Capital Z Partners on Dec. 23 made its first buyout in the sub-prime lending industry when it agreed to acquire Aames Financial Corp. for a $75 million equity investment.
Los Angeles-based Aames secures home equity loans for high-risk customers. Like other sub-prime lenders, its stock price has fallen dramatically since the summer, leaving it cash-strapped; Aames’ stock price has wilted from about $15 per share in July to $1 per share in November, and it had climbed back to $3.44 per share at press time. Meanwhile, like other sub-prime lenders, Aames has a negative cash flow, as it has had difficulty finding lenders or bond buyers to back the loans it makes at spreads which allow Aames to generate a profit.
Several buyout firms are targeting sub-prime lenders because the groups feel that the public markets have undervalued these companies and that, with operating capital to survive this tight credit market, these lenders can grow.
“The underlying product, the loan to the customer, is still in demand, and we think the product can be produced at profitable levels by efficient and high-quality operators,” said Adam Mizel, a partner at Capital Z.
Capital Z’s theory is that if it invests capital in Aames, Capital Z can use the company as a platform to acquire smaller lenders and reduce operating costs.
Other buyout firms have subscribed to similar strategies and also have jumped into the sub-prime arena including Greenwich Street Capital Partners, which last month agreed to acquire IMC Corp., a sub-prime home equity lender, for a $91 million equity investment, and Thomas H. Lee Co., which is investing $300 million in equity in Metris Cos., a sub-prime credit card issuer (BUYOUTS Dec. 21, 1998, p. 3; p. 6).
But, these are risky investments for equity providers, according to several sources.
Banks and large financial institutions often see the same opportunity, but they also have the ability to back the high-risk loans made by the sub-prime lenders, and to steal sub-prime customers by offering attractive rates to refinance loans. Although banks and large financial institutions have stayed away from the sub-prime industry in the past, sources say they are eyeing high-risk borrowers now and have noticed the success First Union Bank has had investing in The Money Store, even over the last several months.
“The question of the hour is can the independent lender survive if big lenders start consolidating the industry?” asked Jennifer Scutti, a vice president in the financial services group at Prudential Securities, adding that the answer is not yet clear.
G.P.s investing in the sub-prime industry believe large financial institutions are several years away from targeting sub-prime customers and may, then, become buyers of companies owned by financial buyers, a G.P. source said.
Capital Z is assured at least of a fee if another buyer comes in and acquires Aames before its investment closes in February.