ResCap Worries Dent GM

GMAC spokeswoman Gina Proia says, "GMAC and ResCap remain focused on turning [ResCap's business] around amid a very challenging environment."

Proia says the company has reduced its nonprime exposure significantly. For instance, she says it has stepped up remediation and loss mitigation efforts. It's restricting origination of mortgage products that have limited market liquidity, and it is right-sizing its structural cost base.

She also says ResCap's weakness is "primarily" located in its subprime portfolio, but it has seen a rise in defaults on so-called Alt-A loans, which are prime loans with high loan-to-value ratios for which borrowers provided little documentation of their income.

On a second-quarter conference call with analysts, ResCap CEO Jim Jones said increased default rates had also spread to second mortgages in the prime category.

Shares of Countrywide closed down 83 cents, or 4%, to $20.49 after it reported its need for emergency financing. The company has a much bigger stake in the overall lending market; Countrywide reported earnings in 2006 of $2.7 billion on revenue of $11.6 billion, compared with ResCap's operating earnings of $182 million on revenue of over $3 billion.

But ResCap's business was more heavily weighted toward the nonprime market. Countrywide reported total loan production last year of $421 billion, of which roughly 8% was classified as nonprime. ResCap had loan production of $161.6 billion, of which 19% was nonprime.

Moody's and Fitch both kept Countrywide's credit ratings in investment grade territory, while ResCap was reduced to junk. Meanwhile, even if ResCap is able to weather the credit storm, Merkle says GM's profitability will face stiff headwinds in the fourth quarter.

"They're not going to make the production cuts they need to make in the third quarter, so they're going to be slow to react to the softening demand out there, partly because of GM's ongoing labor negotiations with the United Auto Workers union," says Merkle. "So by October, we're going to see inventory levels for the Big Three balloon again, and trying to cut production against a backdrop of falling demand is very difficult for these companies."