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Fair Game

Mortgage Unit Troubles Ally Financial

WHEN General Motors was bailed out, the government sank $17 billion of taxpayers’ money into G.M.’s troubled finance arm, GMAC.

Three years on, we’re still waiting for the payback.

While the Treasury Department sold most of its holdings in G.M. last year, it unloaded only a small portion of its stake in GMAC, which is now known as Ally Financial. Taxpayers today own roughly a quarter of G.M., but they still own 74 percent of Ally.

G.M. is making a lot of money (last week, it reported a first-quarter profit of $1.32 billion) but all is not going smoothly at Ally. While the company’s overall numbers are improving, its mortgage unit is in deep trouble.

That unit, Residential Capital, missed a $20 million debt payment in mid-April. Given that it has roughly $300 million in debt payments coming due from now till June, speculation is rife that ResCap will file for bankruptcy.

It’s no shock that an aggressive mortgage originator like ResCap is experiencing hard times. Like others in the industry, it has absorbed enormous losses from bad loans. ResCap also faces a flood of demands to buy back the mortgages it sold to investors and guarantors. These parties contend ResCap breached promises when it sold the loans.

Clearly, ResCap is a burden Ally wants to shed.

Gina Proia, a spokeswoman for Ally Financial, said that maximizing value for shareholders, including taxpayers, was the company’s top priority and that “addressing the risks in the mortgage business is crucial to successfully pursuing strategies that would best position the company.”

A bankruptcy is always messy. But a bankruptcy inside a financial holding company that also owns a bank could be particularly ugly. What might be the unintended consequences? Taxpayers might wonder, for instance, whether a ResCap bankruptcy would hurt Ally’s other operations — and its ability to pay them back.

Granted, the old GMAC has had some success rebuilding itself as Ally Financial. Overseen by Michael A. Carpenter, a former top executive at Citigroup, the company generated net income of $310 million in the first quarter of 2012, versus $146 million in the same period last year.

Ally Bank had $47.2 billion in deposits at the end of the first quarter, with retail deposits up $1.6 billion, or nearly 6 percent. It renewed $15 billion in auto-loan credit facilities that quarter. So far, the company has paid $5.5 billion in stock dividends to the Treasury.

Ally Financial has $11 billion in long-term debt coming due this year. As of March 31, it had $24.5 billion in liquidity.

Such apparent strengths aside, worries over a ResCap bankruptcy prompted Fitch Ratings to warn last month of a possible downgrade in Ally’s senior debt rating, already a junk-bond-grade BB-minus. “These kinds of developments create uncertainties and it is very hard to predict how they play out,” said Christopher Wolfe, a Fitch analyst.

ResCap had $653 million in cash and cash equivalents on its balance sheet at the end of the first quarter, more than enough to pay the debt maturing in coming weeks. Skipping the $20 million debt payment last month, however, sent a clear message that ResCap is in asset-protection mode.

For the moment, depositors and creditors of Ally Financial seem relatively unfazed. That’s surprising, given the deep ties between Ally Financial and ResCap.

As of March 31, for example, Ally had extended $1.4 billion in financing to ResCap. Ally concedes that it might not be paid back if ResCap went bankrupt.

Ally also covered ResCap’s $110 million cash payment in a foreclosure settlement with state attorneys general earlier this year. And Ally’s most recent quarterly report estimated that losses related to ResCap’s litigation and loan repurchase obligations could reach $4 billion more than it has set aside.

“ResCap’s ability to pay for any such losses is very limited,” the filing noted. Disappointed claimants would almost certainly try to move up the corporate ladder to Ally for payment.

Ally could face other costs from a ResCap bankruptcy. For instance, Ally might have to pay more for its financing if investors become spooked or tire of protracted litigation. If yields on Ally’s almost $100 billion in debt, with an average maturity of 3.5 years, rose by one percentage point, that would cost the company $3 billion on a present value basis. This is not an aggressive estimate; after the ResCap bankruptcy talk took hold, spreads on Ally Financial credit default swaps increased by one percentage point.

ANOTHER danger would be the acceleration of all the repurchase claims lodged against ResCap by investors and mortgage guarantors. The unpaid principal balance on these loans is estimated to be $34 billion currently, but that figure could grow in a bankruptcy filing as additional claimants come out of the woodwork. That’s what happened in the Lehman Brothers bankruptcy, for example.

Although repurchase claimants would be considered general unsecured creditors in a ResCap bankruptcy, the put-back demands would very likely be somewhat senior to those of other unsecured creditors because of their contractual nature.

Moreover, the litigation surrounding these claims is sure to go on for years. Almost four years after Lehman filed for bankruptcy, the residential mortgage repurchase demands represent the largest group of disputed claims remaining in the matter, according to a January 2012 report on the Lehman estate.

If ResCap continued operating, however, many of these repurchase claims could be defeated, in part because statutes of limitations covering the disputes are expiring.

Other litigation would also ensue. For example, Ally purchased assets from ResCap in a series of complex transactions during 2007 and 2008 and creditors would probably scrutinize valuations in those deals, as well as whether Ally’s board conducted satisfactory due diligence on them.

Is there an alternative to bankruptcy? Experts say that out-of-court restructurings often work well in these situations. Such a deal would have costs for Ally, but it could be less expensive than a ResCap bankruptcy.

Timothy G. Massad, assistant secretary for financial stability at the Treasury, said the government was working closely with the Ally board. “Successfully addressing the legacy liabilities at ResCap would put taxpayers in a stronger position to continue recovering their investment in Ally,” he said.

ResCap’s board, which is separate from Ally’s, will ultimately decide the matter. Those directors declined to comment, through the Ally spokeswoman.

Given the ties between ResCap and its parent company, Ally will almost certainly have to write a check to escape this mess. The only question is how big that check will have to be.

A version of this article appears in print on  , Section BU, Page 1 of the New York edition with the headline: Mortgage Unit Troubles Ally Financial. Order Reprints | Today’s Paper | Subscribe

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