Subprime Auto Defaults Are Soaring, and PE Firms Have No Way Out - Bloomberg

BloombergMarkets 5 Subprime Auto Defaults Are Soaring, and PE Firms Have No Way Out f t lh s

Most Read
A Cryptocurrency Founder Sold All His
1
Coins After 7,500% Rally

Apple Plans Combined iPhone, iPad &

2 Mac Apps to Create One User
View
View
View
these
these
these
Pendants
Earrings
Rings
Experience
Bloomberg the Company & Its Products Bloomberg Anywhere Remote Login Bloomberg Terminal Demo Request

Bitcoin Tumbles From Record in

3
Biggest Slump Since Futures

Cable TV’s Password-Sharing

4 Crackdown Is Coming

Subprime Auto Defaults Are Soaring, and PE Firms Have

5 Subprime No Way
Auto Defaults Are Soaring,
and PE Firms Have No Way Out

Out

By Gabrielle Coppola and Claire Boston

December 21, 2017 3:00 AM

➞ No market for PE exits as car demand wanes, loan losses mount

➞ Lax underwriting, delinquencies plague PE-backed auto fnance

https://www.bloomberg.com/news/articles/2017-12-21/subprime-auto-defaults-are-soaring-and-pe-firms-have-no-way-out[12/21/2017 7:58:27 AM]

Subprime Auto Defaults Are Soaring, and PE Firms Have No Way Out - Bloomberg

Photographer: Daniel Acker/Bloomberg

Private-equity frms that plunged headlong into subprime auto lending are discovering
just how hard it might be to get out.

Register for a free account to continue enjoying

Bloomberg’s premium content
Registered users get:
● Unlimited access to Bloomberg articles
● Bloomberg Watchlist to manage and track your portfolio
● Live video, top interviews, and shows

Already have an account?

REGISTER

Sign in
or T
Connect with the Terminal

A Perella Weinberg Partners fund has been sitting on an IPO of Flagship Credit
https://www.bloomberg.com/news/articles/2017-12-21/subprime-auto-defaults-are-soaring-and-pe-firms-have-no-way-out[12/21/2017 7:58:27 AM]
Subprime Auto Defaults Are Soaring, and PE Firms Have No Way Out - Bloomberg

Acceptance for two years as bad loan write-offs push it into the red. Blackstone Group LP
has struggled to make Exeter Finance proftable, 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 fnancial crisis, buyout frms poured billions into auto fnance,
angling for the big profts 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 profts.

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 fne 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 levels

Auto finance Banks and credit unions

345678910%2011201220132014201520162017Mar20102017

https://www.bloomberg.com/news/articles/2017-12-21/subprime-auto-defaults-are-soaring-and-pe-firms-have-no-way-out[12/21/2017 7:58:27 AM]

Subprime Auto Defaults Are Soaring, and PE Firms Have No Way Out - Bloomberg

Source: New York Fed Consumer Credit Panel / Equifax

Note: Shows 90+ day delinquency rates for credit scores at origination <620 <="" p="">

The apparent turnabout represents a sobering shift in what has been a booming market.
Since the turn of the decade, buyout frms, hedge funds and other private investors have
staked at least $3 billion on non-bank auto lenders, according to Colonnade. Among PE
frms, everyone from Blackstone and KKR & Co. to Lee Equity Partners, Altamont Capital
and CIVC Partners waded in.

Many targeted smaller fnance 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 fnance companies frst 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

https://www.bloomberg.com/news/articles/2017-12-21/subprime-auto-defaults-are-soaring-and-pe-firms-have-no-way-out[12/21/2017 7:58:27 AM]

Subprime Auto Defaults Are Soaring, and PE Firms Have No Way Out - Bloomberg
shrunk as delinquencies spiked and auto sales peaked.

In some ways, buyout frms 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 fnance 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, hasn’t been proftable since 2011, when Blackstone took a majority
stake, an S&P Global Ratings report in September showed. That’s after the PE frm
invested $472 million to help Exeter expand and cycled through three CEOs at the lender.

On a pretax basis, Exeter turned a proft in 2016 and 2017, according to Matthew
Anderson, a spokesman at Blackstone. He added the New York-based frm 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 identifed because it’s private.

Bad loans remain an issue. This year, a rash of delinquencies in two bonds stuffed with
loans that Exeter made in 2015 caused the securities to dip into their extra collateral to
keep investors whole.

https://www.bloomberg.com/news/articles/2017-12-21/subprime-auto-defaults-are-soaring-and-pe-firms-have-no-way-out[12/21/2017 7:58:27 AM]

Subprime Auto Defaults Are Soaring, and PE Firms Have No Way Out - Bloomberg
Another example is Flagship, which Perella Weinberg bought in 2010. (Innovatus Capital
Partners, which manages the lender on behalf of Perella Weinberg, was formed by former
Perella Weinberg managers last year after they split from the frm.)

