By Nick Brown
NEW YORK (Reuters) - A bankruptcy judge on Wednesday approved a settlement in which the U.S. government-owned Ally Financial Inc , formerly the finance arm of General Motors Co., will pay $2.1 billion to its bankrupt unit Residential Capital LLC .
U.S. Bankruptcy Judge Martin Glenn also made public a previously sealed examiner's report concluding that Ally made missteps that left ResCap with an "unreasonably" small amount of capital before putting it into bankruptcy last year.
The settlement is a key step in ResCap's eventual exit from Chapter 11 protection. It also will help Ally focus on its core business of auto lending and on repaying the U.S. government roughly $10 billion outstanding on a $17 billion loan for a bailout during the financial crisis.
The agreement still must be incorporated into a formal plan by ResCap charting its bankruptcy exit strategy, which will also need court approval.
"The standards applicable to this plan support agreement are not the same as the standards applicable to approving" a bankruptcy exit plan, Judge Glenn said during a hearing in U.S. Bankruptcy Court in Manhattan.
Creditors had alleged that Ally had hastened ResCap's collapse by stripping some of its most valuable assets. A report by former bankruptcy Judge Arthur Gonzalez, the examiner in ResCap's bankruptcy, probed Ally's role.
That hefty study, which cost ResCap's estate about $80 million, had been kept under seal, but Glenn made it public now that the sides have settled.
Gonzalez found that ResCap was insolvent since December 31, 2007, and "left with unreasonably small capital" from August of that year until it filed for bankruptcy in 2012.
It "reasonably should have believed it would incur debts beyond its ability to pay," Gonzalez found.
Gonzalez listed about $3.1 billion in legal claims that he believes would have likely prevailed if asserted in court, including claims for misallocation by Ally of certain loan revenues and ResCap tax attributes. He examined 9 million pages of documents, interviewed 83 witnesses, and turned in a 2,235-page report.
The government still owns about three-quarters of Ally, formerly a GM unit known as General Motors Acceptance Corp. Mortgages made by ResCap led to huge losses for Ally, and it still owes the government $10 billion.
Ally would pay the ResCap estate $1.95 billion in cash and expects $150 million more to come from its insurers. The total proposed contribution is up from the $750 million it initially offered, which creditors lambasted as far too low.
"Ally is highly encouraged by this pivotal court approval, which enables all parties involved to move forward to the final stages of ResCap's Chapter 11 cases," Ally said in a statement.
A lawyer for ResCap could not immediately be reached on Wednesday.
The settlement could yield a profit for unsecured bondholders like Paulson & Co, which will receive $351 million or so, about 35 cents on the dollar for their roughly $1 billion in claims.
While Paulson has not disclosed what it paid for its stake, it likely acquired it at a discount, as the bonds were trading lower than 30 cents on the dollar last May, when ResCap filed for bankruptcy, according to bond tracking program TRACE.
MBIA and FGIC , which insured residential mortgage-backed securities issued by ResCap, stand to get a larger piece of the settlement pie, about $1 billion total. But they have had to pay billions of dollars in claims stemming from the failed securities and may have to pay more in the future.
Other bond insurers would get about $96 million.
Holders of residential mortgage-backed securities - of which there are more than 40,000 among 392 separate RMBS trusts - stand to recoup about $672 million.
The settlement also resolves litigation including a securities class action led by the New Jersey Carpenters Health Fund, which would receive $100 million. A trust created for the benefit of other private securities claimants would receive $226 million.
The case is In re Residential Capital LLC, U.S. Bankruptcy Court, Southern District of New York, No. 12-12020.
(Reporting by Nick Brown; Editing by Gerald E. McCormick and David Gregorio)