Eyes Are on Kidder as Woes Mount : Brokerages: Parent company GE denies a sale is in the works for the scandal-plagued firm.
When the prominent Wall Street brokerage firm Kidder, Peabody & Co. disclosed in April that its chief government bond trader had allegedly falsified transactions to create $350 million in bogus profits, the company sought to portray the situation as isolated misconduct by a wayward employee.
But to the chagrin of Kidder and its parent company, General Electric Co., the incident has instead focused attention on the overall soundness of the firm.
And many on Wall Street do not like what they see. Kidder is heavily invested in exotic securities backed by mortgages, and rising interest rates have severely undermined the value of those assets.
Just how bad the problems are--and what General Electric might do about them--is the latest guessing game on Wall Street.
A front-page article in the Wall Street Journal last week alleged that GE had Kidder on “life support” and had been forced to inject $400 million in fresh capital into the firm.
Indeed, one Wall Street source said GE was on the brink of liquidating Kidder entirely. Under this scenario, GE would transfer billions of dollars in troubled mortgage-backed securities into another GE unit while selling Kidder’s retail brokerage operations and other marketable assets.
GE and Kidder vigorously deny such predictions. GE, they say, has injected $200 million--not $400 million--into the brokerage. And Kidder has hardly been a basket case; last year, the brokerage earned $439 million.
“We believe Kidder Peabody is a strong franchise today, and we fully expect it to be an even stronger franchise a decade from now,” Dennis D. Dammerman, GE’s chief financial officer, said last week. Providing “the financial wherewithal to support our businesses during difficult times is a hallmark of GE.”
But just as a scandal-ridden Drexel Burnham Lambert was driven out of business when the market for junk bonds collapsed, the doomsayers are speculating that Kidder will be brought low by its exposure to mortgage-backed securities. No other major Wall Street house has anywhere near Kidder’s exposure in such instruments.
The allegations surrounding government bond trader Joseph Jett have cast serious doubt on the judgment of Kidder management. Jett, who had a spotty track record before joining Kidder, suddenly began racking up enormous profits in a business where Kidder was not a major force.
Many believe Jett could not have carried out his scheme without the acquiescence of his bosses. Jett denies the allegations; an arbitration case is pending. The Securities and Exchange Commission is conducting an investigation, and GE has launched its own inquiry.
The incident was a major embarrassment for GE Chairman Jack Welch; GE was forced to take a $210-million charge against earnings. But that is small potatoes compared to the problems GE might face if Kidder’s reported $12-billion portfolio of mortgage-backed securities is really in bad shape.
To start with, Kidder has a far higher ratio of assets to capital than most Wall Street firms. That means it is especially vulnerable to declines in the value of the assets. And as interest rates have risen, the value of securities based on mortgages has plummeted.
Moreover, many of the securities are exotic “derivatives” that are very difficult to value and virtually impossible to sell in a falling market.
However, Kidder claims to have cut its portfolio of mortgage securities by about a third since its peak earlier this year. And many analysts support the notion that Kidder’s problems have been exaggerated.
Nicholas Heymann of Natwest Securities raised his rating on GE stock last week, arguing that “fear about the potential for additional large, onetime charges (due to Kidder’s problems) is misplaced.”
GE shares fell 37.5 cents to $47.375 on Monday in New York Stock Exchange trading, down from a February peak of $54.875, even though Kidder has accounted for just 2% of the parent company’s operating profit since 1989.
Martin Knoblowitz, director at the credit rating agency Standard & Poor’s, said there is nothing to indicate that GE’s AAA credit rating would be endangered.
“They have substantial capacity,” he said.
One Wall Street analyst who asked not to be named noted that GE, with its array of 24 different financial services subsidiaries, has vast experience in dealing with troubled portfolios. He speculated that the company might move the troubled Kidder assets into another GE subsidiary and then try to sell the remnants of Kidder.
Perrin Long, First of Michigan Corp. analyst, said Kidder’s retail brokerage might be worth $100 to $150 million--small change compared to the $1.3 billion GE has spent on Kidder since 1986.
Not long after it acquired a controlling stake in Kidder, GE found itself deeply enmeshed in Wall Street’s insider trading scandals. Longtime executive Martin A. Siegel pleaded guilty to selling inside information to stock speculator Ivan F. Boesky, and Kidder was forced to pay more than $25 million in fines and penalties. Later, following the market crash of October, 1987, the firm--like other Wall Street giants--retrenched.
GE reportedly has been trying to sell Kidder on and off for several years, but the brokerage is considered unmarketable with its problems.