‘Satisfactory Return’

As its loan portfolio surged to almost $3 billion from just $89 million in 2011, bad loan
write-offs mounted and left the company with losses last year. Since then, it’s been forced
to cut back origination and tighten underwriting standards. Kroll Bond Rating Agency said
in November it expects Flagship to post another loss this year before returning to
proftability in 2018.

“We’re concerned about the company’s ability to earn a satisfactory return,” S&P said in
August.

That might not bode well for Flagship’s initial public offering, which could potentially
provide an exit for its owners. The IPO has languished and its prospectus hasn’t been
updated since July 2015.

Representatives for Perella Weinberg, Flagship and Innovatus declined to comment.

In hindsight, the planned sale may have come a year too late.

Santander Consumer USA Holdings Inc.,

Start your day with what's whose investors included KKR and Warburg
moving markets Pincus, went public in January 2014, turning

Enter your email Sign Up then-CEO Thomas G. Dundon into a

billionaire. (He didn’t respond to a request for
comment.) The shares have lost about a
quarter of their value since then as the lender restated earnings going back to 2013 and
agreed to pay almost $25 million to two states to settle a probe into predatory lending.

https://www.bloomberg.com/news/articles/2017-12-21/subprime-auto-defaults-are-soaring-and-pe-firms-have-no-way-out[12/21/2017 7:58:27 AM]

Subprime Auto Defaults Are Soaring, and PE Firms Have No Way Out - Bloomberg
Santander says it has improved its governance, risk management and capital buffers.

Perfectly Timed

“Tom Dundon at SC timed it perfectly,” said Dan Parry, co-founder of Exeter who now
runs TruDecision, a fntech frm that serves car dealers and lenders. “Others haven’t been
that fortunate.”

Indeed, while subprime delinquencies of 90 days or more have stabilized at banks, the rate
at non-banks is close to the highest since 2009, according to the Federal Reserve Bank of
New York, which noted the industry’s hasty underwriting standards.

Many of the large banks that provide funding to subprime auto lenders have taken notice
and become far more conservative in doling out credit lines, says David Knightly, a vice-
president at Innovate Auto Finance, which buys loans from dealerships and auto fnance
companies to help them raise cash.

“From a standpoint of subprime auto right now, if you’re small, people aren’t lining up,”
he said. “Everybody’s trying to guess when the next 2008 is.”

Bigger subprime auto lenders can still turn to the capital markets. Sales of subprime auto
ABS have reached $25 billion, topping last year’s total and almost triple the amount in
2010. They’ve also shored up fnances by lending to borrowers with stronger credit, said
Amy Martin, an analyst at S&P. That in turn has buoyed shares of some of the biggest ones
in recent months.

Martin expects a lot of mergers as car sales slow. In the meantime, PE frms have largely
lowered their expectations for a big exit and are trying to make their companies leaner to
extract a dividend or sell the loan portfolios.

“Nobody wants to pay much more than book value” for these companies, said Colonnade’s

https://www.bloomberg.com/news/articles/2017-12-21/subprime-auto-defaults-are-soaring-and-pe-firms-have-no-way-out[12/21/2017 7:58:27 AM]

Subprime Auto Defaults Are Soaring, and PE Firms Have No Way Out - Bloomberg
Gillock. “It’s not a disaster, but it’s a failure.”

— With assistance by Matthew Monks, David Carey, and Pamela Roux

Before it's here, it's on the Bloomberg Terminal.

LEARN MORE

Have a confdential news tip?

Get in touch with our reporters.

From The Web Sponsored Links by Taboola     

Reclusive Millionaire Bitcoin Expert’s “3-Step Leo's New Yacht Is The

Warns Americans: "Get Hack” To A Retirement Size Of 5 Football Fields
Stansberry Research James Altucher WeightLossGroove

Does Mom or Dad Need How To Fix Your Nicole Kidman's Yacht
a Ride? Fatigue (Do This Every Makes The Titanic Look
AARP CareConnection GundryMD LoanPride

Terms of Service Trademarks Privacy Policy Careers Made in NYC Advertise Ad Choices
©2017 Bloomberg L.P. All Rights Reserved Website Feedback Help

https://www.bloomberg.com/news/articles/2017-12-21/subprime-auto-defaults-are-soaring-and-pe-firms-have-no-way-out[12/21/2017 7:58:27 AM]