More Subprime Fall-Out: ResCap Files Chapter 11

Remember Ally Financial, Inc., headquartered in Detroit, Michigan? Think subprime mortgages and historic lawsuit settlement.

February’s Historic $25 Billion Settlement

In what was the largest industry settlement since big tobacco in 1998, February 9 brought a settlement agreement between 49 states and the U.S. Department of Justice. The suit was brought against the five largest mortgage lenders – Ally Financial, Bank of America, Citigroup, JPMorgan Chase, and Wells Fargo. President Obama said this “landmark settlement… [will] begin to turn the page on an era of recklessness.”

In this historic settlement, Ally Financial’s mortgage subsidiary Residential Capital, LLC, (ResCap) paid a fine of $212 million. On May 14, with over 3,500 employees and 2.4 million loan customers, ResCap filed a Chapter 11 voluntary petition with the U.S. Bankruptcy Court for the Southern District of New York. In re Residential Capital, LLC, Case No. 12-12020.

President William E. Brewer of the National Association of Consumer Bankruptcy Attorneys (NACBA) gave this decisive response to ResCap’s filing:

“[The] NACBA will be seeking global relief from the automatic stay to allow consumers in bankruptcy cases of their own to bring actions in those cases related to ResCap/Ally/GMAC claims. NACBA is committed to quickly obtaining the broadest and most efficient relief from the stay as possible, so that consumers and their attorneys can continue to bring lien-strip actions, objections to claim, and other actions in bankruptcy cases, without having to individually seek permission from the bankruptcy court in NY.”

AttorneyLawrence‘D’ Pew is a member of the NACBA.

ResCap’s Toxic Mortgage Assets

Like Bank of America’s Countrywide, ResCap was a big player in the subprime mortgage debacle. (ResCap stopped originating subprime mortgages in 2007.) After writing off $22 billion in old mortgage assets over a three-year period from 2009 to 2011, the bleeding continued into 2011 with ResCap losses at $402 million.

With ResCap under bankruptcy protection, Ally Financial can get out of the residential mortgage lending business altogether and focus on what really makes money – direct banking and automobile loans.

Not all may go well for Ally Financial. Investors in ResCap residential mortgage-backed securities (RMBS) have sued Ally Financial and want the parent organization to buy those securities back. Although subsidiary ResCap has protection in bankruptcy, there is no assurance that Ally Financial as corporate parent will be protected fromRMBS-investor legal challenges. The fall-out from ResCap could mean a loss to Ally Financial of $400 million to $1.25 billion, according to an AprilSECfiling.

Ally Financial’s CEO, Michael A. Carpenter, had this to say about the ResCap Chapter 11 restructuring:

“The action by ResCap will enable Ally [Financial] to achieve a permanent solution to its legacy mortgage risks and put these issues behind us… further strengthening [Ally’s] already leading U.S. auto finance and direct banking franchises.” Carpenter also commented that “[t]he single most important thing [Ally] can do for the U.S. taxpayer is to not put billions of dollars into this business [ResCap] on a going-forward basis.”

The GMAC “legacy” mortgages and securities that Carpenter referred to predate 2009 and amount to $10.9 billion as reported on Ally Financial’s annual report.

Stalking-Horse Bidders Vie for Post Position

A stalking-horse bidder is an initial bidder that sets a floor price at the auction; other bidders must counter with higher offers. The ResCap auction is scheduled for September. Nationstar Mortgage Holdings, Inc., (Fortress Investment Group, LLC, is the majority owner of Nationstar) was expected to bid $2.4 billion to purchase most of ResCap’s mortgage-servicing assets and debt. But Warren Buffett’s Berkshire Hathaway, Inc., is looking to replace Nationstar as the initial bidder. The remaining assets and charges would go to Ally Financial. Some expect ResCap to come out of bankruptcy protection by December and to wind down.

Taxpayer Bailout Funds for Ally Financial

In 1919, the General Motors Acceptance Corporation (GMAC) was founded by General Motors for the sole purpose of making auto loans. By 2005, GMAC was involved in far more than loans for cars and trucks, having added commercial financing, direct banking, mortgage lending, and insurance to its list of services. In 2006, a struggling GM sold 51% of GMAC to Cerberus Capital Management. At the same time, GMAC took on a new name – Ally Financial.

Ally Financial received $17.2 billion in loans as part of the General Motors and Chrysler taxpayer bailouts (receiving substantially more than Chrysler). While Ally Financial has repaid about $5.5 billion of the bailout money, it still owes $11.7 billion. And the U.S. Treasury Department still remains a 74% owner. In a presidential election year, pressure has been on Ally Financial to repay the bailout money, and ResCap has proven itself to be a black hole of unmanageable financial liability.

Commenting on ResCap’s Chapter 11 filing, U.S. Treasury Secretary for Financial Stability, Timothy Massad, stated that “[w]e believe that this action puts taxpayers in a stronger position to continue recovering their investment in Ally Financial.”

Ally Financial May Go Public

Some bankruptcy experts believe Ally Financial, a privately held company, may go public. Putting ResCap into Chapter 11 bankruptcy and ridding itself of that dead weight was a necessary housecleaning decision prudently made in advance of any offering.

If Ally Financial successfully turns things around with the ResCap bankruptcy, will Bank of America Corporation follow suit with its troubled Countrywide mortgage business?