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Cerberus Capital Management took LBOs to a rare level of complexity when it bought Chrysler in 2007 by selling both the debt and the equity backing the deal to other hedge funds. One bankruptcy/bailout later and the last remnant of the investment is the equity interest in auto loan originator Chrysler Financial.
Because Cerberus syndicated the Chrysler Finco equity to hedge funds rather than private equity firms, a relatively active secondary market in the shares emerged recently after original holders turned bearish and bailed out. Now distressed investors are snapping up the stub equity interests as a cheap bet that trading levels are below liquidation value and Chrysler’s mothballed lending platform might attract a new buyer, said five buyside sources.
As car sales rebound in the US, the auto manufacturers that spun off their lending arms are scrambling to arrange buyer financing and Chrysler Finco is the only significant standalone operation available. “[Chrysler Finco has] an enormous infrastructure in place already, which includes customer lists,” said one hedge fund analyst.
Even if the financing unit remains independent, its runoff value will cover outstanding debt with plenty to spare for equity distributions, said three fund analysts and a portfolio manager. Equity interests in Chrysler Finco traded around 45 cents on the dollar this month, up from a low of 10 cents on the dollar last year, said one of the analysts and the PM.
Cerberus only owns between 10% and 20% of Chrylser Finco, said a second analyst. But the firm retains the right of first refusal on any trade of the equity interests, said two of the buysiders. Anecdotal evidence is that the fund is opting not to exercise that right on any trades, the second analyst noted.
A spokesperson for the company declined to comment. A Cerberus spokesperson said no one was available to comment by press time.
Hair of the dog
In May 2007, Cerberus bought an 80.1% equity interest in Chrysler Holding LLC, while existing owner DaimlerChrysler AG held on to the remaining minority interest. The new holdco housed Chrysler Corp LLC – producer of Chrysler, Dodge and Jeep branded vehicles – and Chrysler Financial.
The deal was funded with USD 7.2bn of equity, but the equity commitment subsequently grew by USD 1bn to fund a USD 500m loan to pre-petition Chrysler Corp and a USD 500m payment to the US Treasury. Finco separately issued USD 8bn of debt.
In its now infamous restructuring of the holdco, the US government bailed out Chrysler’s manufacturing arm in exchange for a majority stake. Cerberus and its co-investors were left with ownership of Finco, subject to a priority distribution to the Treasury, which was later restructured and repaid. DaimlerChrysler agreed to contribute its 19.9% post buyout stake in exchange for legal indemnity, said the second analyst.
That left the hedge funds with ownership of an auto lender without a legacy manufacturing relationship during the most dramatic decline of automotive sales in recent memory. The loss of Chrysler Corp. as a funding source mostly pushed Finco out of the origination business and into run-off mode, sending its equity interests into penny-stock purgatory.
There it remained for much of last year and 1Q10 as the company continued to service and collect on its USD 26bn portfolio of existing loans. While Chrysler Finco’s new loan origination slowed, it did use existing cash flows to whittle its mountain of debt down to a relatively small USD 1.6bn second lien loan. A spokesperson confirmed Finco still continues to write new and used vehicle loans to retail consumers originated through Chrysler, Jeep and Dodge dealers.
That balance sheet overhaul was enough to catch the interest of distressed investors and given the rising value of the used cars backing its loans, Chrysler Finco will likely return cash to shareholders if it eventually liquidates, said four of the buysiders. Run-off value could come in as high as 70-80 cents on the dollar for equity interest holders given the company’s over-reserved book, the second analyst said.
“All these fincos marked their lease books down in 2009 assuming that used car values would be down, instead they are at an all time high,” the same analyst continued. Competitor Ally Financial reported strong remarketing gains and better recovery rates as used vehicle values rose in 1Q10 and hit a record high in March, based on the Manheim Used Vehicle Index, according to an earnings presentation.
Finco for sale
Chrysler Finco’s low leverage and established infrastructure make it an attractive target, said the first analyst. Based on the initial equity investment of USD 8.2bn and the 45 cents on the dollar market price of the equity interests, the company is worth USD 3.7bn on a present value basis.
The fly in the ointment is that the two most logical buyers – Chrysler Corp. and General Motors – are both beholden to the White House, as is competitor Ally.
When the government played matchmaker between bankrupt Chrysler Corp and its post-petition owner Fiat last year, it forced them to name GMAC, now known as Ally, as the reorganized entity’s preferred lender. Not coincidentally, Treasury owned a majority stake in GMAC after recapitalizing the loan originator that Cerberus acquired in 2006 through a transaction very similar to the Chrysler buyout.
