The new company, Residential Capital Corp, attracted an impressive $17bn of orders from almost 400 investors for its $4bn debut in the capital markets, signalling the institutions' confidence in the robustness of this part of the business.
GMAC's subsidiary Residential Funding Corp, based in Minneapolis, has long been one of the biggest mortgage lenders in the US, financing itself with a mixture of securitisation and loans from GMAC.
Even before its downgrade to junk by Standard & Poor's on May 5, GMAC had been planning to hive off RFC into a separate company to ensure that the mortgage business could continue to be financed economically and to make it easier to sell if that became necessary.
In its new standalone form, Residential Capital is rated Baa2 by Moody's, the same level as it rates GMAC; BBB- by S&P, two notches above its parent; and BBB by Fitch, one notch above. All the ratings are on negative outlook.
ResCap had to cope on its debut with yet another down draught in car companies' bond prices, after Ford yet again lowered its 2005 earnings forecast on Tuesday. ResCap insulated itself by pricing its deal to sell.
Lead managers Bank of America, Bear Stearns, Citigroup and JP Morgan priced Residential Capital's $2.5bn five year fixed rate tranche at 262.5bp over Treasuries — 200bp tighter than GMAC but 175bp wider than Countrywide, the mortgage financier ResCap most wanted to compare itself to.
The $1bn two year FRN came at 137.5bp over Libor and the $500m 10 year at 292.5bp over Treasuries.
"The company made a conscious decision to price on the cheaper side to reward investors and leave them with a good taste in their mouths," said a banker at one of the lead managers. "They left a bit on the table specifically so that if there was volatility in the auto sector their deal would continue to perform well."
ResCap's prudence turned out to be valuable. Between the deal's pricing and being freed to trade on Tuesday, Ford cut its 2005 earnings guidance from $1.25-$1.50 a share to $1-$1.25, because of a worsening outlook for its North American auto operations.
Moody's then placed Ford's Baa3 rating and Ford Motor Credit's Baa2 on review for possible downgrade.
Auto bonds slide
Spreads on auto paper widened on the news and by Thursday some Ford bonds were 78bp wider on the week.
Residential's deal bucked the trend and tightened as much as 15bp-20bp on the break on Tuesday. Even while the wider market started selling off after a plunge in US equities on Thursday afternoon, ResCap's five year was still trading 6.5bp tighter than its launch spread.
"The market gave them a lot of credit for the protections in the operating agreement," said a banker at one of the leads, referring to Residential's corporate structure. "They have independent directors from GMAC, have a dividend restriction and the step-up language in the deal got people comfortable in the transaction," he added.
Even so, Residential was not completely successful in convincing investors it no longer carried car industry risk.
"ResCap was trying to convince them it was not entirely GMAC risk but should instead be compared more with Countrywide," said a global syndicate head at one of the Wall Street banks. "Whether they were successful is still debatable. They got a price 200bp through GMAC, so that's great, but at 175bp wide of Countrywide on the five year I don't think they convinced people they were a mortgage company like Countrywide and not a subsidiary of an auto company."
That tinge may lessen over time. "GMAC's mortgage unit has been able to sustain impressive profitability, even with the decline in residential mortgage industry volume," S&P commented on May 6. "This unit is benefiting from growing market share in the residential sector, a countercyclical increase in mortgage-servicing income, increased fee-based business, and expansion in overseas markets."
GMAC capitalised ResCap on May 20 with $2bn of equity by converting some of its intercompany loans to equity. The residential unit still owes GMAC $8.2bn, of which $5bn will be converted to long-term subordinated debt.
Fitch reported that ResCap was likely to use proceeds of its own debt issuance to repay its debts to GMAC, which in turn will lighten GMAC's debt burden.
Wave of high grade deals
The Residential Capital deal was the highlight in a wave of more than $18bn of new issuance this week, including a slew of $1bn-plus jumbo global bonds.
IBM added to the supply on Thursday with a blowout $1.5bn two year floater, priced flat to three month Libor and led by Citigroup and HSBC.
Abbey issued $2bn of two year floaters at 1bp over Libor via Citigroup, Credit Suisse First Boston and Goldman Sachs.
Goldman self-led $3bn of five year fixed and floating rate notes; HSBC $2bn of 10 year notes at 96bp and Bear Stearns a $1bn offering of five year fixed rate global notes.
The continued flattening of the Treasury curve this week took its toll of issuers raising 30 year money.
Fosters, the Australian wine and beer group, issued a successful $700m 10 year bond at 114bp over Treasuries, led by Citigroup, CSFB, Goldman Sachs and JP Morgan, but paid 160bp for its $300m 30 year tranche.
Metlife also had to offer a significant pick-up in spread over its 10 year for its $1bn 30 year bonds, priced at 132bp by lead managers Bank of America and Goldman. That compared with the 92bp spread on its $1bn 10 year.
"The 10s and 30s credit curve has steepened as the Treasury curve between 10s and 30s has flattened, because investors are requiring more spread to go out to 30 years to compensate for what they have lost in Treasury yield," said one syndicate manager.
By Thursday afternoon, the high grade corporate bond market was showing definite signs of indigestion, and it was upset by the oil price hitting $60 a barrel and its impact on US equities.
"We have gotten through a pretty substantial portion of supply in the last couple of weeks and I think the market is due for a bit of a pause going into the end of this month and the July 4 holiday," said a head of global syndicate in New York. "We also have second quarter earnings coming up so you will probably see a bit of a slowdown in the calendar at the beginning of July. But we will have had one of the more active months we have had all year."
There are still deals in the pipeline, including a $1bn debut by Wrigley, the chewing gum maker.
