commercial finance companies’ flirtation with independence appears to be over, with the last large stand-alone firm on Monday agreeing to a buyout by financial conglomerate General Electric Capital Corp.

In doing so Heller Financial Inc., a $20 billion-asset Chicago lender that is majority-owned by Japan’s Fuji Bank Ltd., reached the same conclusion as its former independent peers already had. Those companies found the disadvantages of pitting their resources against the balance sheets of the biggest banks and industrial companies had become too great to ignore.

“The lesson here is that commercial finance is a good business that is better off being done by banks or big companies with large balance sheets and lower funding costs,” said Reilly Tierney, an analyst at Fox-Pitt Kelton.

With the sale to AAA-rated GE Capital, any constraint from having lower credit ratings, and therefore higher funding costs, should disappear. On Monday, Standard & Poor’s and Moody’s Investors Service said they were reviewing Heller for a future upgrade. Heller has an A- and A3 rating from Standard & Poor’s and Moody’s, respectively.

“GE Capital’s strong balance sheet will enhance asset growth and offer Heller’s customers the most cost-effective solutions for their growth needs,” the two companies said in a prepared statement Monday.

Heller received a solid premium in the deal. The sale for $5.3 billion, or $53.75, a share valued the firm at a 50% premium to its Friday closing price. It also includes the commitment of Fuji to tender its 52% stake in the company.

The announcement followed the June sale of another public commercial finance lender — New York’s CIT Group — to diversified manufacturer Tyco International Inc. Another Japanese bank, Dai-Ichi Kangyo, now an affiliate of Fuji, was the biggest minority shareholder in CIT. Indeed the announcement of that deal in May caused a flurry of speculation about a GE-Heller transaction.

Still, Heller said it had not been courting bids.

“We were not looking to sell — we fully intended to keep on doing what we were doing,” said Gunnar Branson, a Heller spokesman, on Monday. “The offer came out of the blue,” he said.

But the agreement makes sense given the particular challenges that the handful of stand-alone finance companies have faced since they went public in the late 1990s, said analysts.

Pressure from ratings agencies to hold down their leverage levels meant that returns on equity paled in the eyes of investors compared to other specialty lenders, like credit card companies.

Even with constraints on leverage and funding, Heller never ran into the kind of trouble that beset several other stand-alone finance lenders such as Finova Corp. The Scottsdale, Arizona commercial finance company declared bankruptcy in March as a result of bad loans and higher borrowing costs.

Ann Maysek, a bond analyst with Bear Stearns & Co., said that she has long believed commercial finance companies were unlikely to remain independent because the pressures of being a publicly-traded company conflicted with their business models — which were based on being opportunistic and taking advantage of market anomalies. “When you have to satisfy the short-term mindset of the equity community, every quarter is expected to generate earnings growth,” she said.

“To be held to unrealistic growth expectations puts these companies,” in a position where they may decide “to book business they ultimately should have passed on,” she said.

Heller offset some of the disadvantage it had to larger balance sheet lenders like GE Capital or banking companies by steering away from highly commoditized businesses which are more apt to compete on price. Instead, Heller focused on business lines such the highly structured niche of leveraged buyout lending and vendor financing. It reported a 13% rise in net income, to $79 million, for the second quarter.

But this year it ran into an additional problem on the funding side — weak appetite by investors for commercial paper of its class.

Heller “couldn’t benefit from lower rates,” as much as it should have, because “there weren’t enough buyers for their paper,” said Mr. Reilly.

Though banks have steered clear of the last two deals in this sector, commercial finance has been a longstanding business for some.

Through its 1997 acquisition of Corestates, First Union Corp. inherited New York-based Congress Financial Corp., which has $9 billion of assets. Wells Fargo & Co. owns Los Angeles-based Foothill Capital Corp., which has over $4 billion of assets. And more recently, Citigroup gained over $20 billion in commercial finance managed receivables with its acquisition of consumer lender Associates First Capital.