Colonnade Securities offered an extended examination of the below-prime auto finance industry this week, identifying what the independent investment bank focused on the financial services and business services sectors believes are four factors currently impacting the space most.
According to the report, the fundamentals of the below-prime auto finance industry have not deteriorated significantly, but the sector is now out of favor with traditional financial sponsors. In part, Colonnade cited four factors, including:
— Past aggressive underwriting has led to elevated delinquencies for some firms
— Private equity investors have hit the horizon of disappointment
— Bifurcation of the below-prime auto finance sector
— Access to capital
Colonnade explained a wave of investments in 2010 through 2012 led to heightened competition and looser underwriting, followed by a spike in delinquencies and losses. The result is a significant decrease in new equity capital available to the sector, according to the report.
“While banks that lend to the below-prime auto finance industry are more cautious and selective, senior debt availability remains strong for performing industry participants due, in large part, to the asset-backed securities market,” Colonnade said in a news release.
The investment bank added in the report, “The impact of liberal standards has been revealed in the performance of the asset-based securities issued by a few significant issuers.
Colonnade contends the industry has bifurcated between large providers with total receivables of more than $300 million and small below-prime auto finance firms. Colonnade insisted those large, well-run players continue to grow profitably while a few smaller firms have failed.
“These larger firms have invested in automated credit decisioning and data analytics that reduce static pool losses,” Colonnade said in its report. “The larger firms are also able to hire and retain skilled leaders and technical people needed to implement a tech-forward operation. “In addition, large firms have made significant investments in compliance staff and infrastructure.
“The second segment of the industry consists of smaller players that have not achieved critical mass and do not have the resources to invest in credit/analytic technology,” the bank continued in the report.
Colonnade recapped that few M&A transactions have been completed in recent years, although there have been some capitulations (business exits/liquidations). Several of the large, successful firms are still seeking change of control as their private equity owners run through their investment horizons.
“Sponsor-owned firms will eventually be sold due to the 10-year liquidation schedule of the typical private equity fund,” Colonnade added in its report.
Colonnade expects to see an uptick in mergers and acquisitions activity in the industry over the next 18 months as private equity investors are forced to take their properties to market.
“There will be transactions, but the valuations are unlikely to meet the original expectations of the investors,” the investment bank said in a news release. “These market dynamics will create compelling investment opportunities for long-term, yield-oriented investors, such as family offices and other non-traditional financial sponsors.”