Potential ResCap Bankruptcy Filing Spells Trouble for Ally Financial

May 14, 2012

By John Clark

Ally Financial Inc., a government-owned car loan lender, could suffer losses of up to $1.25 billion if its struggling mortgage unit, Residential Capital LLC (ResCap) chooses to file for bankruptcy, according to a report from Reuters.

Sources suggest that ResCap is "actively considering" heading towards bankruptcy court, which has Ally Financial officials concerned about the substantial litigation that would likely ensue if its mortgage unit sought to shed its debts through bankruptcy.

According to a recent report, ResCap may fail to make its upcoming debt payments, which is particularly troubling because the group missed a $20 million bond payment that was due three weeks ago.

The mortgage lender reportedly suffers from dangerously low levels of capital and insufficient cash flow, and a recent release made by the company admits that “further defaults could occur in the future.”

Of course, corporations file for bankruptcy protection all the time, but this case is unique because Ally Financial, which owns ResCap, is effectively owned by the federal government.

Sources say that the U.S. Treasury owns almost 75 percent of Ally Financial thanks to a series of bailouts during the economic recession. The bailouts were made necessary by crippling mortgages losses that threatened to sink the company.

When the loan was made, the Treasury Department had hoped to repay taxpayers by holding an initial public offering of the company’s stock, but this plan was put on hold last year when ResCap continued to experience mounting debt problems.

Because of Ally Financial’s unique position as a government-owned entity, officials have been very quick to note that ResCap executives will be deciding whether to file bankruptcy , and that Ally Financial officers will have no say in the matter.

In a recent conference call, Michael Carpenter, the CEO of Ally Financial, stressed that his outfit and ResCap are completely separate entities, and that the bankruptcy decision rests solely in the hands of the board that runs the mortgage unit.

Of course, Ally Financial has also offered subtle support in other ways. It has forgiven some debts owed by its subsidiary, but its patience may be growing thin.

And, even if the mortgage unit recovers some of its losses, ResCap’s financial future remains bleak because it is facing a “slew” of lawsuits related to allegedly toxic mortgage-backed securities that it sold to investors before the recession struck.