The bankruptcy of ResCap had pitted the market-titans against each other in a major financial and legal battle. ?In this US Government vs. Goldmans vs. Citi vs. Berkshire it is not yet clear where the battle lines are drawn or even who is in which corner. There are already allegations of market manipulation and fraudulent transfers of assets.
What is clear is that billions in assets are being bought, sold, traded and swapped by Goldmans, Berkshire and Citibank whose motives are unclear to the market. ?Part of the reason for the active trading had been for one party to flood and another to starve the?secondary?market for defaulted ResCap debt in order to drive-up or drive down recovery price of this debt. ?On June 6th a credit-event auction was held to settle CDS contracts referencing Residential Capital. According to Market and Creditex the final price was set at ?17.625 cents on the dollar- which means that ?means that sellers of protection will need to pay buyers of protection 82.375% of the notional amount of protection they bought.
Background: the ResCap Bankruptcy.
ResCap filed for Chapter 11 in Manhattan on May 14. The company, one of the largest originators and servicers of mortgages in the U.S., is a unit of Ally Financial, the former financing arm of General Motors that is majority owned?(74%)?by the U.S. Treasury. Ally itself is not in Chapter 11.
The Chapter 11 reorganization plan proposes that Ally Financial will sell the ResCap mortgage origination and servicing businesses to Nationstar Mortgage, which is majority-owned by Fortress Investment Group, and its legacy portfolio, consisting mainly of mortgage loans and other residual financial assets, to Ally. The company said that together, the asset sales are expected to generate approximately $4 billion in proceeds.
But before that, the company will have to deal with a motion to appoint an examiner in the case to look into possible fraudulent transfers between ResCap and Ally, which was filed by Berkshire Hathaway, a development that could potentially derail the company?s plans.
Basically the US government wants to sell Ally. But the highly leveraged ResCap subsidiary had made Ally an unattractive asset because of the fears that Ally may become responsible for ResCap's debt. The US government decided to purge Ally of this perceived risk by putting ResCap into bankruptcy and walking away from the train wreck.
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ResCap posted a $402 million loss in 2011 and had missed a $20 million payment on unsecured debt on April 17, 2012. ResCap listed $10.9 billion in mortgages on December 31, 2012, after wiping $22 billion in mortgages off its books in 2009, 2010 and 2011. The company had booked a substantial number of subprime mortgages. The bankruptcy was seen as a step by Ally to exit the mortgage business to focus on its profitable auto loan and direct banking business.
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Who owns ResCap debt??
ResCap bonds are widely held by numerous investors including many hedge funds. However Berkshire Hathaway until recently owned $500mm of the unsecured junior debt and $900mm of the 9.625% third-lien (secured) notes (40% of outstanding). Holding enough secured notes would allow Berkshire to prevent what's called a "cram-down" on the unsecured notes. In a cram-down the unsecured holders would have to live with (often) harsh restructuring terms pushed through by the secured creditors. By holding enough secured notes, Berkshire would in effect "protect" their unsecured claim by blocking a harsh cram-down. At least that was the theory.
Ally's Contribution to the ResCap Restructuring.
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Ally has proposed paying ResCap $750 million to settle any claims against the parent, buy as much as $1.6 billion of securities if others don?t, and provide $150 million to help finance ResCap?s operations during bankruptcy, according to a company statement.
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However the ResCap creditors are not happy with this proposal. The creditors? committee identified at least 20 different transactions with Ally and its affiliates involving the purchase of assets and businesses from ResCap, or the extension of credit secured by ResCap?s assets. These transactions involved billions of dollars and sizable ongoing businesses, the most significant of which was Ally?s 2009 acquisition of ResCap?s ownership stake in IB Finance Holding Company, the direct holding company of Ally Bank.
Berkshire's Involvement
Berkshire has asked the judge overseeing ResCap?s bankruptcy in Manhattan to approve an examiner to investigate deals made before the company sought court protection, including transactions with its parent, Ally Financial Inc.?This and other transactions may give rise to various potential claims that Ally harvested assets from ResCap before seeking a ?quick and easy divorce through bankruptcy,? Berkshire said.
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The claim ?is that Ally stripped ResCap of some of its best ?assets at below-market prices via "affiliate transactions" prior to filing.
Berkshire Strategy?
Berkshire Hathaway dumped more than $500 million in unsecured bonds of Residential Capital, starting just hours after it filed a court motion seeking the appointment of an independent examiner in ResCap?s Chapter 11 proceedings, court filings show. ?Berkshire's commitment to this fight that would potentially recover more on the unsecured notes was not as solid as predicted
Who did Berkshire sell the notes to??
The exact details of the sale are unknown, but the market talk is that Berkshire sold at least a large part of their holdings to Citi. ?Apparently Citi decided to deliver these notes into the ResCap CDS settlement auction. It was suggested that that Citi was long ResCap CDS protection. Dumping a big block of bonds would make the recovery lower and the payment on the CDS higher.
Who bought the ResCap bonds at the CDS auction??
It turns out that Goldman was on the other side of the trade. Being short the ResCap CDS (as many suspect it was), Goldman was interested in raising the recovery price because that would mean the bank didn't have to pay as much on the CDS settlement. The reason Goldman believed the recovery was going to be higher had to do with Berkshire's court filing (discussed above), complaining that Ally was stripping ResCap of good assets. Also Berkshire's holding of the secured (3d lien) notes to protect the unsecured gave Goldman comfort that Berkshire will fight for higher recovery in the unsecured bonds. And that likely got the firm involved in the short CDS trade. If Berkshire is indeed expected to recover more on the unsecured, the CDS will have to pay out less. But when Berkshire dumped their bonds, Goldman got caught on the wrong side of the trade and had to bid on the bonds to defend their CDS position.
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During the auction, there was a faceoff between two of the dealers, one delivering bonds and one that had a long thesis, according to sources. Those dealers were Goldman Sachs and Citi, sources said.
Goldman and Citi faced off during the CDS auction about the recovery of these unsecured bonds, because Citi came to market with a big block of the bonds ? presumably Berkshire's ? while Goldman had a long thesis that gave them more recovery, using Berkshire's own call for an examiner as support for the possibility that this allocation could somehow be renegotiated to get more recovery. At the CDS auction, Citi offered $520 million of the bonds &or sale, and Goldman bid on $345 million of those...
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What was the auction recovery on the CDS??
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Heavy trading of ResCap 8.5% notes due 2013 began June 5, continuing through today, at between 17 and 21.5, according to trade data. The level is not surprising given that the credit-event auction held on Wednesday to settle CDS contracts referencing Residential Capital set a final price of 17.625 cents on the dollar...
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Who benefited from this mess?
Why Berkshire decided to sell the bonds remains unclear, but the firm is obviously not interested in a prolonged fight for the unsecureds' recovery. Berkshire may have taken a hit on its position. It is possible the firm hopes for a better recovery on their secured bond holdings. The cram-down is now far more likely as Berkshire no longer has the unsecured notes to defend.
It is also unclear if Citi made money on this transaction, although it looks like the bank (which coincidentally is also partially US government owned) was more in the loop than Goldman. GS is now stuck with the unsecured bonds (which it bought in the CDS auction) as part of the game of ResCap musical chairs.
Status of the Unsecured Claims.
The new bond holders, with Goldman being the largest, will try to prove in court that Ally (effectively the US government) needs to cough more money because of the bank's affiliate transactions with ResCap. It certainly would be politically easier for the US government to fight Goldman in court than to take on Berkshire. Goldman vs. the US government will make for an interesting court case to say the least. Whatever the outcome, this story is far from over.
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