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ResCap Bankruptcy Probe to Detail $25 Billion Ally Threat

Ally Financial Inc. (ALLY), the auto lender owned by U.S. taxpayers, may learn today how hard it will be to escape $25 billion in claims made against its bankrupt mortgage arm, Residential Capital LLC.

At noon, a bankruptcy examiner is scheduled to report the results of an investigation into whether Ally exerted so much control over ResCap that creditors can force the parent company to pay the mortgage unit’s debt.

Former U.S. Bankruptcy Judge Arthur J. Gonzalez oversaw the probe, spending $82.8 million to collect 2 million documents, interview Ally and ResCap executives under oath, and review every important contract and financial transaction involving ResCap, Ally and its former majority owner, an investment group led by Cerberus Capital Management LP.

“It could throw a monkey wrench into things,” Jesse Rosenthal, an analyst at New York-based Creditsights Inc., said in a phone interview. “This is many months in the making and many millions of dollars. I expect this to be hefty weekend reading.”

After getting a government bailout, Ally is now 74 percent-owned by U.S. taxpayers. Federal officials have been seeking to recoup the government’s $17.2 billion investment. The company considered an initial public offering before scrapping it until ResCap is resolved.

Gonzalez’s report may tell the market just how hard it will be for Ally to break free from ResCap and avoid years of litigation over soured mortgage-backed securities. Gonzalez’s findings aren’t binding on the bankruptcy judge who ordered it prepared, Martin Glenn in Manhattan.

Settlement Talks

Glenn and all sides in the case have said repeatedly that the investigation will influence settlement talks between Ally and creditors, as well as ResCap’s plan to file a bankruptcy proposal that pays as much of its debt as possible. Creditors and Detroit-based Ally have been in mediation for weeks.

Ally had proposed paying $750 million to settle claims that creditors say are worth billions. The official committee of unsecured creditors opposed that settlement, saying it was too low.

ResCap filed for bankruptcy almost a year ago, on May 14, 2012, partly to help it resolve lawsuits brought by investors that purchased mortgage bonds backed by home loans. The investors claimed the bonds lost value because many of the loans were bad. Such losses account for much of the $25 billion in unsecured debt that the creditors committee claims ResCap owes.

Board Agreement

Before the filing, the boards of Ally and ResCap agreed to that Ally would pay $750 million to the ResCap estate in what Ally Chief Executive Officer Michael Carpenter later called a “hostage payment.” ResCap also agreed to settle lawsuits with mortgage-bond investors by giving them the chance to collect as much as $8.7 billion.

From 2004 to 2007, a ResCap predecessor issued $197.8 billion in non-agency mortgage bonds, according to Inside Mortgage Finance, an industry publication based in Bethesda, Maryland.

After selling its mortgage-servicing business and a loan portfolio, ResCap has more than $4.5 billion to try to split among creditors claiming to be owed tens of billions of dollars.

Secured bondholders, whose debt trades at more than 100 cents on the dollar, are owed about $2.1 billion. The company also owes about $972 million to creditors holding unsecured, publicly traded debt, according to court documents.

ResCap claims to owe Ally at least $1.13 billion.

Chrysler Bankruptcy

Gonzalez, who presided over the bankruptcy of Detroit automaker Chrysler LLC, investigated a range of legal issues, including whether creditors may be able to sue Ally and ResCap executives and the companies for breach of fiduciary duty and fraudulently transferring assets from ResCap to Ally.

Under the U.S. Bankruptcy Code, if a parent company causes a subsidiary to become insolvent by taking away property without providing reasonable compensation, creditors can sue claiming that a fraudulent transfer took place.

Creditors can also force the parent to pay a unit’s debt by showing that the two “operated as a single economic entity.”

One point of contention between the company and creditors is Ally’s online bank. Creditors allege that Ally improperly stripped ResCap of a stake in the unit, robbing them of value that could be used now to reimburse losses.

Last year, hedge fund Elliott Management Corp., which owned a small stake in Ally at the time, said the Internet lender could fetch from $13.1 billion to $16.3 billion in a sale.

Fitch Ratings said Ally’s debt ratings will be negatively affected if it’s forced to cover many of the liabilities, according to a report yesterday. Ally has said litigation and private-label security claims may be from zero to $4 billion, Fitch said.

“Ratings could come under pressure if Ally is viewed as being liable for ResCap’s liabilities and is exposed to claims at the higher end of this range,” the ratings firm said. If the impact on Ally is immaterial, that could lead to “ratings stability,” Fitch said.

The case is In re Residential Capital LLC, 12-bk-12020, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

To contact the reporters on this story: Steven Church in Wilmington, Delaware at schurch3@bloomberg.net; Dakin Campbell in San Francisco at dcampbell27@bloomberg.net

To contact the editors responsible for this story: John Pickering at jpickering@bloomberg.net; David Scheer at dscheer@bloomberg.net

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