Subprime Woes At Cerberus

It bit off a big hunk of risky loans when it bought GMAC

By Dawn Kopecki

General Motors took some flak when it sold a 51% stake of General Motors Acceptance Corp. (GM ), then the carmaker's most profitable unit, to Cerberus Capital Management and others in late 2006. Most figured the private equity firm got a good deal from the beleaguered carmaker, paying $7.4 billion for the auto and mortgage lender. That investment isn't doing so well now that GMAC's mortgage business, ResCap, is losing money. Owing to that drag, GMAC reported a $12 million loss for the first half of the year, compared with profits of $1.3 billion in the same period of 2006.

ResCap had once been the gem of the finance company, with earnings growing much faster than in auto lending; home financing accounted for 48% of GMAC's profits in 2005, up from 20% five years earlier. But the subprime woes have spread to ResCap--and perhaps more so than to other lenders. It hasn't posted a profit since the third quarter of 2006, months before problems surfaced at other subprime players. That has left Cerberus and GMAC's other investors scrambling to shore up the business. "We remain committed, supportive, and enthusiastic about our investment in GMAC Financial Services," says Peter Duda, a spokesman for Cerberus.

The private equity firm has other headaches in housing. Cerberus is in discussions to modify its deal to buy Option One Mortgage Corp. from H&R Block Inc. (HRB ) and, according to the tax preparer, may buy just the loan servicing business. In August, Aegis Mortgage, one of its portfolio companies, filed for bankruptcy. Four months earlier, Aegis co-founder and former CEO D. Richard Thompson, who was fired in October, 2006, sued Cerberus, claiming it mismanaged the business. (ResCap is run by a former Aegis executive, James Jones.) Cerberus declined to comment on the litigation.

For now, Cerberus and GMAC's other owners seem determined to come up with cash for ResCap. In March, GM forked over an additional $1 billion to Cerberus as a "price adjustment" to reflect the deteriorating conditions at ResCap, according to GMAC'S filings with the Securities & Exchange Commission--money that eventually made its way to ResCap. GM says it's not on the hook for any more payments to Cerberus if ResCap's earnings continue to decline.


Meanwhile, Citigroup, one of the original investors with Cerberus, recently renegotiated its line of credit with GMAC. The bank more than doubled the credit line (which was previously extended solely to the car loan unit) to $21.4 billion in August--with $14 billion doled out to ResCap as a loan, according to Citigroup. The mortgage group got a boost this quarter when it sold a health-care financing unit to another GMAC division for $775 million. That could help it weather the subprime storm. "If you stay in business, you will be profitable in the future, because the law of supply and demand will eliminate marginal players," says a source familiar with the GMAC deal. "No other [independent] mortgage company remains as well capitalized as ResCap."

ResCap jumped aggressively into subprime back in 2003. Today such risky mortgages account for 71% of its $62.7 billion loan portfolio. In ResCap's holdings, delinquent loans (those more than 60 days past due) spiked to 15.5% of the mortgages' outstanding balances as of June 30, from 13.7% a quarter before. ResCap has also lost 18 cents for every $100 of the subprime loans made in 2005 and 2006 that it owns, vs. the industry average of 12 cents, according to Fitch Ratings Ltd. "Their overall performance has been weaker [than their competitors']," says Christopher Wolfe, a Fitch analyst. "This goes beyond just general market conditions." Says Gina Proia of GMAC: "We have taken aggressive action to date and will continue to restructure operations in line with the changed environment."

Deteriorating conditions may only complicate matters. With huge numbers of adjustable-rate mortgages resetting through 2008, the market could face another wave of defaults and foreclosures. One GM executive, who declined to be named, says he expects a rough third quarter for GMAC because August and September were rocky for housing. "It could be 2008 before quarterly earnings [at ResCap] appear," says Phillip Kibel, a Moody's analyst. "Profitability prospects are not good."

With David Welch in Detroit

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