General Electric Co., the biggest issuer of U.S. corporate bonds, has a one-in-three chance of losing its AAA credit rating in the next two years as earnings deteriorate, Standard & Poor’s said.

S&P cut the outlook on the company and that of its GE Capital finance arm to negative from stable. While the AAA ratings were left intact, S&P said in a statement today that it was concerned about cash flow and funding for the finance unit as global conditions worsen. GE Capital’s stand-alone rating, without parent support, would be A+, four levels below, it said.

GE Chief Executive Officer Jeffrey Immelt said Dec. 16 that the company’s industrial businesses, which include NBC-Universal, will rise no more than 5 percent next year. That’s less than a range of 10 percent to 15 percent given in September. Profit at GE Capital will decline to $5 billion in 2009 from about $9 billion excluding restructuring expenses, he repeated.

“The priority concern from our perspective are the earnings prospects of” GE Capital Corp., S&P analyst Scott Sprinzen, who follows the finance arm, said in an interview. “And we know that they operate in a cyclical business, and that we’re in the midst of a cyclical decline. To some extent, that’s factored into the ratings. It seems that this is unfolding as an extraordinarily severe downturn.”

GE Capital would have to fall “well short” of the $5 billion in net income forecast for next year for S&P to reconsider the rating, Sprinzen said in the interview.

GE declined $1.43, or 8.2 percent, to $15.96 at 4:15 p.m. in New York Stock Exchange composite trading. Credit-default swaps on GE Capital rose 20 basis points to 415 basis points after reaching a one-month low of 395 earlier today, according to broker Phoenix Partners Group.

Known Risk

“The institutional investors that really make the market for GE’s debt, they already know the level of risk, regardless of what you call it, AAA or AA+,” said Guy Lebas, chief economist at Janney Montgomery Scott LLC in Philadelphia. “They’re trading with yields that are not reflective of a AAA credit rating. That’s largely because the company has exposure to the financial world.”

GE’s 5.875 percent bonds due in 2038, its most actively traded securities, rose .105 cents to 96.424 cents on the dollar at 3:40 p.m. in New York, according to Trace, the bond price- reporting system of the Financial Industry Regulatory Authority.

GE Capital’s “earnings deterioration in 2009 and 2010 could be greater than we previously assumed,” S&P said in today’s statement. “The outlook revision reflects the continuing risks posed by GECC’s reliance on confidence-sensitive wholesale funding, despite the benefits of temporary U.S. government support programs and of management’s ongoing efforts.”

Immelt’s Plan

Immelt outlined a plan to use capital to support the AAA rating, the highest available, and the $1.24 a share annual dividend, which the company has committed to paying in 2009, the same level as in 2008.

“If we successfully execute on our plan, S&P will reconsider its outlook,” Russell Wilkerson, spokesman for Fairfield, Connecticut-based GE, said in an interview. “We’re confident in our plan as laid out on Tuesday and we’ll execute in 2009.”

Immelt is shrinking GE Capital to less than 40 percent of the parent company’s profit next year from about half in 2007. On Dec. 2, the company said it planned to issue about $45 billion in long-term debt next year, less than the $66 billion it has maturing, and reduce commercial paper to $50 billion in 2009, less than the $75 billion it said previously. GE is reducing its leverage ratio to 6 to 1.

Dividend Cost

The company, which was approved to sell Federal Deposit Insurance Corp.-backed bonds up to $132 billion under that program, has issued about $12.5 billion so far this year to “prefund” the $45 billion it plans to refinance next year. The parent company added $5 billion in funds to GE Capital to help meet the new leverage ratio, Immelt told investors on Dec. 16.

“If we need to do more in that context as time goes on, we’ll do more,” Immelt told investors. “Because I think the AAA’s important.”

GE said in September it would keep its $1.24 annual dividend the same for 2009, the first time in at least 32 years with no increase. The dividend costs GE about $13 billion a year based on the number of shares outstanding on Oct. 2. That payout will be covered by cash generated from operations and dispositions this year of about $18 billion, according to a chart from the CEO’s presentation.

In 2009, a $13.4 billion dividend payout should be covered by cash generation, the GE Capital payment to the parent company and dispositions totaling about $16 billion, the chart said.

Vulnerable

The S&P outlook change is “another piece of evidence that the economic outlook is extremely negative,” said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York. “They’re an extremely diversified company. Their financial aspects have always been hard for investors to fully get their arms around. They’re so big, involved in so many things, their financial exposure does make them vulnerable to a downgrade in this environment.”

Moody’s Investors Service Dec. 2 affirmed its AAA rating and “stable” outlook designation for both the parent company and finance unit. Today, it repeated that assertion for GE Capital.

In its Dec. 2 note, Moody’s said it expects GE Capital to earn at least $5 billion in each of the next several years; that GE Capital can restore its historic payment level to the parent company in 2010; and that the non-finance units will generate cash flow that exceeds $16 billion in 2010.

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US and European shares rallied Tuesday a day after punishing losses as investors looked past the gloom that provoked Monday’s rout, but analysts say the rally remains fragile.

Wall Street was lifted by hopes for an auto sector rescue by the US government and General Electric’s better-than-expected business update while European bourses rose on a pledge by European Union ministers to implement economic stimulus measures.

The Dow Jones Industrial Average rallied 270.00 points (3.31 percent) to close at 8,419.09, coming off a horrific 679-point loss on Monday.

The Nasdaq composite climbed 3.70 percent to 1,449.80 and the Standard & Poor’s 500 added 3.99 percent to 848.81, after both fell more than eight percent on Monday.

Market action came as the Big Three Detroit automakers were pressing Congress for emergency loans of some 25 billion US dollars to avert a potentially catastrophic collapse. General Motors, Ford and Chrysler presented their business plans outlining how they would restore profitability.

