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Subprime auto lender rides top-, bottom-line tailwinds into IPO market


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Subprime auto lender rides top-, bottom-line tailwinds into IPO market

The performance of subprime auto loans and lenders continue to defy media prognostications of impending doom for that part of the auto market, setting the stage for the first initial public offering of a company focused on the business in several years.

Blackstone Group LP-backed Exeter Finance Corp. on Jan. 8 filed its long-anticipated IPO registration statement, which highlights the company's upbeat outlook for originations growth in a fragmented sector, resilience from a credit perspective and prospects for operating leverage to contribute to continued earnings expansion.

Pretax income for Exeter Finance Corp.'s predecessor company surged to $57.4 million for the first nine months of 2018 from $12.1 million in the year-earlier period, according to the filing. Its pretax income for all of 2017 totaled $45.3 million.

Net loan receivables grew to $3.81 billion as of Sept. 30, 2018, from $3.27 billion on the same date in 2017 as gross originations for the first nine months of 2018 rose to $1.77 billion from $1.33 billion in the year-earlier period and $1.71 billion through all of 2017. The company reported a net interest margin of 16.13% for the first nine months of 2018, an increase of 76 basis points year over year.

Exeter Finance, like a number of its peers, benefited from corrective actions employed in response to weakening credit quality in 2015. The company's new management team shifted its focus to generating appropriate risk-adjusted returns through optimization of pricing, terms and dealer relationships from a strategy driven by revenue growth.

That move led to a 19.7% decline in gross originations in 2016, but over the longer term it has produced more profitable loan vintages.

While Exeter Finance continues to generate a majority of its originations from what it characterizes as its "core channels" of relationships with various types of auto dealers, it has increasingly produced business through partnerships, where currently two captive finance companies, a used car dealer group and a bank forward to Exeter loan applications that do not meet their underwriting criteria. Exeter Finance views both approaches as drivers of future growth as it seeks to grow market penetration within its existing dealer relationships and produce higher volumes through partnerships.

The company listed the maturation of older loan vintages and concurrent phasing in of the vintages subject to its current underwriting strategy as a driver of "meaningful incremental earnings growth." It also referenced the strength of auto loans from a credit perspective relative to other consumer lending products during the financial crisis as a sign of the resiliency of the asset class.

In 2018, a surge in used-vehicle prices, strong demand for subprime auto asset-backed securities and favorable macroeconomic trends proved beneficial for the industry.

For 2019, S&P Global Ratings said in its recently released global structured finance outlook that it expects subprime auto loan collateral to remain "generally stable," based on the current macroeconomic outlook and actions over time by individual lenders to tighten credit standards and improve dealer oversight. It further issued a "generally positive" ratings outlook for subprime auto ABS, particularly for tranches with investment-grade ratings. The two lone S&P Global Ratings downgrades in the asset class pertained to a single 2016-vintage deal sponsored by Honor Finance Corp., and there are only two classes of subprime auto ABS on CreditWatch negative.

"In our view, the 2018 downgrades and the above-mentioned credit watch negative actions are linked to idiosyncratic originator/servicer issues rather than symptomatic of widespread issues in the subprime auto sector," S&P Global Ratings said.

Still, subprime auto lending is a sector with a history of significant cyclicality that is subject to high levels of headline and regulatory risks relative to other financial services specialties. Historically high levels of employment and a less aggressive Consumer Financial Protection Bureau might not persist over the long term.

How prospective investors approach the Exeter Finance story, weighing those potential risks against the company's strong recent performance may be key not only to the offering's success but also the near-term futures of other private equity-backed lenders in the space. They will have few recent comparable IPOs to evaluate.

Subprime-focused installment lender Elevate Credit Inc. closed its IPO in April 2017, but it has not been since January 2014 that a company primarily engaged in subprime auto finance went public. Santander Consumer USA Holdings Inc., at that time, completed an IPO of a minority stake in the company. The long-term performance of that issue has been underwhelming as Santander Consumer shares last traded at or above their $24 IPO price in August 2015, though that performance might be more reflective of operational and regulatory challenges specific to that company.