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Subprime auto lessor making 1st trip to securitization market

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Two years ago, in May 2016, York Capital Management acquired RAC King, a subprime auto lessor based in Memphis, Tenn., through a leveraged buyout. The company, which does business as American Car Center and is still run by its founder, B. Michael Shivers Jr., has since expanded rapidly across the Southeastern U.S. In 2017, it opened 13 new dealerships, more than the previous three years combined, and increased its managed portfolio by $60.8 million, or 37%, compared with 2016.

Now RAC King is tapping the securitization market for financing that could further accelerate its growth. It is bundling $269.9 million of leases – the bulk of its $284 million portfolio – into collateral for bonds in a transaction called ACC Trust 2018-1, according to Kroll Bond Rating Agency.

The deal is split-rated. Kroll expects to assign an A credit rating to the $154.3 million senior tranche of notes to be issued, which mature in December 2020 and benefit from 44.85% credit enhancement. Two subordinate tranches of bonds maturing in 2021 and 2023 that are rated BBB and BB, respectively, will bring total proceeds to $212.6 million.

Moody's Investors Service takes a less favorable view; it only rates the senior tranche Baa2 and the subordinate tranches Ba1 and B2.

RAC originates leases to subprime obligors with FICO scores ranging from 320-826 through its 32 company-owned dealerships. It puts these customers into vehicles that are two to four years old and have been driven an average of 60,000 miles, according to Kroll.

The rating agency cites as a key credit consideration the company’s “committed ownership and experience management team.” Shivers founded the company in 2000, and has managed it through many business and credit cycles.

He maintains a minority ownership and is closely involved in the day-to-day operations.
Kroll acknowledges the risk of rapid growth, which “could lead to difficulty running the business operations including managing the dealerships, vehicle inventory, lease servicing and performance of the receivables.” Motivation to sell more vehicles and extend credit to lower quality borrowers to support growth may also result in higher losses, the presale report states.

However, the rating agency takes comfort from what it calls RAC King’s “proactive investments” in infrastructure, as well as the company’s integrated business model. “All retail locations are company owned dealerships that employ a simple sales and financing model, financing only though leases (no cash sales or loans) and no negotiations on vehicle price or lease terms,” the presale report states.

Nevertheless, Kroll expects losses to reach 26% over the life of the transaction, in its base-case scenario, given the limited financial means of the lessees, who either have either a negative or nonexistent credit history.

Interestingly, the transaction has less exposure to a potential decline in the residual value of vehicles coming off lease than a prime lease securitization, according to Kroll. That’s because RAC King encourages lessors to hold on to the their vehicles at the end of a lease, rather than turning them in, by setting the residual value at a low level and offering lessors an interest-free loan to fund the purchase.

Moody's cites the low exposure to residual losses, along with credit enhancement as the strengths of the deal. However it sees the sponsor's small size and lack of prior securitization experience as weaknesses.

Moody's also noted that the high rate (35%) of customer payments made at dealerships, as opposed to a centralized billing center, could pose problems in the event of a servicing transfer. "To address this risk, ACC has entered into a contract with CheckFree Pay, which offers an alternative payment method that allows walk-in customers to pay at various locations, in addition to existing means of payment such as direct debit, phone payments, online payments and mail," the presale report states. In addition, the transaction
also incorporates a mechanism that would eliminate in-store payments two months before RAC formally provides notification that it will cease to be the servicer,

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