From Bloomberg:
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No market for PE exits as car demand wanes, loan losses mount
- Lax underwriting, delinquencies plague PE-backed auto finance
Private-equity firms that plunged headlong into subprime auto lending are discovering just how hard it might be to get out.
A Perella Weinberg Partners fund has been sitting on an IPO of Flagship Credit Acceptance for two years as bad loan write-offs push it into the red. Blackstone Group LP has struggled to make Exeter Finance profitable, despite sinking almost a half-billion dollars into the lender since 2011 and shaking up the C-suite multiple times. And Wall Street bankers in private say others would love to cash out too, but there’s currently no market for such exits.
In the years after the financial crisis, buyout firms poured billions into auto finance, angling for the big profits that come with offering high-interest loans to buyers with the weakest credit. At rates of 11 percent or more, there was plenty to be made as sales boomed. But now, with new car demand waning, they’ve found the intense competition -- and the lax underwriting standards it fostered -- are taking a toll on profits.
Delinquencies on subprime loans made by non-bank lenders are soaring toward crisis levels. Fresh investment has dried up and some of the big banks, long seen as potential suitors, have pulled back from the auto lending business. To top it off, state regulators are circling the industry, asking whether it preyed on borrowers and put them in cars they couldn’t afford.
“The PE guys sailed into this thing with stars in their eyes. Some of the businesses have done fine and some haven’t,” said Chris Gillock, managing director at Colonnade Advisors, a boutique investment bank. But right now, “it’s about as out-of-favor a sector as I can think of.”
Auto Finance Split
Subprime delinquency rate for non-bank lenders back near recession levelsThe apparent turnabout represents a sobering shift in what has been a booming market. Since the turn of the decade, buyout firms, hedge funds and other private investors have staked at least $3 billion on non-bank auto lenders, according to Colonnade. Among PE firms, everyone from Blackstone and KKR & Co. to Lee Equity Partners, Altamont Capital and CIVC Partners waded in.
Many targeted smaller finance companies that often catered to the least creditworthy borrowers with nowhere else to turn. Overall, subprime car loans -- those extended to people with credit scores of 620 or lower -- have increased 72 percent since 2011. Last year, about 20 percent of all new car loans went to subprime borrowers.
It usually works like this. Subprime finance companies first borrow money from the big banks and then compete for loans from car dealers. They make their margin from the spread between their funding costs and the interest they can charge, minus operating expenses and whatever losses occur when borrowers can’t pay. What they don’t keep on their books usually gets bundled into bonds and sold as asset-backed securities. Some will also sell loans to banks or brokers to raise cash.
For many PE-backed subprime lenders, which invested heavily to expand, margins have shrunk as delinquencies spiked and auto sales peaked.
In some ways, buyout firms can only blame themselves. Because of the limited time to show a return on their investments, usually four to six years, there was immense pressure to grow. That led many finance companies to loosen their standards -- like lengthening repayment periods and lending to borrowers with lower credit scores -- to gain an edge as car sales roared back from the depths of the recession and competitors jumped in. Many pushed into “deep subprime,” the riskiest part of the business that’s grown in recent years.
Not Pretty
The results haven’t always been pretty.
Take Exeter. The company, which is licensed in all 50 states and works with roughly 10,000 dealerships, was unprofitable from 2011 -- when Blackstone took a majority stake -- through 2015, according to S&P Global Ratings. That’s even as the PE firm invested $472 million to help Exeter expand and cycled through three CEOs at the lender.
On a pretax basis, S&P said Exeter turned a profit last year, and Matthew Anderson, a spokesman at Blackstone, says the company will do so again in 2017. He added the New York-based firm hasn’t tried to sell the lender.
Blackstone may look to unload Exeter later next year, said a person familiar with the matter, who asked not to be identified because it’s private....MUCH MORE
