Updated from 2:01 p.m. EDT
Subprime lending worries on Tuesday drowned out the initial optimism that
inspired by confirming the release of its long-delayed 2006 earnings report.
The automaker's shares popped on Monday after it announced that its results were due out before Wednesday's opening bell, but those gains were being returned on Tuesday. The stock recently was trading down $1.15 cents, or 3.7%, to $30.17 after GM's finance business confirmed a jump in defaults in its subprime mortgage portfolio and said it will receive $1 billion from the automaker.
Before it delayed its earnings release in late January, GM was expected to report its first fourth-quarter profit since 2003 and point to that as a sign of progress on its long campaign to revive its business. Now, the company faces issues related to GMAC's lending problems.
GMAC connects the world's largest automaker with problems at major mortgage investment companies, like
New Century Financial
Accredited Home Lending
( LEND), who have spooked the financial markets by warning of a sudden rise in defaults and liquidity crunches.
"People didn't expect things in subprime to get this bad this fast," says Morningstar analyst John Novak. "Also, GMAC has more exposure to the sub-prime mortgage market than most people think."
GMAC is the largest provider of auto loans in the U.S., but its Residential Capital home-lending unit, known as ResCap, is one of the top 10 mortgage lenders in the country as well.
For the fourth quarter, GMAC reported earnings of $1 billion, up sharply from $112 million a year earlier, but the latest results included a $791 million tax benefit from its conversion to a limited liability company. At ResCap, GMAC reported an operating loss of $651 million, compared with profit of $118 million a year earlier.
"ResCap has sharply reduced its production of nonprime mortgages and has stepped up its loss mitigation efforts as it relates to the company's existing nonprime mortgage exposure,'' GMAC said in the statement.
In a bid to raise cash, GM sold a 51% stake in GMAC to a consortium led by Cerberus Capital Management in November. The deal valued the business at around $14 billion, but the finance company's book value is still being negotiated by the parties.
The recent carnage in the subprime lending market is now complicating that negotiation.
"We believe that one cause for the delay in GM financials is the need to adjust GMAC's book value -- and therefore the Cerberus purchase price -- due to provisions and write-downs from subprime mortgages," wrote Lehman Brothers analyst Brian Johnson in a recent research report. "We had originally estimated GM might need to contribute $300 to $400 million in cash to GMAC to rebate part of the closing proceeds. In light of recent profit warnings from other players active in the subprime market, we reexamined our assumptions."
Now, GMAC says GM will pay it roughly $1 billion because its mortgage portfolio is valued at less than previously believed under the deal.
That said, with roughly $21 billion in cash on its balance sheet, most observers are hopeful that any charges will be little more than a hiccup on GM's road to revival.
"Whatever the issue ultimately is, my sense is that it will be manageable," says Novak. "It's completely possible that because of the charges, the company won't have a positive net income quarter, but people will be willing to overlook that. The risk is that they come out and say they still can't quantify what their exposure is yet. That's a downside scenario."
GM, which has restated its results seven times in the past two years, filed a request with the
Securities and Exchange Commission
for an extension of the March 1 deadline for its 2006 financial results. In mid-February, the company said it had "substantially completed" a review of accounting issues that forced it to restate financial results back to 2002 again.
Excluding any one-time charges, analysts expect the company to report fourth-quarter earnings for the fourth quarter of $1.19 a share, which would put its 2006 earnings at $4.39 a share, according to Thomson First Call.
E.K. Riley Advisors analyst Robert Toomey, who holds a buy rating on GM shares, expects an upside to Wall Street's forecast. He estimates the company will report earnings of $1.21 a share for the quarter, before charges.
"If results come in around expectations and the company offers a guidance to the effect that they don't see the subprime issues as a continuing problem, then we'll be in good shape," says Toomey. "We're going through a hiccup in the consumer cycle. I don't think we're going into a recession, though it's a possibility. We're going through this financing cycle and it's going to be ugly, but a year from now, this will not be the issue that it is now."
If credit issues extend beyond the subprime market, the broader health of the U.S. economy could be weakened and that could hurt automotive operations at both GM and
. But that's a prospect that Wall Street has yet to entertain.
"Investors are mainly focused on GM's outlook for the rest of this year and how things stack up for the new products that have been introduced lately," says Novak. "Everyone recognizes that this is a work in progress, and so they're looking for signs of progress."