While in some sectors specialty finance companies have taken a beating over the last year-and-half, behind-the-scenes subprime auto issuer Ugly Duckling Corp. has grown steadily - peddling deals in the private (sometimes Rule 144A) market on a quarterly basis, said Duckling's Senior Vice President and Chief Financial Officer Steve Darak.
The company will securitize its next batch of loans by the end of the month in a some-odd $150 million deal, managed by Greenwich Capital Markets. The deal will feature a wrap from MBIA Insurance Corp., Darak said.
Founded in 1992, Phoenix-based Ugly Duckling was brought public in 1996. Since going public, Duckling has become the nation's largest chain of used car dealerships that focus exclusively on subprime customers, Darak said. Through 77 dealerships, Duckling sells cars and originates loans in 13 regional markets across eight different states.
In March of 1996, Duckling launched its first asset-backed securities deal and has hit the private market 16 times since.
Speedy Paper
Though originally placing its securitizations directly with investor SunAmerica, over the last few years Duckling has been issuing via underwriter Greenwich Capital Markets, which placed Duckling's last deal in April.
"At this point we have an excellent relationship with Greenwich," Darak said. "We don't anticipate any changes in the near future, but that's a deal-by-deal thing."
Duckling's securitizations have steadily increased in size. April's deal was backed by a $148 million pool of loans, with a $103 million A-bond, Darak said. Though the company expects steady growth, it hasn't yet found need to access the public market.
"At this point, [a public deal] is something we continually evaluate, but the execution with Greenwich has been fairly efficient for us, and the relationship has worked well," Darak explained.
Through Greenwich, Duckling has been able to establish a core investor group. The deal structure has been fairly consistent, where nearly all transactions are tranched and insured up to a triple-A rating.
To investors, Duckling offers a unique, speedy A-bond that holds 71% of the principal loan balance, Darak explained. Duckling sets aside a 4% reserve account which builds to 8% over the life of the deal.
Therefore, the A-bond holders have 29% overcollateralization to the the principal, plus 4%-growing-to-8% in cash reserve accounts. The average life of the A-class is generally 13 months.
"A lot of financial institutions look for asset classes that drop into selected places in their asset/liability duration models," Darak said. "Our paper kind of has a unique, high-speed runoff."
Duckling has a $125 million line of credit with GE Capital, where the company stores its loans prior to securitization. The proceeds from securitization are used to pay down the warehouse line.
Leveraging the Web
According to Darak, Duckling has no direct competitors, as other originators of subprime auto loans generally purchase them instead of operating their own dealerships.
This makes Duckling unique among other finance companies, in that it operates as a fully vertically integrated entity, allowing it to take advantage of both the brokering and finance ends of the business.
"We believe that what makes Ugly Duckling successful is the same issues that have caused challenges to others," Darak said. "The shortfall of dealer operations is that they really don't have control over the finance side, and we believe the shortfall of some of the finance companies is that they really don't have control over the dealership operations."
In the second quarter 2000, more than 5% of Duckling's origination took place over the Internet, though the company views the Web as a marketing method - a way to garner customers - and is not currently using the automated origination tools that are gaining popularity among other lenders.
Darak has found that the Internet works well for the subprime borrower because it provides anonymity.
"A lot of the customers that are concerned about being classified as subprime hail this as an opportunity to have anonymity over the Internet," Darak said. "Then once they receive preliminary indication of approval, they'll come in and pick out a car, and we'll finish the interview and underwriting process at that time."
Generally, 20% of the customers applying over the Internet are online approvals, though they're still required to fill out the paperwork at the dealership. Another 20% don't qualify. The balance of customers can be approved only after coming into the dealership and going through the traditional process, Darak explained.
Strategic Changes
In September 1998, the company stopped using a gain-on-sale accounting method. "The Street really lost confidence in it," Darak remarked.
Starting the fourth quarter of 1998, Duckling adopted the collateralized borrowing approach, where, even if a portfolio is securitized, it remains on balance sheet.
Currently, Duckling is holding approximately $500 million of securitized loans on its balance sheet, Darak said.
In the past, Duckling was not only an originator of loans, but a purchaser, resembling other specialty finance companies that acquire loans from third-party brokers.
"We focus exclusively now on our own originations," Darak said. "In prior years, we were in several other businesses, but we have discontinued all of those operations at various times prior to last year. At Dec. 31, 1999, we were out of all other businesses except our dealership chain."
Duckling's dealership chain has grown from 42 units two years ago, to 56 units a year-and-a-half ago, to 72 at the end of 1999. Since the beginning of the year, Duckling has added five dealerships, now operating 77 in total.
"We continue to grow our dealerships and accordingly, we're growing our originations," Darak said. The company anticipates approximately $500 million in origination by the end of the year.
Market Strategy
"For people who qualify as subprime, we think traditional automobile companies will have a hard time placing those loans, because typically those subprime loans will require a discount for the finance company," Darak said.
As the economy is expected to slow, Duckling actually sees an increase in business. In a slowing economy, businesses that might have been lending to non-prime borrowers over the last couple of years could tighten up, which in turn could push the borrowers down the credit scale, Darak predicts.
"For our customers, a car is not a luxury," he said. "If they can't get it from a non-prime source, they're going to step down and get it from a subprime source."
