Ally Financial’s ResCap: A Smart Bankruptcy

The welcome move, plus asset sales, will free Ally from its subprime mortgage burden and help pay back Uncle Sam

By Dan Burrows, InvestorPlace Feature Writer

Residential Capital, the mortgage unit of privately held Ally Financial — formerly the financing arm of General Motors (NYSE:GM) known as GMAC — has filed for Chapter 11. It’s about time. Although bankruptcy is always a bummer, especially for a company’s creditors, 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.

Ally shelved plans for an initial public offering last year, the proceeds of which would have gone to pay down taxpayers’ 74% stake in the company, because of subprime mortgage woes. Ally was also one of only four financial firms to fail the Federal Reserve’s last round of stress tests, most likely because of ResCap.

ResCap will continue to service mortgages. Plus, a new owner is waiting in the wings. Nationstar Mortgage Holdings (NYSE:NSM), which is majority-owned by private equity shop Fortress Investment Group (NYSE:FIG), has stepped up with a bid. A bankruptcy court has to approve the filing and oversee the ResCap auction, but all the pieces appear to have been carefully put in place.

With the subprime mortgage mess behind it, Ally can focus on making car loans, internet banking — and paying back the Treasury Department. (Back when Ally was still GMAC, it received a total of $17 billion in public funds as part of the broader bailout of the U.S. auto industry.)

To that end, Ally is also looking sell operations in Canada, Mexico, Europe and South America to raise cash and refocus on its U.S. businesses. The divestitures could help Ally pay back about $8 billion of the $12 billion it still owes in bailout funds.

Ally said there’s no plan to put the IPO back on track, but it remains a possibility. Whether it’s a possibility that can provide the cash the firm still owes the government remains to be seen.

(What Bank of America (NYSE:BAC) can learn from Ally to use in dealing with its Countywide mortgage millstone is just speculation at this point.)

Give credit to Ally’s management for resolving not to throw more good money after bad. These are messy but necessary moves to put the subprime mortgage crisis behind it. And, more important, to pay back its public loans.

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