Colleen King at Schaeffer’s Investment Research said driving the market gains was “auto bailout speculation,” or anticipation that the Detroit firms will prevail in their request for government aid.

Gregory Drahuschak at Janney Montgomery Scott said GE was another big factor in the rally, noting that the US conglomerate reassured markets with its quarterly update.

Drahuschak said the nearly nine percent loss in the S&P 500 was due to “fear that GE’s webcast today would include some significantly negative news.”

But the markets snapped back, he said after the updated was “not as bad as feared.”

GE said its fourth-quarter profit would be at the lower end of its forecast as it embarks on restructuring and other actions to cope with financial turmoil.

But despite the difficult economic environment, the company expects to earn more than 18 billion US dollars in 2008, before restructuring and other charges, GE vice chairman Keith Sherin said.

John Wilson, equity strategist at Morgan Keegan, said the stock market may be able to sustain a rally even with the economy mired in recession.

“The market will begin to look through the trough well before we or the economists see it, so the fact that we are in a recession doesn’t preclude the stock market forming a major low in here,” he said in a note to clients.

He said one model “shows the S&P 500 over 70 percent undervalued (compared) to the 10-Year Treasury note.”

European investors drew encouragement from news that finance ministers from all 27 European Union endorsed plans for a stimulus plan totaling 200 billion euros, equivalent to 1.5 percent of EU gross domestic product.

“Despite a lack of consensus amongst national governments, the European Commission’s bailout package is giving hope to equity investors,” said Kim Forkes at Economy.com.

In London, the FTSE 100 index of leading shares closed 1.41 percent higher at 4,122.86. In Paris, the CAC 40 was up 2.35 percent at 3,152.90 and in Frankfurt the DAX jumped 3.12 percent to 4,531.79.

Forkes said European markets “were also buoyed by hopes of deep monetary policy rate cuts by the European Central Bank and the Bank of England.” Both were due to meet on Thursday.

In other markets, Asian bourses fell in the wake of Wall Street’s plunge Monday. But Brazil’s Bovespa rose 0.75 percent and the Mexican Bolsa index added 1.38 percent. Canada’s S&P/TSX fell 0.93 percent.

Volatile trading conditions showed no signs of abating.

“As we are in the midst of the largest market fall since the Great Depression, it’s an understatement that the outlook is extremely uncertain,” said European equity strategists at JP Morgan.

Investors are looking to central banks this week for the latest round of action to combat the worst financial crisis since the 1930s which is threatening to plunge the global economy into recession.

Official data showed Tuesday that eurozone producer prices fell at their sharpest rate on record in October following another big drop in energy costs, raising the odds of a large interest rate cut for the eurozone on Thursday.

Analysts say the cut in the benchmark rate by the European Central Bank could be between 0.50 and 0.75 percentage points from its current 3.25 percent.

Traders were anticipating a big cut to British borrowing costs when the Bank of England policymakers meet on Thursday.

A steep interest rate cut by Australia’s central bank on Tuesday and fresh steps by Japan to tackle the credit crunch failed to soothe investor fears across Asia.

Tokyo closed down 6.35 percent on Tuesday, Hong Kong slid 5.0 percent, Seoul shed 3.3 percent and Sydney dropped 4.2.

Australia’s central bank slashed interest rates by 100 basis points — a larger cut than expected that dropped the official cash rate to 4.25 percent, its lowest level in more than six years.

But the rate cut “didn’t do anything to boost the market,” said CommSec market analyst Juliette Saly.

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Fifth Third Bancorp, which is receiving $3.5 billion in bailout money, will acquire Florida’s failed Freedom Bank.

The Bradenton, Florida bank, which was shut down on Friday by state regulators, is the 17th bank failure this year. The bank had total assets of $287 million and total deposits of $254 million, according to the Federal Deposit Insurance Corporation.

In addition to taking over the deposits of the failed Freedom Bank, Fifth Third of Grand Rapids, Mich. will purchase $36 million of assets. The FDIC will retain the remaining assets — mainly loans — to dispose of later. The failed institution had $214 million in loans, as of June 30, according to a July letter to shareholders.

Fifth Third Bank this week said it has received $3.5 billion as part of the federal government’s $700 billion plan to recapitalize the nation’s financial system.

Fifth Third is the second bank in a week to announce an acquisition after receiving its share of the government bailout funds. On Friday, PNC said it would acquire struggling regional bank National City in a deal worth about $5.6 billion. PNC is receiving $7.7 billion from the government.

Banks have come under fire for signaling they would use the money for acquisitions, rather than to resume lending to businesses and consumers. The federal government is strongly encouraging institutions to jumpstart their lending to revive the weak economy.

In Friday’s announcement, the FDIC said that that the cost to the Deposit Insurance Fund will be between $80 million and $104 million.

“Fifth Third’s acquisition of all deposits was the least costly resolution” for the FDIC’s insurance fund, the FDIC said in a statement.

The four branches of the failed Freedom Bank will open on Monday as branches of Fifth Third Bank. All customer accounts were automatically transferred to the new bank and their accounts will continue to be insured by the FDIC, according to the release.

No deposit customer at Freedom Bank will lose any of their deposit savings, according to Fifth Third.

Customers of the banks can still access their money by writing checks or using ATM or debit cards. Checks drawn on the bank will continue to be processed. Loan customers should continue to make their payments as usual, according to the FDIC’s statement.

The transaction will give Fifth Third approximately $675 million in deposits in the Bradenton-Sarasota-Venice area, and raise its deposit market share in that market from 8th to 4th, according to recent FDIC data. Fifth Third already had 16 branches in the Bradenton-Sarasota market as part of its nearly 1,300 branches in 12 states.

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