Banks are mostly backing out of the mortgage servicing business, so why does Warren Buffett’s Berkshire Hathaway (NYSE:BRK.A, BRK.B) want in?
Probably because (as the Oracle of Omaha likes to say) price is what you pay; value is what you get. And despite the disaster that the Residential Capital bankruptcy has been to privately held Ally Financial’s bottom line, Berkshire sees value there — at least at the current price.
Ally Financial, formerly the financing arm of General Motors (NYSE:GM) known as GMAC, swung to a steep second-quarter loss Wednesday on costs tied to the ResCap bankruptcy. But as we noted back when Ally’s ResCap filed for bankruptcy protection back in May, it’s ultimately a good thing.
Yes, bankruptcy always is a bummer, especially for a company’s creditors, but in this case it’s very welcome news for American taxpayers. Losing the ResCap mortgage burden helps free Ally to repay some of the $12 billion in bailout funds it still owes Uncle Sam.
Back during the housing boom, ResCap was a major lender of subprime mortgages and a massive generator of profits. But for the past three years, the unit’s portfolio of dodgy mortgages has been an albatross around its parent company’s neck.
Defaults on the part of subprime mortgage borrowers forced ResCap into bankruptcy protection — and scuttled Ally’s plan for an initial public offering, of which part of the proceeds would have helped pay down some of its debt to the federal government.
ResCap still is in business as it goes through bankruptcy organization and even has a buyer waiting in the wings in the form of Fortress Investment Group (NYSE:FIG).
But then in early June, Buffett’s Berkshire Hathaway got into the act with a better bid for ResCap.
So what does Berkshire see in ResCap, the fifth-largest mortgage servicer in the nation, collecting payments on nearly 2.5 million U.S. mortgages?
True, Wells Fargo (NYSE:WFC) and U.S. Bancorp (NYSE:USB) are posting record-breaking profits largely on the strength of mortgage and refinancing activity. But most big banks — especially Countrywide-hobbled Bank of America (NYSE:BAC) — are shrinking their mortgage servicing business.
With Buffett and Berkshire, it always comes down to price and value. The conglomerate has combed through ResCap’s books and found an under-valued asset. That’s the key to everything Buffett does.
Berkshire said it will match Fortress’ $2.4 billion bid and offer better terms on any break-up fee. It also bid $1.45 billion for ResCap’s loan portfolio, which Ally wants to buy for $1.4 billion.
Either way, it’s a small deal by Berkshire’s standards. The company spent $9 billion to acquire Lubrizol last year and nearly $28 billion for the remaining stake in Burlington Northern Santa Fe railroad in 2010.
Oh, and the company is sitting on about $38 billion in cash — and Buffett hates sitting on idle cash when there are undervalued assets to be found.
Furthermore, Buffett actually is bullish on the housing market over the long haul, and ResCap fits with Berkshire’s hodgepodge of businesses and investment.
Berkshire might be best-known for its insurance company holdings, but it also owns Clayton Homes, a homebuilder with a mortgage division. It also counts a few billion dollars of mortgage-backed securities in its investment portfolio.
Whomever wins the battle over ResCap, it will emerge from Chapter 11 relived of its crippling debts. More important, it will help free up Ally Financial to pay back the billions it still owes taxpayers.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.