General Motors could make a bid, but a potential tie-up would be rife with complications stemming from government ownership of that OEM as well, one of the analysts suggested. Speculation began swirling last month about GM buying back Ally, which is now a bank holding company, or eventually starting its own lending operation.
However, Ally CEO Michael Carpenter’s comments that it would be illegal for GM to own a bank and public criticism from Chrysler executives have left tongues wagging about the manufacturer’s plans. The draw of an in-house lending arm might trump politics for either Chrysler or GM, said one of the analysts.
When GM’s CFO Chris Liddell was asked during a 1Q10 earnings call about the necessity of a captive lender, he stated that the company has been disadvantaged from a sales perspective by not having one, particularly in the subprime segment.
GM will likely clarify the short-term future of its vehicle lending ahead of its expected IPO, the banker said. The company’s legacy agreement to get exclusive financing from Ally is said to expire in 2013 and new equity buyers will seek transparency on the issue, he added.
Access to financing is an important part of the vehicle sales process, and GM is using a multi-pronged approach to provide competitive financing for its dealers and customers, according to a company statement. The car maker is developing relationships with other financial sources on a selective basis for specialized financing needs, such as leasing and sub-prime financing. Going forward, GM believes the auto financing business will continue to evolve and the company will continue to assess its overall needs.
The advantage to having an in-house lender is subjective and the traditional captive role is being blurred by the proliferation of alliance programs, where lenders partner to mitigate risk, said Melinda Zabritski, Director of Automotive Credit for Experian Automotive.
“The advantage to having a captive depends on the mission and the charter, which has evolved over time, and whether the goal of the captive is to strictly move metal,” Zabritski continued. “The challenge also hinges on what the strategy is for managing losses. From the manufacturer’s standpoint there can be a great advantage as long as you are willing to take on the risk of those high risk loans when they become delinquent.”
Another alternative to a sale would be for Cerberus to use Chrysler Finco to create its own finance company to compete with CIT-type middle market lenders, said two of the buysiders. A number of parties could look at Finco as a vehicle to maintain an auto loan focus or find a funding source that could also add housing and student loans to the mix, a lender added.
Chrysler ended 2009 with USD 6.7bn of equity value, a USD 1.6bn of profit before tax and USD 15.5bn of ABS debt, said a former debt holder. The ABS debt included USD 1.3bn of leases and USD 14bn of retail “straight finance,” said the same source, noting that USD 9bn was on-balance sheet and USD 6.5bn was off. The company recorded a USD 1.8bn loss in 2008 thanks to significant charges for depreciation, “huge” impairments on the lease book and some derivative losses, the same source said.
Sales soar, speed bumps remain
Domestic auto sales are on the upswing after a two-year slide. US light-vehicle sales plummeted to 10.4m in 2009 versus 13.19m in 2008 and down from above 16m for the earlier part of the decade, according to Ward’s Automotive Group. The total number of light vehicle sales year-to-date though May increased 17.3% to 4.62m, from 3.94m in the comparable period last year, WardsAuto.com data shows.
US sales are expected to increase about 12.5% in 2010, but US light-vehicle sales are not forecasted to reach 2007 levels until 2013, according to Standard & Poor’s. During periods of stability or growth, customer loans, leases, and dealer loans provided by the captives create important additional profits and revenue/profit stabilization, S&P noted. However, the industry’s short-term challenge has been the compounding effect of tighter credit and the sensitivity of captives to market conditions given their sizeable ongoing funding needs, according to the agency.
Delinquencies on 30 and 60-day auto loans do seem to be topping out. The 30-day delinquency rate fell 1.06% to 2.79% in 1Q10 from 2.82% in 1Q09, according to Experian Automotive. The 60-day delinquency rate fell to 0.78% from 0.79% over the same timeframe.
Despite the drop, lenders are still cautious. The average credit score for a new vehicle loan in 1Q10 was 776, up three points from 1Q09, Experian’s analysis shows. In addition, the percent of near prime, subprime and deep subprime loans for new vehicles dropped from 17.99% in 1Q09 to 16.86% 1Q10, they said.
The lending landscape is likely to change dramatically as sales rebound. “As sales increase the market gets more competitive for financing, and as it gets more competitive lenders typically change their risk spectrum to grab a bigger piece of the pie, or they move into more geographic areas,” Zabritski said. “At the peak a lot of lenders did both of those things and during the crash they did the reverse.”
Chase Auto Finance sits atop the lender perch originating 6.69% auto loans year-to-date through the end of April, while Toyota Financial takes the second slot with 5.81%, according to Experian Automotive. Wells Fargo Dealer Services, GMAC, Ford Motor Credit, American Honda Finance, Bank of America, Nissan Infiniti Financial Services, Capital One Auto Finance and Fifth Third Bank, round out the top 10, the information services provider said.
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