GMAC Must Keep Insurance Rating Agencies Satisfied

Implications: GMAC, LLC includes real estate financing, auto insurance financing, and insurance.  Insurance is delivering much needed income and stability while the mortgage business hemorrhages and the auto loan business stagnates.  But insurance requires a very stable capital structure, and the insurance rating agencies like AM Best are watching GMAC closely to see how it resolves its mortgage problems.

Analysis:  It's no fun to clean up your messes in front of everybody, but GMAC, after years of relative privacy under the GM corporate umbrella, is now doing just that.  As a standalone company, GMAC must share all its warts, including Residential Capital, its real estate finance business.  Like most other real estate lenders, ResCap lost a ton of money in 1Q08 -- $859 million to be exact.  While GMAC describes to the business press its efforts to control the damage and salvage some value from ResCap, another key constituency is quietly watching.

P&C insurance, covering both auto dealers and auto owners, is about a $4 billion business, or about 40% of total GMAC revenue.  Insurance company sales, whether to consumers, businesses or other insurers (in the form of reinsurance) are highly subject to financial strength ratings.  AM Best, the leading insurance rating agency, currently rates GMAC at A-, or Excellent, but is watching closely.  A reduction in AM Best rating to B++ would be a huge setback for the insurance operation.  While the Best rating scale is fairly continuous, the perception of insurance buyers and especially insurance agents is not.  "A" rated companies are perceived as "strong enough", whether the rating is A+, A, or A-.  But "B" rated companies are perceived by many as "shaky", even if it's a B++ rating, which, analytically, is not that much different from A-.

GMAC acknowledged in its 1Q08 report of results that it has taken actions specifically to "aid in maintaining the current A- (excellent) financial strength rating issued by AM Best."  The company notes that the move is "expected to preserve the value of the insurance operations".  So the company is doing what is necessary to keep the insurance business healthy.

The relevance to investors is that, because of the sensitivity to rating agencies of its insurance business, GMAC has less flexibility with its capital structure than a pure finance operation.  So the company is highly motivated to resolve ResCap quickly, to prevent it from dragging down the insurance business.