Ally Financial walked the same road as Bank of America last quarter when it sought counsel to evaluate the benefits of sending its mortgage arm, Residential Capital(ResCap), into bankruptcy. Rumor has it, the plan is a no-go, but has the damage already been done? The goal of distancing itself from ResCap would have been to gussy up the parent, strengthening its position before a planned IPO. But, did merely considering this maneuver compromise the offering’s potential value? Or, did a separate agenda achieve a different goal?
The Problem with Bankruptcy
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“There’s a reputational hazard,” told Harvey Miller a veteran bankruptcy lawyer at Weil, Gotshal & Manges to the Wall Street Journal in November. “Once you put a subsidiary into bankruptcy, people start to wonder: How safe is the parent? How safe are the other affiliates?”
This may have been the case with Bank of America’s decision to pay the $8.5 billion settlement for certain of its subsidiary, Countrywide’s, liabilities. The board voted unanimously against bankruptcy proceedings for Countrywide when certain risks (such as fears that parent company creditors would ask for additional debt guarantees, and that bankruptcy may not completely release Bank of America from future liability) were exposed. In Ally’s case, a heavy-hitting group of ResCap bond holders (including funds managed by John Paulson, David Tepper, and Warren Buffett) likely influenced the decision, retaining the services of White & Case LLP to protect their collective interests of some $800M in debt.
“A forced ResCap filing would be a big mistake and create significant litigation against Ally,” Gerard Uzzi, a partner at White & Case in New York, said in a statement from the firm. Adam Steer, an analyst at Brookfield Investment Management, told Bloomberg News, “The bondholders are saying, ‘You can try, but we’re going to fight you tooth and nail.’”
All speculation aside, there were real consequences to these rumors. Institutional Risk Analytics downgraded Ally’s outlook to negative in mid-November following reports of the bankruptcy consideration. “The idea of the affiliate of a bank holding company defaulting without causing the parent company to also slide into a bankruptcy is absurd,” said Christopher Whalen, an IRA Senior Vice President.
An Ulterior Motive?
Yet, some are speculating that talk of a ResCap bankruptcy may have been somewhat of a device. Bankruptcy rumors “sent ResCap’s bond prices falling, making it easier for Ally to reach an agreement with ResCap creditors, including Warren Buffett’s Berkshire Hathaway, to amend their ResCap debt,” said the New York Post. “Without ridding itself of ResCap,” it speculated, “it was unlikely Uncle Sam could recoup its bailout cash.”
It seems the matter was never a simple case of a parent company wanting to fly higher by cutting loose its own dead weight. Ally Financial’s own troubled position finds planned proceeds from its IPO already earmarked to help pay off $17B in bailout funds. It must also strive to stabilize the $36B in mortgage assets in its non-ResCap portfolio. ResCap alone has another $19B, bringing the grand total of mortgage assets owned by Ally and its subsidiaries to $55B.
The Deal is Off
There were other problems with the deal, reported the New York Post, saying that “Fannie Mae, Freddie Mac, and others would immediately sue Ally if ResCap filed [for bankruptcy] because they have the right to [assign] improperly underwritten loans back to the originator. Then Ally depositors would likely start withdrawing some of their $44 billion of deposits.”
So, what’s Ally’s best move at this point in time? It already delayed IPO plans in Q1 of 2011 and never followed through with its announced plan to wait out a temporarily soft market to pursue its IPO in July. It also never ended up buying ING Direct’s online banking arm in order to bolster its deposits. And recent ResCap bankruptcy talk has simply added to the perception that Ally is grapsing.
Perhaps it could cultivate confidence by showing not only that it has come up with some viable plan, but also by demonstrating a renewed commitment to doing what it says it will. Given legal, popular and political outcry surrounding subprime mortgage lending offenses, it’s unlikely that Ally can employ any tactic to change its situation. One way or another, Ally (and its creditors) will continue to pay for the company’s bad decisions.