Financial Message
Sanjiv Khattri
Executive Vice President and
Chief Financial Officer
It was a mixed year for GMAC. A landmark transaction was completed in record time. Most of our core businesses delivered good operating performance, including record earnings from our insurance unit. But we had a very disappointing year in residential real estate, historically one of our strongest and most profitable businesses.
In global auto finance, whose $791 million1 in 2006 operating earnings were down approximately 10 percent year over year, strong originations and favorable credit performance were obscured somewhat by a $135 million third quarter upfront expense related to a $1 billion repurchase of zero-coupon bonds. While it adversely impacted 2006 results, the repurchase enabled us to retire some of GMAC’s most expensive long-term debt.
ResCap results, with 2006 earnings down about 82 percent2 versus 2005, suffered from a difficult U.S. residential real estate market that worsened rapidly in the fourth quarter of 2006. Market pressure severely depressed the value of ResCap’s portfolio of nonprime assets, necessitating increased reserves for increased delinquencies and severities in mortgages held for investment. Also contributing to poor performance were an increasingly difficult market for mortgages held for sale, credit losses related to lending relationships with third-party nonprime market participants, flat to declining U.S. home price appreciations and the slowdown in new home construction. The bright spot for ResCap was its record 2006 earnings performance in its International Business and Business Capital groups.
Our insurance business unit’s record $1.1 billion in 2006 earnings, up by more than 170 percent over 2005, reflected solid operating performance and a significant fourth quarter capital gain of $568 million from the rebalancing of our investment portfolio. Our move from a 70/30 fixed income/equity mix to a more conservative 90/10 mix was designed to result in a lower regulatory capital charge and more stable investment income over time.
In 2006, we announced the restatement of financial results for the first, second and third quarters, and the years 2001 through 2005, related to the accounting treatment of certain hedging activity. These restatements had no economic or cash impact on our business.
At year-end 2006, GMAC had an outstanding liquidity position, with $18 billion in cash and total additional available funds of $149 billion from a variety of sources. In 2006, we saw a tightening of our unsecured credit spreads as a result of GM’s sale of a controlling interest in GMAC and improved credit ratings. Both GMAC and ResCap completed unsecured bond deals at the end of 2006. As we go from playing defense to a more aggressive, growth-oriented strategy, we will continue to place a high priority on maintaining a prudent and balanced approach to liquidity.
In 2007 and beyond, our priorities include building upon the GM relationship, continued revenue diversification, reducing structural costs and improving our U.S. real estate business. Frankly speaking, we misread the U.S. residential real estate market in terms of nonprime weakness and experienced significant losses as a result. We are already addressing our portfolio issues, enhancing credit processes and working to stabilize this area of the business. This is a key personal priority for me.
During 2007–2008, you will see GMAC making significant progress in reducing structural costs through the consolidation and centralization of key business functions. We expect this important work to create a much more efficient and better aligned global organization.
Looking ahead, our global automotive finance business is well positioned to convert improved funding costs into attractive returns. We expect our insurance operations to continue to excel. We see steadily improving performance in GMAC Commercial Finance, and we’re confident we can manage our real estate finance business through an environment that will continue to be challenging at least into the early part of 2007.
We are moving forward as a fundamentally stronger company, with an improved credit profile and greater flexibility to pursue broader growth over the long term. We see an exciting future ahead for GMAC and its investors.
Sincerely,
Sanjiv Khattri
Executive Vice President and Chief Financial Officer
1 Excludes an LLC conversion benefit of $383 million
2 Determined using ResCap operating earnings of $182 million for 2006, which excludes an LLC conversion benefit of $523 million