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Foreclosures Smack GMAC

GMAC's woes continued in the fourth quarter, and some investors view the company's promise of profitability in 2008 as less than credit-worthy.

The finance unit of General Motors (GM), which is now 51%-owned by private equity firm Cerberus Capital Management, posted a fourth-quarter loss of $724 million, down 28% from $1.02 billion in the same quarter last year.

Record mortgage foreclosures in the U.S. last year led to a $2.3 billion companywide loss for 2007, but GMAC vowed to return to profitability in 2008, despite falling home prices and the likelihood of an economic recession.

"Losses in the fourth quarter decreased compared to the prior quarter. However, GMAC's performance throughout 2007 was severely affected by the ongoing challenges in the mortgage, credit and capital markets," said GMAC CEO Eric Feldstein. "As a result, 2007 was a year of significant transformation for the organization -- driving aggressive actions designed to reduce risk, streamline operations and rationalize our cost structure. We believe the steps taken position the company for future success."

The company's home lending business, Residential Capital, posted a net loss of $921 million, while the prior-year net loss was $128 million. It said the results reflect writedowns on the value of credit residuals and mortgages.

Meanwhile, GMAC's auto-lending business reported a 77% drop in earnings to $137 million. The company attributed that to a lower gain on the sale of auto loans in North America and it took writedowns on "certain residual interests and other assets."

The results fanned speculation on Wall Street that the credit problems that have slammed the U.S. home lending industry are spreading to the auto industry. In the fourth quarter, GMAC said its North American 30-day delinquency rate on managed loans climbed to 2.67% from 2.35%, while loan charge-offs fell to an annual rate of 1.3% from 1.36%.

"Clearly, auto finance delinquencies are increasing," says Bradley Rubin, automotive sector specialist with BNP Paribas. "We think there will be a significant increase in auto finance delinquencies this year. That will impact the company's underlying earnings negatively."

Profits at GMAC's insurance arm also fell, down 91% to $68 million on year-earlier capital gains. The value of GMAC's insurance investment portfolio declined 5% for the quarter to $7.19 billion.

As for its home lending business, GMAC said it bought $740 million of ResCap debt during the quarter to bolster its capital reserve and prevent and breach of its debt covenants. ResCap ended the period with equity of $6 billion, which GMAC said exceeded requirements set by lenders. The company also said it is exploring acquisitions, sales, alliances and joint ventures that could help ResCap, but it's unclear whether a transaction will emerge.

Moody's Investors Service responded to the results by downgrading ResCap's senior debt today to B2 from Ba3 and dropped the senior unsecured rating of GMAC to B1 from Ba3, with a negative outlook for both firms. The credit ratings firm cited "the risk that ResCap's net worth could fall below its minimum net worth covenant if GMAC doesn't provide more support, and its belief that "ResCap's franchise is impaired."

Sean Egan, president of a Egan & Jones Ratings, says his firm is planning more dramatic cuts to GMAC's credit ratings.

"GMAC needs an investment-grade credit rating to survive in the long-term, but it's moving in the opposite direction," Egan says. "The company needs to turn things around in the next month and a half or it's going to be in worse trouble."

GMAC's results will also weigh on GM's fourth-quarter earnings, due out next Tuesday. Toyota (TM) just reported its first decline in North American quarterly sales since 2003, which is another sign of an economic downturn that could be especially tough on GM, Ford (F) and Chrysler -- which is also owned by Cerberus.

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